Chicago Daily Observer

The U.S. Securities and Exchange Commission agreed to back an effort by banks that may delay writedowns on some securities tied to losses that have cost companies more than $640 billion.

Banks in certain cases may account for perpetual preferred securities as debt, allowing them to postpone writing down their value, SEC Chief Accountant Conrad Hewitt wrote in a letter yesterday to Financial Accounting Standards Board Chairman Robert Herz. Hewitt’s interpretation can be used immediately, as companies prepare quarterly financial reports.

inancial problems have not yet dragged down the economy, but it is also true that the economy is not the cause of financial-market problems. Most of the loans that have been going bad in recent months would have gone bad even if the economy had been growing twice as fast. So what is to blame for the “worst financial crisis since the Great Depression”?

The answer seems simple. Mark-to-market accounting rules have turned a large problem into a humongous one. A vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. Firms that are otherwise solvent must price assets to fire-sale values. Not only does this make them ripe for forced liquidation, but it chases away capital and leads to a further decline in asset values.

A mere accounting rule change won’t reduce foreclosures or raise home prices—then again, if spared drastic writedowns, banks might be more willing to lend, raising home prices and reducing foreclosures.

A mere accounting rule can’t alter the underlying economics of a lending business—then again, no longer worried about insolvency-by-accountant, investors might discover new confidence to inject capital and improve the underlying economics of a lending business.

No accounting rule is worth $700 billion. Then again, the essence of the Paulson plan was to raise the value of bank assets to help banks escape the regulatory equity trap. Does that mean we can change an accounting rule and save Congress from having to appropriate $700 billion?

Let’s find out.

Under intense political pressure, regulators for securities and accounting standards this afternoon issued what they called a “clarification” to provisions that have come under fire from bank executives and some lawmakers for contributing to the credit crisis.

Regulators said that the new guidance will help companies figure out the value of complex mortgage-related investments at a time when there are few trading partners willing to purchase them.

As a business appraiser in a CPA firm, I see similar issues all the time. The problem is that we have conflicting definitions of the word value. The new rules essentially define value as “what you can cash out for today.” In some circumstances, this may be the important number to know, but in others, it’s more important to know the intrinsic value—the present value of what you can expect to receive from it, allowing a proper rate of return for the risk involved.

The problem occurs when readers of a balance sheet, who are used to seeing numbers closer to intrinsic value, suddenly see lower market-snapshot numbers and think it’s an intrinsic number. This may have a substantive effect in the case of banks, where the reduction can throw you out of regulatory compliance, or where a loan covenant is endangered. (Kind of like playing a basketball game ... Read More...