Two Sets of Books Require Two Sets of Accounting Standards

What was at the core of the current economic crisis?

The financial transactions embedded in the SIVs (structured investment vehicles) located off-balance sheet within our major financial institutions brought our country to its knees. As the securities housed in these SIVs plunged in value, Uncle Sam was forced to ride to the rescue and bail out Wall Street.

Uncle Sam’s bailing required not only billions in dollars but also the coordination and complicity of the accounting industry. The Federal Accounting Standards Board (FASB) knows that Congress, supported by Wall Street, jammed revised accounting standards in place in order to facilitate Uncle Sam’s bailout.

The FASB, in an attempt to save face and a degree of integrity, has pushed back on Wall Street by passing FAS 166 and 167 which would require investments in off-balance sheet vehicles to be brought on-balance sheet. The implementation of FAS 166 and 167 is imminent and would require financial institutions to set aside increased capital against selected assets.

Wall Street is asking for a reprieve from FASB 166 and 167 and just may get it. I addressed this development just last week in writing,

12th Street Capital provides us updated developments on this very important topic with the following release:

A bit of good news for banks today. In a Bloomberg interview, FDIC Chairman Sheila Bair said that she is in favor of giving banks “some breathing room” to raise the additional capital that will be required to support the hundreds of billions of dollars of securitized assets that will be consolidated onto their balance sheets as as result of the implementation of FASB Statements 166 and 167. Bair said she hopes to have the matter voted on at the December 15 meeting of the FDIC’s board.

I get the strong feeling that the executives at FASB are becoming increasingly peeved by the manner that the banking industry has been able to run roughshod over basic accounting principles.

Investors are beyond challenged to determine the overall health and well being of our banking institutions given the lack of real transparency and integrity in their accounting practices. Who knows this? None other than FASB itself. To that end, FASB is now promoting an effective new set of accounting rules for bank regulators to utilize in assessing the overall financial health and well being of banks. New accounting rules? Disregard the rules implemeted by FASB earlier this year? In so many words, FASB is inidcating that if banks are effectively utilizing two sets of books to run their businesses, then regulators should use two sets of accounting rules.

How might this work? The New York Times addresses this dramatic development in writing, Board to Propose More Flexible Accounting Rules for Banks,

In the prepared text of a speech planned for a conference in Washington, Robert H. Herz, the chairman of the Financial Accounting Standards Board, called on bank regulators to use their own judgment in allowing banks to move away from Generally Accepted Accounting Principles, or GAAP, which his board sets.

“Handcuffing regulators to GAAP or distorting GAAP to always fit the needs of regulators is inconsistent with the different purposes of financial reporting and prudential regulation,” Mr. Herz said in the prepared text.

“Regulators should have the authority and appropriate flexibility they need to effectively regulate the banking system,” he added. “And, conversely, in instances in which the needs of regulators deviate from the informational requirements of investors, the reporting to investors should not be subordinated to the needs of regulators. To do so could degrade the financial information available to investors and reduce public trust and confidence in the capital markets.”

In so many words, Herz is addressing the fact that regulators need to utilize different accounting rules than those currently in place in order to protect investors.

Herz’ comments are a veiled indictment of the integrity of the books of the financial industry.

Two sets of books and two sets of accounting standards never portends a favorable outcome.

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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1 Comment on Two Sets of Books Require Two Sets of Accounting Standards

  1. Suggest you read the actual comments to the rules proposed by depository regulators in response to adoption of FAS 166 and 167 BEFORE you glibly dismiss as Wall Street is pushing back and may get its way. FAS 166 and 167 are rush job (pols drooling for a FASB response) fixes to a Rube Goldberg paper-clips and gum set of evolving rules. They do not 100% capture offenses like SIVs, they don’t always put the structure back on the makers/servicers balance sheet, and they catch a lot of harmless fish in the net and in some cases inflate balance sheets without adding any information for investors, creditors, regulators and other users of GAAP reports. Also, Herz has been struggling for months to get Congress clowns and anyone who will actually listen to understand that regulators have a different objective using GAAP reporting than other users.GAAP should not be designed for specific industries – it’s up to regulators to build on GAAP. Regulators have continued since the thrift crisis to adjust GAAP items when assessing regulatory capital. There is no reason why they shouldn’t, given their responsibility for the functioning of the SYSTEM, on which the economy depends, not take into account issues like the pro-cycle nature of GAAP reporting. Specifically, with regard to fair value accounting, investors have rightly focused on banks’ tangible capital while regulators have continued to reverse the effects of fair value accounting on available for sale assets (as most bank security investments are accounted for). This regulatory treatment of GAAP capital accounts has been in place for YEARS. Herz speech is simply a reminder that FASB has a different mission than do bank regulators.

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