BankThink – Strip FASB of its powers

The latest Financial Accounting Standards Board debacle may finally cause the government to step in and end its monopoly power to dictate accounting standards on banks and financial regulators.

The most recent step in that direction was a June 4 letter from a bipartisan group of four U.S. senators to Treasury Secretary Steven Mnuchin, in his role as chairman of the Financial Stability Oversight Council.

The letter requests that the oversight council conduct a study on lending and the economic consequences of FASB’s new requirement that insured depository institutions adopt (a senseless) form of mark-to-market accounting rules called the current expected credit losses, or CECL.

The CECL requires banks to estimate credit losses over the life of a loan, and to book those losses upfront. Thus, a bank that makes 30-year mortgage loans would have to estimate and book its losses on that portfolio on day one.

This policy is terribly wrong-headed. It is essential that all bank regulation be countercyclical. Yet, CECL is the opposite.

In good times, bankers will be unrestrained in their lending because models will underestimate probable losses. In bad times, such as now, the models will demand excessive capital and reserves, causing banks to withdraw from lending at the worst possible time when it’s most needed.

The larger banks have already begun to implement the CECL standard, while the smaller banks received a little more time to comply.

The delay granted by Congress for the smaller banks speaks volumes about what is wrong with the CECL standard. Not only was Congress spot-on correct in delaying implementation of CECL for small banks, it needs to immediately take whatever steps necessary to suspend or repeal CECL’s application to larger banks.

The senators’ June 4 letter references a March 2020 letter to the FASB from Federal Deposit Insurance Corp. Chairman Jelena McWilliams expressing concern that the coronavirus pandemic has caused “sudden and significant changes in the economy,” and contending that CECL’s long-term model requirements are “potentially more speculative and less reliable at this time.”

The latest letter also notes that CECL’s impact on loan-loss reserve levels for banks of all sizes is already dramatic. The reserves for the 200 largest banks jumped “by nearly 60% at the end of the first quarter” from a year earlier, the letter said, “representing billions of dollars of capital that has been taken out of the system during a moment when it is most needed.”

This is not FASB’s first flirtation with disaster, potentially causing massive damage to the economy. During the early 2000s it imposed mark-to-market accounting rules requiring financial institutions track and write down changes in the market value of long-term assets.

This FASB action was previously opposed in 1992 by federal regulators and the Treasury secretary at the time, and previously caused economic damage when it was used before and during the Great Depression.

Finally, in 1938 President Franklin Roosevelt himself abolished the standard.

Unfortunately, to the detriment of the nation and even the world, FASB ignored many warnings and proceeded with mark-to-market accounting rules at the turn of the century. Financial institutions were required to write down their asset values by $500 billion during 2008 and 2009.

Generally, banks can loan about eight times their capital, so the $500 billion write-offs destroyed roughly $4 trillion of lending capacity, which Congress attempted to replace by adopting the $700 billion Troubled Asset Relief Program funded by taxpayers.

It is past time for Congress to intervene and strip FASB of its self-anointed authority to dictate generally accepted accounting principles without any meaningful oversight from the government.

The standards board is a private entity, created by the accounting firms in 1973. It obtains its funding from the accounting industry; its seven-member board is selected by the accounting industry; and it is not subject to meaningful government regulation.

This system cannot stay in place any longer. The Securities and Exchange Commission should set the accounting standards for the banking industry, with a requirement that the SEC formally seek and consider the views of the public, including the accounting industry, and the views of the Treasury Department, Federal Reserve, FDIC, National Credit Union Administration and the Office of the Comptroller of the Currency before adopting or amending any rules.

William M. Isaac, a former chairman of the FDIC and Fifth Third Bancorp, is co-chairman of the Isaac-Milstein Group.

Howard P. Milstein is chairman of Emigrant Bank and New York Private Bank & Trust. He is also co-chairman of the Isaac-Milstein Group.

William M. Isaac , Consultant