First, Kill All the Accountants

The accountants let us down.

That is one of the clear lessons of the financial crisis that drove the world into a deep recession. We now know the major banks were hiding dubious assets off their balance sheets and stretching rules if not breaking them. We know that their capital was woefully inadequate for the risks they were taking.

Efforts are now being made to improve the rules, with some success. But banks have persuaded politicians on both sides of the Atlantic that the real problem came not when their financial inadequacies were obscured by bad accounting, but when they were revealed as the losses mounted.

“There were important aspects of our entire financial system that were operating like a Wild West show, huge unregulated opaque markets,” said the man whose job was to write the accounting rules, Robert H. Herz, chair of the Financial Accounting Standards Board.

“The crisis highlighted how important better transparency around that system is,” Mr. Herz added in an interview this week. “I would hope that would be a major lesson learned or relearned.”

Unfortunately, some seem to have learned exactly the opposite lesson.

Accounting rule makers at FASB and its international equivalent, the International Accounting Standards Board, have been lambasted for efforts to improve transparency by forcing banks to disclose what their dodgy assets are actually worth, as opposed to what the banks think they should be worth.

Both boards have tried to resist, but have been forced by political pressure to back down on some specifics.

In the case of FASB, the retreat took a few weeks after Mr. Herz was ordered to act at an extraordinary Congressional hearing.

The international board was given a long weekend to retreat, with the European Commission threatening to impose its own rules if the board did not cave in.

Both boards tried to reduce the damage by forcing more disclosures, but it is unclear how much good that will do.

Neither was willing to defy the politicians.

The banks have argued that market values can be misleading, and that their own estimates of the eventual cash flow from assets are more realistic than what they – or others – will now pay for those assets.

The rules already allowed them to ignore so called “distress sales” in assessing fair value, but the banks pushed to broaden that exemption in the United States, while in Europe they got the regulators to allow them to retroactively stop calculating market value for assets they said they did not intend to sell.

Some of the biggest and worst surprises of the financial crisis came when banks suffered large losses from assets that they had not even reported they owned. “With the benefit of hindsight, we know that standards were not complied with,” said Mr. Herz, regarding the rules on which assets could be left off balance sheets.

Those rules hinged largely on something called “qualified special-purpose entities,” or Q’s for short.

If a bank set up a Q so that it would operate automatically, with others owning the securities it issued, the bank could get the assets off its own balance sheet.

As the Securities and Exchange Commission pointed out in a report to Congress, banks were able to greatly expand the scope of Q’s, “beyond the simple pass-through entities envisioned by the FASB” …

FASB now is moving to get rid of Q’s, a category that the international board never accepted to begin with …

But that move comes years too late. The S.E.C. report quoted above was issued in 2005, but nothing happened as a result.

“If they had gone after that at the S.E.C., it might have taken a couple of quarts of gasoline away from the fire,” said Jack T. Ciesielski, whose newsletter, The Analyst’s Accounting Observer, repeatedly warned of off-balance-sheet problems.