In January, the Mortgage Bankers Association, supported by five of the nation's largest lending institutions, asked the Financial Accounting Standards Board to relax certain accounting rules concerning how restructured -- that is, failed -- loans are written down.
The purpose of the request, according to the MBA, was to relieve banks from the administrative burden of complying with the accounting rules, but the effect will be to materially limit the onerous loan losses that lenders will absorb as more residential loans default, and if home prices continue to decline.
This request for relief stacks one unfortunate irony upon another.
Supported by Citigroup, JP Morgan Chase and its potential acquisition, Washington Mutual, and Bank of America and its new acquisition, the apparently failing Countrywide Financial, the rationale for relaxing the accounting rules was that compliance with existing standards "would be extremely time-consuming and would likely involve additional staff dedicated to this purpose." In fact, the motives are strictly financial and the underlying hope is to buy time.
It should, because accounting for restructured loans has been a matter of some controversy for more than 30 years. FASB, the primary source of accounting standards in the United States, first grappled with the issue in 1976 on the heels of a sharp recession, when it issued an exposure draft of FASB Statement No. 15.
That standard initially provided that when lenders granted creditors concessions on troubled loans, a loss should be recognized if the present value of future payments was less than the carrying amount of the loan. The proposed accounting made both economic and financial sense. If, for example, a lender attempted to sell a troubled loan, the market purchaser would value the loan on its future cash flows discounted for a fair rate of return. And that rate of return -- the discount rate -- would be based upon the risk that the cash flows would be realized as anticipated.
Economic and financial sense, however, don't always make political sense. Citibank and Chase Manhattan (Citigroup and JP Morgan Chase's predecessors, respectively) were among a record 850 respondents to the exposure draft, most of whom were critical of FASB's proposed accounting standard.
Using a present-value calculation, the bankers argued at the time, would compel write-downs that would prevent banks from paying dividends, from making long-term, fixed-rate loans, or from reporting results of operations with any consistency.
In other words, the accounting rules would exacerbate losses. Further, others argued that banks would no longer be able to make loans to disadvantaged borrowers, municipalities, emerging companies or less-developed countries -- as if these endeavors were charitable. Instead, what the bankers proposed was that restructured loans should only be written down to the future value of anticipated payments, a method with no economic basis whatsoever.
Faced with the criticism of Chase's David Rockefeller, Citibank's Walter Wriston, Federal Reserve Chairman Arthur Burns and a hostile banking industry, FASB capitulated and the final rules adopted the future-value methodology.
The surrender, however, was not without consequence.
By the early 1980s, many U.S. financial institutions were again in severe financial distress -- particularly banks that lent to oil-related businesses or newly deregulated thrift institutions that had made long-term, fixed-rate loans that had been financed with short-term, high-yield deposits in a period of rising interest rates. By mid-decade, when both the commercial and residential real estate markets began to decline in many areas of the country, if not simply fall off the ledge, loan restructurings were common.
But because the accounting rules were permissive, appraisals corrupted and auditors pliant -- if not all too often compliant in management financial reporting frauds -- there were hundreds of zombie savings and loan institutions that were, in reality, operating as the living dead by failed managements who continued to take their inflated salaries and unearned bonuses and subjected their institutions to even greater risks simply because they knew that there was nothing left for their already insolvent institutions to lose. That was one price of artificial accounting.
In the aftermath of the S&L debacle, one of the primary changes made by FASB was to scrap future-value methodology and revert to the present value of anticipated payments that had been initially proposed 16 years before. With the promulgation of FASB Statement No. 114 in 1993, good sense, it seemed, finally prevailed over bad politics, at least with respect to restructured loans. Enron was still to come, however.
Do the banks and mortgage bankers believe that our memories are so short, or that the American people will buy their argument that the relaxation of restructured loan accounting for home mortgages is merely an administrative convenience?
Given that Citigroup was compelled to accept a $7.5 billion equity investment from Abu Dhabi in November and is reportedly seeking an additional $10 billion from foreign sources, I would hope not.
And if our markets are truly free, then shouldn't the foolish, even if they are mighty, be permitted to fall?
Gordon Yale, CPA, is a Denver-based forensic accountant and the principal of Yale & Co.
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