The Truth about Accounting “Standards”

An Open Letter to the Financial Accounting Standards Board

To: Financial Accounting Standards Board
From: John P. Hussman, Ph.D.

Dear FASB Board members,

As one of the few economists that urgently warned three years ago about the oncoming financial crisis (see Minding the Hinges on Pandora’s Box ), I am not simply disappointed, but stunned that the FASB has indicated a willingness to move back to amortized cost in the accounting of bank loans, in a banking system that is well known to have trillions of dollars in mortgage loans with underwater collateral, as well as millions of delinquent but unforeclosed loans. Rather than opting for procedures that would require adequate reflection of impairment or even quasi-market valuation such as 3-year averaging, the FASB appears intent on laying a lovely turf lawn over a toxic waste dump.

The FASB is a standards board. Standards. You are not running a popularity contest. Leslie Siedman cited “strong signals from the board’s constituents” as the basis for the accounting decision, but precisely who are your constituents? Are they the bank representatives and lobbyists who undoubtedly stuffed your in-boxes with objections, or are they the general public – who rely on full, fair and accurate disclosure – but who scarcely can be expected to address the FASB on detailed accounting rules and therefore must trust you to act on their behalf?

Does any among you believe that the mortgage loans on bank balance sheets are actually worth amortized cost, when many of those loans are presently considered “current” only because they have been modified to tack delinquent payments onto the back end of the payment stream? You know better.

It matters urgently which “constituents” you presume to represent. Consider today’s text from the Wall Street Journal:

“The Financial Accounting Standards Board preliminary vote would allow banks to continue valuing many of their loans at amortized cost, an adjusted version of their original cost, as they do now. That backtracks on an FASB proposal last May to expand fair value to bank loans. The reversal is a victory for the banking industry, which says it would have hurt lending and unfairly reduce banks’ book value. Supporters of the FASB fair-value proposal say it would have improved transparency and unmasked potential weakness at banks. The FASB indicated the overwhelmingly negative reaction to its proposal from companies and investors played a large role in prompting the board to change its mind. The board received more than 2,800 comment letters on its fair-value proposal, most of them opposed to the move.”

That text might as well now read as follows:

“The Financial Accounting Standards Board preliminary vote would allow Bernard Madoff to continue valuing many of his funds based on the value of the original investments made by investors, before they were embezzled, as Madoff does now. That backtracks on an FASB proposal last May to expand fair value to pyramid schemes. The reversal is a victory for the Ponzi industry, which says it would have hurt lending and unfairly reduce Ponzi schemes’ book value. Supporters of the FASB fair-value proposal say it would have improved transparency and unmasked potential weakness in Ponzi schemes. The FASB indicated the overwhelmingly negative reaction to its proposal from Ponzi schemes and investors hoping to trade the schemes higher played a large role in prompting the board to change its mind. The board received more than 2,800 comment letters on its fair-value proposal, most of them opposed to the move. Ordinary and less sophisticated investors [not to mention the public who will eventually be called on to clean up the mess], trusting the FASB and the SEC to get it right, didn’t realize that they had to write a letter, and are therefore [expletive deleted] out of luck.”

Congratulations. You’ve turned the U.S. banking system into the Love Canal.

I urge the Board to think very carefully about precisely who its constituents are, and to maintain the words “standards,” “complete,” “fair,” and “accurate” in the forefront of its deliberations.

Sincerely,

John P. Hussman, Ph.D.
Hussman Investment Trust

via Hussman Funds – Weekly Market Comment: Cash and Credit – Implications for the Financial Markets – February 28, 2011.

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