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Commentary by Jonathan Weil

"July 23 (Bloomberg) -- Turns out America’s accounting poobahs have some fight in them after all.

Call them crazy, or maybe just brave. The Financial Accounting Standards Board is girding for another brawl with the banking industry over mark-to-market accounting. And this time, it’s the FASB that has come out swinging.

It was only last April that the FASB caved to congressional pressure by passing emergency rule changes so that banks and insurance companies could keep long-term losses from crummy debt securities off their income statements.

Now the FASB says it may expand the use of fair-market values on corporate income statements and balance sheets in ways it never has before. Even loans would have to be carried on the balance sheet at fair value, under a preliminary decision reached July 15. The board might decide whether to issue a formal proposal on the matter as soon as next month.

“They know they screwed up, and they took action to correct for it,” says Adam Hurwich, a partner at New York investment manager Jupiter Advisors LLC and a member of the FASB’s Investors Technical Advisory Committee. “The more pushback there’s going to be, the more their credibility is going to be established.”

Broad Consequences

The scope of the FASB’s initiative, which has received almost no attention in the press, is massive. All financial assets would have to be recorded at fair value on the balance sheet each quarter, under the board’s tentative plan.

This would mean an end to asset classifications such as held for investment, held to maturity and held for sale, along with their differing balance-sheet treatments. Most loans, for example, probably would be presented on the balance sheet at cost, with a line item below showing accumulated change in fair value, and then a net fair-value figure below that. For lenders, rule changes could mean faster recognition of loan losses, resulting in lower earnings and book values.

The board said financial instruments on the liabilities side of the balance sheet also would have to be recorded at fair-market values, though there could be exceptions for a company’s own debt or a bank’s customer deposits.

The FASB’s approach is tougher on banks than the path taken by the London-based International Accounting Standards Board, which last week issued a proposal that would let companies continue carrying many financial assets at historical cost, including loans and debt securities. The two boards are scheduled to meet tomorrow in London to discuss their contrasting plans.

Differing Treatment

While balance sheets might be simplified, income statements would acquire new complexities. Some gains and losses would count in net income. These would include changes in the values of all equity securities and almost all derivatives. Interest payments, dividends and credit losses would go in net, too, as would realized gains and losses. So would fluctuations in all debt instruments with derivatives embedded in their structures.

Other items, including fair-value fluctuations on certain loans and debt securities, would get steered to a section called comprehensive income, which would appear for the first time on the face of the income statement, below net income. Comprehensive income now appears on a company’s equity statement.

Another quirk is that the FASB doesn’t intend to require per-share figures for comprehensive income. Only net income would appear on a per-share basis. My guess is that means Wall Street securities analysts would be less likely to publish quarterly earnings estimates using comprehensive income.

Imagining the Impact

Think how the saga at CIT Group Inc. might have unfolded if loans already were being marked at market values. The difference was greater than CIT’s reported shareholder equity. TThe commercial lender, which is struggling to stay out of bankruptcy, said in a footnote to its last annual report that its loans as of Dec. 31 were worth $8.3 billion less than its balance sheet showed. hat tells you the company probably was insolvent months ago, only its book value didn’t show it.

The debate over mark-to-market accounting is an ancient one. Many banks and insurers say market-value estimates often aren’t reliable and create misleading volatility in their numbers. Investors who prefer fair values for financial instruments say they are more useful, especially at providing early warnings of trouble in a company’s business.

‘Religious War’

“It’s been a religious war,” FASB member Marc Siegel said at last week’s board meeting. “And it’s been very, very clear to me that neither side is going to give, in any way.”

So, the board devised a way to let readers of a company’s balance sheet see alternative values for loans and various other financial instruments -- at cost, or fair value -- without having to search through footnotes. At last week’s meeting, FASB member Tom Linsmeier called this a “very useful approach that addresses both sets of those constituents’ concerns.”

This will not satisfy the banking lobby, which doesn’t want any significant expansion of fair-value accounting. “I guess the nicest thing I can say is it’s difficult to find the good in this,” Donna Fisher, the American Bankers Association’s tax and accounting director in Washington, told me.

If the bankers don’t like it, that’s probably a good sign the FASB is doing something right."

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