As expected, last week the Financial Accounting Standards Board eased its guidance on FAS 157-e, better known as mark-to-market. The concept of mark-to-market, in which banks adjust the prices of assets to reflect current market prices, had been blamed for contributing to the current travails in the financial sector. That’s because assets had to be marked down as prices dropped, even if the bank had no intention of selling them anytime soon. As the assets’ values declined, buyers were even less inclined to buy them, the banks said. What’s more, the banks risked violating capital reserve requirements, given that their balance sheets appeared weaker.

With the FASB’s vote last week, banks can “parse out the credit component of loss from other issues, like market liquidity,” says John Keyser, managing director with accounting firm RSM McGladrey, Inc. So, while they will have to take a charge to earnings for any losses related to the issuer’s creditworthiness, they don’t have to for losses attributed to market uncertainty.

Many financial institutions hailed the change. “I am pleased to see the changes being made and believe they will provide more accurate information,” said Mark C. Oldenberg, CFO with Security Financial Bank, speaking in the Journal of Accountancy.

However, the new ruling won’t necessarily alleviate the challenges facing banks. Potential investors in banks still will determine their own assessment of the assets’ value and aren’t likely to simply rely on the banks’ estimates. After all, the banks have an inherent interest in inflating the assets’ value, as Catherine Schrand, a Wharton professor of accounting, notes in the report “Are Mark-to-Market Accounting Rules on the Mark?”: “They have an incentive to manipulate the model.”

Moreover, banks’ new ability to keep assets on their books at higher values is likely to undermine government programs, such as PPIP, intended to get financial institutions to sell these so-called toxic assets off their books.

The change in mark-to-market accounting may offer financial institutions some short-term relief, particularly when it comes to regulatory capital requirements. However, the inherent values of the assets affected by the ruling aren’t going to change, and reporting for them based on management’s assumptions and calculations isn’t going to solve the credit crunch. ###