'Mark-to-market' accounting rules fuel debate

TORONTO -- Two Canadian financial heavyweights have taken up opposite corners in the raging debate over controversial "mark-to-market" accounting rules and their role in fuelling the current economic crisis.

In a lecture to the C.D. Howe Institute in Toronto, David Dodge, the former Bank of Canada governor, called for the accounting standards to be scrapped, blaming them for amplifying market gyrations and exacerbating the volatility of profits reported by financial institutions. Nick Le Pan, the former federal banking regulator, told another audience that the crisis would have been worse without the current rules.

Mr. Dodge, who led the Bank of Canada from 2001 until the beginning of this year, said the rules have created "incentives for excessive risk-taking on the upswing and excessive credit contraction on the downswing."

"The almost religious zeal with which accounting standards bodies have foisted detailed rules requiring financial institutions to continuously mark assets to market for reporting purposes has been a major contributor to volatility over this decade," he said at the lecture on Tuesday.

But Mr. Le Pan, who spoke yesterday to the Economic Club of Toronto, strongly defended mark-to-market rules, saying they are the best solution for investors. He argued that the rules did not create the current economic crisis, and that the crisis would be greater without them.

"Suspension of the rules is likely to lead to even more opacity and might further undercut confidence," he said.

The mark-to-market or fair-value rules require companies to record the current market value of assets each quarter, making balance sheets more vulnerable to volatility.

The standards have been blamed for exacerbating the current market crisis by forcing banks and other companies to take big hits to their balance sheets by significantly writing down the value of securities and other assets, even if they plan to hold them for the long term.

Mr. Le Pan, who is chairman of the Canadian Public Accountability Board and headed the federal Office of the Superintendent of Financial Institutions from 2001 to 2006, said executives at banks and other companies use mark-to-market techniques internally when they run their institutions, so "why shouldn't shareholders and other have access to the same information?"

While defending the rules, Mr. Le Pan was nonetheless critical of the accounting regulators who drafted the mark-to-market standards, saying the implementation was weak and the rules were not adequately tested in advance. That has led to confidence-shaking changes that have been made on the fly as foreseeable crises have emerged, he said.

"I cannot believe that people who have been proponents of this rule can be happy with the implementation, based on recent experience," he said. "Changing important rules like this in the middle of a crisis, I don't think that's the predictability that financial reporting needs."

Mr. Le Pan said it was a mistake, for example, that detailed guidance was not drafted from the beginning to tell companies how they should value assets when there are no markets for those assets or when the market values are based only "on a handful of actual trades."

"International accounting and auditing standard setters need to road test rules like this a lot more," he said.

Indeed, he said accounting standards setters in Canada and the rest of the world have only recently become concerned with assisting in the implementation of their rules - an attitude that may now change in the face of the current crisis.