by Kathleen Brooks

A few weeks ago we blogged about the change to Financial Accounting Standards Board's accounting rule 157. The new rule allows banks to value the assets they can't sell — the ones that have been eating holes in their balance sheets — using their own "judgment."

On Friday, officials at the Federal Reserve
announced that the new guess work won't cut it, at least not for considering what would happen to the banks in a deep and lasting recession.

[I]n order to reflect greater uncertainty about realizable losses in stressful conditions, supervisors did not incorporate the new FASB guidance.

Translation: the Federal Reserve wants these stress tests to unearth what a loss would look like in the case of financial Armageddon. Officials want this number to be the bogey man who will scare bankers' in their beds at night. By comparison, FASB's rules are the equivalent of rose-tinted glasses.

 

As pointed out by the Financial Times this morning, harsher rules will be used to determine banks' capital requirements, while FAS 157 allows banks to avoid losses on their balance sheet:

This two-track approach could create an additional buffer between the amount of capital lined up now and the way banks report the erosion of that capital.

The change to FAS 157 has caused controversy since it was enacted last month. Supporters have applauded FASB for protecting banks from unusually stormy financial waters, while those who are opposed to the change think it's a perversion of the rules of financial markets.