The financial system’s recovery from the ravages of the Great Recession took a step backward on January 25 when the Financial Accounting Standards Board indicated that it would not require banks to mark their loans to market. That makes it likely that banks will continue to be able to use amortized costs when valuing their loans.
The FASB’s decision ought to be classified as financial malpractice. It’s akin to a surgeon leaving a life-threatening but removable blockage in place in a patient’s circulatory system. In the case of the US banking system, the patient isn’t likely to regain lasting health until institutions deal openly and fully with the problem loans that litter their books. “Forbearance” is another term for “avoidance.” Or for “whistling past the graveyard.”
Policymakers and regulators clearly are playing a dangerous game. They’re betting that the economic recovery will be strong enough and last long enough to improve the performance status of a sizable percentage of the bad loans on banks’ books before those loans go completely sour.
That is a monumental gamble. What are the chances that it will pay off? Not good. In the shorter term, the government life-support that has been buoying the economy in recent quarters is fading. In the longer term, history shows that an economy eventually finds itself in serious trouble when the authorities run huge deficits, monetize the debt, and debauch the currency.
What’s ahead? As long as the charade of using amortized costs continues, bad loans will continue to hamper banks’ willingness to lend, hindering the economic recovery. Investors will pay less and less attention to the financial statements of lenders, reinforcing the belief that, despite its origin in the word “credo,” there is little to believe in the credit system. And banks that are poorly capitalized now will face immense problems the next time the pillars of the system begin to shake.
It is imperative that lenders unclog the arteries of the credit system soon, while there may be time to do so in an orderly way before another crisis hits. If lenders’ management teams won’t, investors should move to oust them. If regulators, policymakers, and politicians stand in the way, people should bring pressure on them to act, or vote against them. And if some banks fail, so be it. Suffering pain from necessary surgery now is a reasonable price to pay to avoid a catastrophic outcome later.
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