Dear Congress: Leave accounting standards to FASB
Members of Congress have recently introduced bipartisan legislation to delay the implementation of a new accounting standard that will require many banks to more carefully calculate, and report in advance, expected future loan losses.
The particular debate about this new standard regarding current expected loan losses, or CECL, is less important than the harmful precedent that congressional involvement in accounting standard-setting would engender. This legislation is a very dangerous idea, as it would set a precedent for future politicization of the financial reporting process.
The current process for accounting standard-setting involves a private-sector, nonprofit organization, the Financial Accounting Standards Board. FASB considers the implications of accounting changes through deliberation by a number of advisory committees populated by company and industry representatives, including representatives of the banking industry.
The FASB has a primary institutional interest in maintaining the integrity and reliability of generally accepted accounting principles. This is accomplished through rigorous analysis by accounting and finance academics and practitioners who provide a number of comment letters. Individual accounting standard changes are also crafted in light of the overarching tapestry of GAAP.
The threads are held together by foundational principles, like the rule of conservatism, which says that losses should be estimated even when gains cannot, and the matching principle, which seeks to match expenses with related revenues. The raw interest group politics of the legislative process is not conducive to such a technical and interrelated process. Indeed, with respect to CECL, the primary complaint from industry is precisely that CECL follows the rule of conservatism in recognizing future loan losses but not future loan gains.
U.S. public companies have a market capitalization of $30 trillion, and investors in that $30 trillion rely on financial statements to price their investments. Without reliable accounting information investors will not only have difficulty determining the value of individual investments but will also be unable to compare the value of similarly situated companies.
Consider, by analogy, arguments for an independent central bank. Central banks around the world work best when their interest rate policy decisions are independent of political influence. This prevents politicians from advocating for short-term economic stimulus that could ultimately cause economic harm in the form of inflationary pressures.
The same logic arguing for central bank independence also applies to financial accounting standard-setting. Short-term political considerations of individual interest groups may diminish the reliability of the standard-setting process itself over the long term, thereby threatening the viability of the markets.
In the short term, financial accounting standards will continue to be a target of political pressure from both the left and the right. Business interests target accounting policies that bear significant transition costs, a position that often gains sympathy from Republicans in Congress.
Progressive groups influential with Democrats on the other hand would like to morph quantitative, financially focused accounting standards into a twisted perversion of the objective accounting standards we enjoy today. Those groups would use financial statements to penalize non-compliance with social objectives like climate change or labor policy. If Congress gains traction to influence the accounting standard setting process, a race to the bottom will result and both parties will participate.
The last time Congress flirted with involvement in accounting standards was when the FASB rightly amended GAAP to require that stock options compensation be expensed on company income statements. The logic was simple — issuing stock instead of writing checks to pay employees still decreased the proportional equity stake of current shareholders, much like cash payments would. Critics in Congress cried wolf and predicted the end of Silicon Valley. Nearly two decades later, the empirical evidence suggests that stock options expensing has not hindered innovation in the tech sector.
It is surprising that banks are willing to put the independence and reliability of the financial accounting standards-setting process into jeopardy, given that banks are themselves so heavily reliant on financial statements as they manage loan portfolios. While that is a remarkably short-term view, it is yet another reminder of why the longer-term perspective of an independent FASB in setting accounting standards is so important.