Financial Transparency May Cost You
Tuesday, June 1st, 2010
“For now we see through a glass, darkly;” — 1 Corinthians 13
In recent years, financial transparency has become a fetish. Demands for more detailed disclosure, along with the regulations to back it up, are constant and invariably defended on the grounds of providing more transparency.
Here is a statement issued last week by the Chairman of the Financial Accounting Standards Board, Robert Herz: “The proposal would impact the reporting by financial institutions and all other entities that have financial instruments as the goal of greater transparency in financial statements is pursued.” The Board, known as Faz-Bee, determines the rules of accounting. The proposal to which Mr Herz refers would require banks to record loans at “fair value” along with the current method of “historical cost.”
Before we get too lost in accounting jargon, let’s take an example. Say a bank makes you a $150,000 30-year mortgage at an interest rate of 5%. Under current accounting rules, the bank carries your mortgage on its books at its current principal balance as long as you keep paying. But what if, at some point in the life of the loan, rates for new mortgages rise to 8%. If the bank were required to report its loans at “fair value,” it would have to write down the value of your loan, even though you kept paying. You may say, “So what? That doesn’t change my loan.” True enough, but the prospect of having to record such a loss in the future, could very well influence the kind of mortgage the bank would be willing to make in the first place. Perhaps it would demand a higher rate, periodic rate adjustments, or a shorter term. Almost certainly, you would end up with a more expensive and less predictable mortgage. Achieving “the goal of greater transparency” might not be such an unmixed blessing after all.
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