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An accounting-rule change designed to give banks more leeway in valuing assets might undermine the government's plan to help clean up the balance sheets of Bank of America (BAC) (Stock Quote: BAC), Citigroup (C) , (Stock Quote: C), (BAC) (C) Wells Fargo (WFC) (Stock Quote: WFC) (BAC) (C) (WFC) and JPMorgan Chase (Stock Quote: JPM) (BAC) (C) (WFC) (JPM) .
Banks had been clamoring for a relief program that would allow them to unload risky subprime mortgage assets. On March 23, Treasury Secretary Timothy Geithner detailed a plan in which the government would provide cheap loans and guarantees to investors willing to buy the problem assets. Stocks rallied that day, sending the S&P 500 Index up 7.1%.
Now an accounting rule change might prompt banks to ditch the plan and hold on to their troubled assets. The relaxed rule passed last week enables banks to assign higher values to assets, making it less appealing to sell them at a loss. The amended policy could worsen the subprime loan crisis that has roiled the global economy for the past year.
The change to the mark-to-market rule permits banks to value assets based on normal market conditions. Banks were previously required to assign them fair-market values. As subprime mortgages tanked, companies were forced to recognize the losses in their earnings even if they didn't sell the securities.
(BAC) (C) (WFC) (JPM) Now that banks have more latitude in valuing troubled assets, they might be inclined to price them higher than the government would. That would encourage them to keep the assets on their balance sheets rather than sell them at a lower price. The move might shield the banks from losses, but it leaves them open to more volatility.
(BAC) (C) (WFC) (JPM) By keeping problem assets, banks would be betting that the market for subprime mortgage securities will improve. However, if those assets lose more value, holding them would only delay the pain. Banks should take advantage of the government's program and address the problem now before it gets worse.
Investor enthusiasm over the mark-to-market accounting change was perplexing. The adjustment would make sense if subprime mortgage assets turned out to be worth more than they're valued. But if that were the case, wouldn't banks be viewed as less risky?
(BAC) (C) (WFC) (JPM) The future of subprime mortgage assets is hazy. Banks like Citigroup, Bank of America, Wells Fargo and JPMorgan would be wise to wash their hands of this mess through the asset-purchase plan rather mask the problem through accounting.
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