Obama's Regulation Success Depends on Accounting

As the Obama administration unveils a new regulatory paradigm, one critical but oft-overlooked component will be setting definitive and transparent accounting standards.

So-called "toxic" assets, their ambiguous values and firms' exposure to them are at the heart of the crisis. They still plague balance sheets, and threaten to do so until a solution is reached.

The four largest banks in the country, Bank of America (BAC Quote), JPMorgan Chase (JPM Quote), Citigroup (C Quote) and Wells Fargo (WFC Quote), reserved $114 billion against potential losses on loans and other assets. However, it's nearly impossible to tell what metrics were used to determine how much they should be reserving for.

The banks are not required to use the same assumptions of economic conditions that could impact the value of their loan books, or view similar types of loans the same way. That's partially evident in the banks' ratios of reserves to the assets covered by those reserves, which ranged from 2.71% at Wells to 4.82% at Citigroup -- a wide gap.

"You can drive a truck through the variance between one bank and another bank," says Jeffrey Curry, who advises financial firms on accounting practices at the consulting firm LECG.

The Obama administration's white paper on regulatory reform, unveiled Wednesday, addresses the issue by recommending that the three "accounting-standard setters" -- the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB) and the Securities and Exchange Commission -- come up with a plan by the end of 2009. The rules will have to handle impairment and long-term loan-loss provisioning with the goal of providing investors with "both fair value information and greater transparency regarding the cash flows management expects to receive by holding investments."