In a much-anticipated board meeting Thursday, the Financial Accounting Standards Board (FASB) reconsidered guidance on the now-infamous accounting rule FAS 157. And we were happy to see the board officially defang some of the rule's more venomous requirements. Most importantly, financial firms now have the leeway to use judgment when valuing assets traded in illiquid markets.
Markets seemed to cheer the official vote, which confirms FASB guidance released earlier in the year. With the rule's amended language, financial firms likely feel more comfortable applying it to assets on their books. Even better, the decision allows them to make use of the new rules in first quarter reporting. While it should reduce further write-downs similar to those we've seen in the past 18 months, it doesn't do much for the over $1 trillion already written down.
Suffice to say, combined with a steeply positive yield curve, the change is likely to be positive for banks' balance sheets. Already, some banks are claiming the rule change could benefit first quarter net bank income to the tune of +20% (but never count your chickens). Did this impending rule change have something to do with the strong market rally in the last three weeks of March? Given how much this rule disrupted markets over the last 18 months, it's fair to say it had some impact. Other factors boosting prices could be confidence in the Treasury's Private-Public Investment Plan (PPIP). But as firms increasingly choose to hold on to "toxic assets" without fear of further write-downs, the Treasury's plan could be rendered moot before it even begins.
Taken together, we're encouraged by the widespread recognition that FAS 157's interpretation of mark-to-market was a root cause of the crisis. As we've said all along, mark-to-market as a general concept is fine for liquid assets, but the fair value rule established by FAS 157 in November 2007—not so much. The bear market was largely kicked off by distortions caused by this esoteric rule set by a fusty accounting board that has never garnered much attention. We're not in the clear yet, but all this hints at improvement ahead.
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