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Rules made for breaking Add to ...

The decision by a U.S. regulator to relax mark-to-market accounting rules, which allows financial firms to value distressed and illiquid assets at more favourable prices, would seem to be bullish for financial stocks.

So what were they doing on Thursday, when the much-anticipated rule change became reality? In afternoon trading, the S&P 500 financials index was up 3.5 per cent - decent, to be sure, but lagging the broader index slightly. Citigroup Inc. was up 3.4 per cent and Bank of America Corp. was up 4.1 per cent.

Is this simply a buy-the-rumour, sell-the-news reaction? Or is there some inherently troubling to investors about the accounting rule change?

According to Bloomberg News, analysts believe the change could reduce writedown by banks and boost their income by 20 per cent or more. However, there is another side to this story.

For example, David Merkel, writing on the Aleph Blog, suggested that giving companies greater latitude in valuing their distressed assets could merely lead to over-valuing those assets. And even if they don't over-value the assets, investors might be worried that they are.

"Darkness encourages skepticism," Mr. Merkel said, in a blog posting made days before the official accounting change, which kicks in in the second quarter."In a period where there are few credit risks, book value accounting [as opposed to mark-to-market accounting]will be well-received. In an era where credit risks are significant, book value accounting will be no help, investors will distrust book value, and the effect might be less than where fair value estimates are provided."

But as for whether banks are now buys, Tracy Alloway, writing on FTAlphaville, believes they are not. "For a start, most of banks' financial assets and liabilities are in the form of loans, which are carried at historical cost and won't be helped by FAS 157-e," she said, referring to the rule change by its official designation. "Secondly, accounting rules may mask cash flow problems but they can't hide them forever."

Point taken. But for sheer entertainment, we like the criticisms levelled by DealBreaker, a gossipy and satirical blog (Hat tip: Abnormal Returns):

"Agreeing that it would be much better if financial firms could just decide for themselves what difficult-to-value items on their balance sheet are worth if the price for similar assets in the market isn't satisfactory to them, FASB voted to grant Imaginationland powers to anyone with a balance sheet."

 

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