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Turner turns fire on bean counters

Finance Blogger: Ian Fraser Ian Fraser

Lord Turner, chairman of the UK's top financial regulator, angered people in the City of London when he told them last August that much of what they do is “socially useless” and that governments had been wrong to allow the financial sector to pursue untrammeled growth for so long (see Taming the wild beast).

In a recent speech to the Institute of Chartered Accountants of England & Wales (ICAEW) he went one step further and attacked the bean counters—and specifically standard setters such as the FASB and to a lesser extent the IASB.

At the World Economic Forum at Davos, Turner also advocated the rationing of credit in up-cycles to ensure that banks do not throw their weight behind economic extremes and repeated that capital surcharges, not a re-enactment of the Glass–Steagall Act, are the most likely means of limiting proprietary trading internationally.

In his speech to ICAEW, Turner did not go as far as blaming individual firms or referring to the continuing conflicts of interest between audit and non-audit work. But he did say that “accounting played an important contributory role in provoking general sectoral collapse and macroeconomic recession.”

He said that bank accounting needs an overhaul if it is going to provide an accurate representation of banks’ assets and their overall financial health. The implication seemed to be there is far too much smoke and mirrors in the current system.

The crux of the problem, said Turner, is that the current framework is far too pro-cyclical, and that mark-to-market accounting prompts a cycle of over-exuberant lending that invariably pushes up asset prices to artificial highs during booms.

It goes like this. Mark-to-market accounting causes asset price inflation which feeds into profit estimates and rewards bankers with handsome bonuses—prompting a vicious cycle of further lending at wafer thin margins at the worst point in the cycle. In other words, an orgy of risk-taking.

Turner conceded that there are real problems where valuing bank assets are concerned. One is that financial contracts—contracts which link the present to the future—exist in a world of inherent uncertainty where there is no such thing as a single truth, or a single set of facts. In such a context Turner said no system of accounting standards is going to be 100% reliable.

He did damn mark-to-market accounting with faint praise when he said it can “provide meaningful facts and a useful management discipline”—but only really at times when other banks can be considered to be acting independently. If banks start acting in herd-like ways, mark-to-market becomes a distorting prism through which to view valuations.

He said: “If all banks simultaneously try to sell all or a significant proportion of their assets, a fully transparent system of mark-to-market accounting could simply increase the speed with which self-reinforcing assumptions about value generate cycles of irrational exuberance and then despair.”

Overall, Turner said that the current accounting framework caused banks to become irrationally exuberant, negligent of risk and profligate during the boom but had exaggerated their negativity, despair, risk aversion, and parsimony (unwillingness to lend) during the bust.

In October 2008 many bankers blamed the financial crisis on mark-to-market accounting. But Turner shot down such bleatings, reminding complainant bankers they had not complained about how it had enabled them to over-value their trading books during their “irrationally exuberant" phase. He also disagreed with the Goldman-esque notion that universal application of mark-to-market accounting might have prevented the crisis.

Where “banking books” are concerned, Turner said that banks must get better at anticipating the future in both their pricing decisions and their capital adequacy levels; and that ways must be found of reflecting this anticipation in their published accounts. He also said they must learn how to provision more accurately for future loan losses. Forming a view before each loan is made as to how much of it will ultimately be recoverable.

Turner, who took over chairman of the UK’s leading financial regulator, the Financial Services Authority, in September 2008, is right in saying accounting needs to be reformed. However I suspect that, given his pronouncements so far, he may be turning a blind eye to wider issues which also played a part in causing recent bank collapses—including the possibility of immorality (and possibly even malfeasance?) at certain UK banks.

Where the FSA is concerned, the body to a large extent remains in the doghouse since it sat idly by whilst UK banks including RBS and HBOS drove themselves into near oblivion through an obsession with scale and excessive risk-taking during the boom years. Even though Turner still seems confident the organization can be rehabilitated he told Bloomberg at Davos that he is “agnostic” about whether it is disbanded by a future Conservative government.

Further reading:

Tags: asset price bubbles , banking , capital adequacy , fair-value accounting , financial crisis , Financial Services Authority (FSA) , Lord Turner , proprietary trading , regulation
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