The Financial Accounting Standards Board has bowed to pressure from lawmakers and banking interests and put forward a proposal to relax fair value standards.

The board has formally scheduled a vote for Thursday on the proposed revisions to the standards, but the outcome seems to be a foregone conclusion at this point.

During a bruising hearing last month before a House subcommittee, FASB Chairman Robert Herz was sternly ordered by one after another grandstanding congressman to meet with his fellow board members and come up with an acceptable solution forthwith (see Congress Pressures FASB to Revise Mark-to-Market). He was given three weeks to do the job and warned that he would be called again before the committee to face another round of tongue-lashing if he didn’t obey.

Herz and his fellow board members quickly responded with a pair of proposed standards that would substantially adjust the rules on fair value accounting to please the banks. Financial institutions want the ability to avoid further steep write-downs on impaired assets such as mortgage-backed securities and the exotic but hard-to-sell financial instruments clogging their balance sheets.

They do have a point that the write-downs are producing a procyclical effect that may well be exacerbating the financial crisis. On the other hand, a lot of those exotic assets were little more than an accounting fiction and part of a larger speculative bubble. Allowing them to be overvalued once again via cash flow models would give new meaning to the phrase “creative accounting.”

However, not all the board members were in harmony at FASB’s meeting before the proposals were sent forth into the world for comment. Two of the five members, Thomas Linsmeier and Marc Siegel, voted against issuing the proposed standards. The other three — Herz, Leslie Seidman and Lawrence Smith — voted to issue the proposals. The final vote this Thursday should spark a lively debate, so you may want to tune in to the webcast on the FASB Web site.

Investors have good reason to be worried about the financial statements the banks will be issuing as a result of the changes. Banks will be able to start keeping the “other than temporary impairments” on their troubled assets out of net income and reclaim billions of dollars they had previously written down.

Jonathan Weil of recommended in a recent piece that investors should instead start paying more attention to the comprehensive income figures that banks report rather than net income. Fitch Ratings in a report published this week wants to see more information in the disclosures that go along with the financial statements.

However, the banking interests are already pushing for further flexibility in a comment letter to FASB on the proposed standards, including which quarter they can recognize the suddenly inflated assets, with the American Bankers Association listing a series of short-term and long-term fixes they want.

Ironically the changes will come soon after Treasury Secretary Tim Geithner announced his plan for removing toxic assets from the banks’ books by setting up a Public-Private Investment Program to encourage private investors to start buying the toxic assets once again with some $500 billion to $1 trillion of reassurance from Uncle Sam. The suspiciously inflated assets are going to be a lot pricier for private investors to buy and a whole lot more dubious in value.

Meanwhile, the International Accounting Standards Board has also been under pressure to revise its fair value accounting standards and is soliciting feedback abroad on whether to adopt FASB’s fair value compromises. The IASB has already been accused of succumbing to political pressure from the European Commission last year and amending its standards for the classification of banks' assets.

The new SEC Chairman, Mary Schapiro, recently expressed her reservations about the IASB’s independence during the confirmation process. But now FASB too is demonstrating that there are limitations on its independence. The banks evidently have Congress behind them, despite the outcry over the misspent $700 billion in bailout money and millions of dollars in bonuses awarded to failed investment bankers and insurance company executives who oversold credit default swaps.

Meanwhile, accountants will be left to wonder if their representatives in Washington may not be up to the task of standing up to the vested interests whose reckless behavior led to the financial crisis in the first place.

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