A broken accounting system in need of repair
The Financial Accounting Standards Board (FASB) continues to forge ahead with its plan to require banks to forecast and book current expected credit losses (CECL) over the life of loans without even an offsetting credit for expected interest income.
Bank regulators should not follow FASB down this dangerous path much as they did two decades ago. We are reminded of FASB’s ill-conceived mark-to-market accounting rules, which needlessly destroyed some $500 billion of bank capital in the U.S. alone and led to a global banking crisis and panic. As the saying goes: “Fool me once, shame on you; fool me twice, shame on me.”
CECL, as was the case with mark-to-market accounting, would be procyclical, meaning banks will be hit hardest in bad economic times when they can least afford it. It would also create a financial monoculture of risk that could deepen and prolong economic downturns when most banks’ balance sheets react the same way in a crisis.
We don’t have to guess about these things as we’ve been through them many times in the past, most recently in the financial crisis of 2008-2010. Why is it that we cannot learn and apply the lessons of the past?
Community banks and millions of customers in the towns and cities they serve across America will be among the hardest hit by the FASB’s latest proposal, just as they were in 2008-2010. A typical community bank might well have half of its balance sheet invested in long-term, fixed-rate mortgage loans.
Forecasting and booking losses over the life of a 30-year mortgage is highly speculative at best and requiring it to be done will likely sound the death knell for long-term mortgages and perhaps the banks holding them.
Community banks and the American Bankers Association have petitioned the government, asking that this process be delayed until a thoughtful and thorough economic impact study — which will look at how CECL performs throughout the business cycle, not just when the economic weather is fine — can be done.
We hope their concerns don’t fall on deaf ears since there is simply no recourse unless bank regulators and/or Congress put the brakes on the FASB.
The good news is that members of the House Financial Services and Senate Banking committees have put in motion legislation to require a one-year delay to enable an economic impact study to be completed and considered.
The FASB, formed by the accounting industry in 1973, was initially conceived to develop and articulate generally accepted accounting principles. It has become a self-perpetuating body of accounting experts. We do not question the expertise or integrity of those professionals. That said, it is a unique body that enjoys an unusually privileged position in the financial world.
Federal law authorizes the Securities and Exchange Commission (SEC) to set accounting standards for publicly reporting companies. The Sarbanes-Oxley Act in 2002 allowed the SEC to delegate its standard setting responsibilities, which it did in 2003 when it designated the FASB.
Unfortunately, the SEC retained only minimal oversight, noting its anticipation of a continued “collegial working relationship.” The FASB was not established by any act of Congress, it largely operates according to its own rules, and it is nearly impossible to challenge its standards or the basis for them in court.
In contrast, the public can invoke a variety of federal laws to pull back the curtain at any federal government agency to see how final decisions have been made and invalidate them if the appropriate processes have not been followed.
Notwithstanding whatever self-imposed transparency and governance rules the FASB has adopted, no such check by the public is available with respect to the FASB. Neither is the FASB subject to Presidential Executive Orders that seek to reduce and streamline financial regulation.
There is simply insufficient due process and no right of appeal when the FASB gets it wrong, as it has several times during its relatively brief existence. If the FASB continues to be allowed to effectively create federal law, it should not continue to enjoy a position of financial power afforded to no other private or governmental entity in this country.
This system of accounting standard-setting is clearly not working. At the very least, the system requires a meaningful review of the delegation to the FASB in view of its track record over the last two decades.
We understand why the FASB would not want a more intrusive level of oversight, but this is precisely why oversight is so essential.
William Isaac is the former chairman of the Federal Deposit Insurance Corporation and Fifth Third Bancorp. He is currently a consultant to financial institutions.
Thomas Vartanian is a former general counsel of the Federal Home Loan Bank Board and Federal Savings and Loans insurance Corporation. He is executive director and professor of law at the Scalia Law School’s Program on Financial Regulation & Technology at George Mason University.