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Thursday, 22 May 2008

Bankers seek to change accounting rules to deflect subprime pain

Glenn Dyer writes:

The banking industry, who helped create the environment that allowed the subprime crisis, US housing slump and credit crunch to flourish, now want the accounting rules changed to help them survive.

The latest edition of The Financial Times reveals attempts by the world’s banks to have accounting laws fiddled to prevent the full impact hitting them:

The proposals on “fair value” accounting by the Institute of International Finance, an alliance of 300-plus companies chaired by Josef Ackermann, Deutsche Bank’s chairman, would enable financial companies to cushion the blow of financial crises by valuing illiquid assets using historical, rather than market, prices.

Under the plan, which has been obtained by the Financial Times, banks that decided to keep assets on their balance sheet would also be freed from the requirement to hold them to maturity and would be able to sell them after two years.

Senior bankers have long sought a change to the accounting rules, arguing that the requirement to mark the value of assets to the market price even when markets are illiquid or frozen creates a vicious circle of excessive losses, capital depletion and forced asset sales.

But the biggest argument against this rather plaintive and self interested call is that when the prices of these financial products were rising before the credit crunch hit midway through last year, the same banks used “fair value” accounting to book profits and pay themselves large bonuses and pay.

The rising “profits” generated from the rising “fair value” of these securities enabled the banks to borrow more, increase debt, leverage and make more money for their banks and themselves. Now that “fair value” is working in the opposite way, they want the rules of the game changed to once again favour them.

One Comment

  1. Kevin Cox
    Posted Friday, 23 May 2008 at 6:10 am | Permalink

    Unfortunately the moral hazard of banks being able to create money through the fractional reserve system rarely hurts the banks. The ability of banks to create money and lend the money against inflated assets and then escape the consequences of their bad loans is not paid by the banks. They come up with schemes as above or they increase the price of existing loans or they let inflation rescue them. A solution to the problem is to make the value of money created for an asset keep the value of the asset. In principle if we create some money that represents the value of an asset then if the asset drops in value so the money should drop in value. At first sight this might appear impossible but it is actually simple to do. If we did this then we would have zero inflation and a much more efficient economy.