Former Federal Reserve Chairman Paul Volcker has come out against a regulatory proposal which would provide the new systemic risk regulator the power to altar accounting standards in times of economic instability. The suggestion is being considered this week by the House Financial Services Committee as an amendment to their version of financial industry regulation. I have to side with Volcker on this one -- changing accounting standards to address a crisis is a terrible idea.

First, here's some detail on the proposal, via the New York Times:

The amendment, proposed by Representative Ed Perlmutter, Democrat of Colorado, and strongly supported by the banks, would give that group of regulators the power to order the Securities and Exchange Commission, which now oversees the Financial Accounting Standards Board, to suspend or change any accounting rule that the council thinks is a threat to financial stability.



And here's Volcker's response:

Mr. Volcker was the founding chairman of the International Accounting Standards Committee Foundation, which oversees the International Accounting Standards Board, and has long been a supporter of independent rule-setting. He has been campaigning for a single set of international accounting standards, but he said on Monday that he feared that effort was being undermined.


"You have the politicians in Europe influencing it," he said. "You have the politicians in the U.S. influencing it." If that continues, he said. "We're never going to get common standards."



The fear is that this power for the new regulator would make accounting standards even more amorphous.

I've always viewed accounting as something of a game. The rules are made by some authority, and then companies try to figure out how to get their earnings to look like what they want them to, based on those rules. And that's fine -- so long as everyone is playing by the same rules, there's a sort of objective light to view the results firms report. Fixed rules allow you to compare and contrast similar firms' financials coherently.

But if those rules become less consistent across industries or nations -- or economic cycles, then certainty vanishes. Suddenly, investors are faced with wondering what the numbers that firms report really mean, and it becomes very difficult to make accurate comparisons between companies.

This problem also speaks to why independence is important. As long as political pressure comes into play, then rules might be changed, which endangers the usefulness of financial reporting. Independence is necessary for objective accounting standards.

I understand the concern that the economy goes crazy in a time of crisis, and regulators want a full toolbox to fix it. But I don't think the ability to change accounting standards is a good tool to use. Accounting rules rarely cause instability. And if they do, such awful rules would be changed by the accounting standards board anyway -- without the need for political pressure or the government to step in.

So really, I think all this proposal would do is create greater uncertainty in the market. Investors would just be confused about how healthy firms are if accounting rules became unstable in times of economic turmoil. Remember, nothing about the firm's health would actually change, just how its financials look. Instead, regulators should address crises while remaining within the boundaries set by accounting standards.

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