Volcker Calls for New Look at Fair-Value Rules

Will the former Fed Chairman tell Obama to ease up on mark-to-market standards for regulated banks?

Calling for a fresh look at current mark-to-market financial reporting rules, Paul Volcker, a top economic adviser to President-elect Obama, has signed off on a financial-reform program more sympathetic to bankers’ views than the current Financial Accounting Standards Board’s fair-value regime has been thought to be.

Indeed, the report on stabilizing the financial system that the Group of 30, which Volcker chairs, issued yesterday, seems likely to reopen what has been a furious debate between banks and investors on the value of market-to-market accounting in a time of extreme illiquidity. And it does so just as the debate seemed to be have been resolved in favor of investors.

Over the past year, bankers and investor groups have hotly contested the validity of the new fair-value accounting regime ushered in by Financial Accounting Standard No. 157, which spelled out how companies should measure the fair value of illiquid assets and liabilities as well as liquid ones.

Spearheaded by the American Bankers Association, representatives of financial institutions contended that overly rigid application of the standard forced them to value their assets at fire-sale prices, thereby shrinking their balance sheets and hastening the onset of the credit crisis. For their part, the investor groups argued that the rules provided much-needed up-to-the- minute transparency to financial reporting.

By year’s end, it appeared that the investor groups had won the battle. In a report to Congress issued recently, the Securities and Exchange Commission affirmed that the Financial Accounting Standards Board’s fair-value rules should stand.

Speaking at a press conference in New York on Thursday that introduced a report on financial reform issued by the Group of 30, an international body of prominent finance officials and economists, Volcker questioned, however, “whether a naive, across-the-board application of mark-to-market accounting [is] suitable for regulated institutions.”

Responding to a question from CFO.com at the press conference, Volcker, a former chairman of the Federal Reserve Board as well as the International Accounting Standards Board, suggested that because commercial banks engage in a number of balancing acts, the gauging of the fair value of their assets and liabilities should be subject to a more flexible and principles-based system than exists today.

Such regulated banks “are intermediating discrepancies in maturities. They are intermediating between the borrower and the lender. The borrower wants the money and the lender wants it safe,” Volcker said. Acting as the middle-man in that way entails operating risks that must be accounted for and reserved for, he says, adding, however that the group hasn’t “got a magic answer.”

In its report, “Financial Reform: A Framework for Financial Stability,” the group, which includes such economics luminaries as Paul Krugman and Martin Feldstein and such prominent government officials as Ernesto Zedillo, the former president of Mexico, and Timothy Geithner, President-elect Obama’s choice for U.S. Treasury Secretary, went further in its criticism of the current system of fair-value accounting.

The group sites an “underlying tension” between the “business purposes” of banks—especially the funding of illiquid loans with short-term deposits— and investors’ need for “the best possible current information on the immediate market value of assets and liabilities.” The report makes a clear distinction between such “regulated” commercial banks and what has been called elsewhere the “shadow” banking system: investment banks, hedge funds, private-equity firms, and other non-regulated lenders.

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