Sunday, January 13, 2013

FSC Chair Hensarling Urged Reform of Fair Value Accounting in 2009 TARP Oversight Panel Report

In additional views to the TARP oversight panel’s 2009 report on regulatory reform, Financial Services Committee Chair Jeb Hensarling (R-TX) called for the reform of fair value market-to-market accounting. Noting that the application of these accounting rules magnified the stress of the financial crisis with serious procyclical effects, he said that when markets turn sour or panic the assets in a mark-to-market accounting system must be repeatedly written down, causing financial institutions to appear weaker than they might otherwise be.

In his view, a superior accounting system would not require financial institutions to write down their assets at a time when prices have fallen precipitously during a rapid downturn, as in the collapse of a bubble. Chairman Hensarling was a member of the Congressional Oversight Panel created to oversee the expenditure of the TARP funds authorized by Congress in the Emergency Economic Stabilization Act. The Panel was also required by law to review the state of the federal regulatory system and report to Congress.

In the report on regulatory reform provided by the TARP oversight panel, Chairman Hensarling suggested that an alternative asset valuation procedures, such as discounted cash flow, should be used instead of mark-to-market. This would make it easier for financial institutions to declare assets as held-to-maturity during periods of financial stress. In normal markets, he noted, prices will fluctuate within a limited range, and will rise slowly if at all. But in times of crisis, write-downs beget fire sales, which beget further write-downs. The accounting rules must be improved, he emphasized, taking into account the lessons learned from the financial crisis. Ultimately, greater transparency and accuracy in accounting standards are necessary to restore investor confidence.

Chairman Hensarling also observed that, in late September 2008, the SEC released encouraging changes in guidance allowing companies greater flexibility in valuing assets in a nonfunctioning market. Moving forward, he continued, accounting rules have to provide transparency and the most accurate depiction of economic reality as possible. More broadly, he said that the development of accounting rules should not be conducted in the political arena.