Federal Reserve Chairman Ben Bernanke said that accounting standards need to be modified to deal better with valuing illiquid assets.

During a speech before the Council on Foreign Relations, Bernanke noted that some accounting rules lead to “procyclical effects” that could exacerbate economic volatility.

“We should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality — that is, do not overly magnify the ups and downs in the financial system and the economy,” he said.

Bernanke noted that there is some evidence that capital standards, accounting rules and other regulations have made the financial sector “excessively procyclical.”

“The ongoing move by those who set accounting standards toward requirements for improved disclosure and greater transparency is a positive development that deserves full support,” he said. “However, determining appropriate valuation methods for illiquid or idiosyncratic assets can be very difficult, to put it mildly. Similarly, there is considerable uncertainty regarding the appropriate levels of loan loss reserves over the cycle. As a result, further review of accounting standards governing valuation and loss provisioning would be useful, and might result in modifications to the accounting rules that reduce their procyclical effects without compromising the goals of disclosure and transparency. Indeed, work is underway on these issues through the Financial Stability Forum, and the results of that work may prove useful for U.S. policymakers.”

During a question-and-answer session after the speech, Bernanke clarified that he did not want to suspend the rules for mark-to-market accounting, as some congressional leaders and business interests have urged, but he said that weaknesses in the current accounting rules needed to be identified and fixed.

The American Bankers Association, which has been lobbying for changes in mark-to-market accounting, applauded Bernanke’s comments. “ABA agrees completely with Chairman Bernanke that it would be useful to review accounting standards in an effort to reduce their pro-cyclical effects without compromising transparency,” said ABA president and CEO Edward L. Yingling in a statement. “We urge that policymakers move to quickly implement the necessary changes in order to avoid any more needless destruction of capital.”

The House Financial Services Committee’s Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises plans to hold a hearing Thursday to discuss the controversy over mark-to-market and fair value accounting. In advance of the hearing, the ABA, along with other organizations including the U.S. Chamber of Commerce and the Financial Services Roundtable, has written to the committee members urging changes in the accounting rules.

“We do not ask that Congress write accounting rules,” they said. “Rather, it is incumbent that the appropriate bodies understand that a pace of business-as-usual is unacceptable. Let us be clear, real economic losses should be recognized and are necessary for orderly markets. However, the recognition of losses that do not have a basis in economic reality is unsustainable in any environment. Appropriate changes in mark-to-market accounting should not wait until mid-year or year-end. That will only allow the spiral of accounting-driven financial losses to continue.”

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