July 15 (Bloomberg) -- Congress can’t make up its mind. First, legislators pushed to let banks take a rosy view of the value of some hard-hit holdings. Now, two key committee chairmen claim banks aren’t being realistic enough about the values of some loans.

The allegation by House Financial Services Chairman Barney Frank and Senate Banking Chairman Christopher Dodd that banks are holding some loans at “potentially inflated values” should trouble investors, since it came just days before institutions like JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. are due to report second-quarter results. If some loan values are “inflated,” that again calls into question the quality of banks’ results.

Why, after arguing for banks to have more leeway, is Congress now pushing back? Because many government responses to the financial crisis are more about manipulating prices -- and behavior -- than truly getting markets back on their feet.

Dressing up bank balance sheets was a first-quarter political priority. Now there is a push to get banks to modify more troubled mortgages. That effort is being stymied by a rosy view taken by many banks of the value of home-equity loans and second-lien mortgages.

Many banks have marked down these loans only by 3 percent to 4 percent, said Paul Miller, bank analyst at Friedman Billings Ramsey & Co. These loans in many cases would likely fetch about 40 cents on the dollar if sold in today’s market.

The losses are “a big part of the toxic asset issues facing banks,” Miller added.

Balk at Losses

A first mortgage on a house often can’t be restructured without the agreement of the holder of the second loan, which would entail writing it down in value. Banks have balked at doing that, due to the losses that would result. And why shouldn’t they? Congress, the Obama administration and regulators all told them earlier this year to hope for the best when it came to valuing their assets.

Let’s review. Congress this spring browbeat accounting rulemakers to make it easier for banks to ignore dour market prices for some holdings battered by the credit crisis. That was designed to help banks’ finances look better.

Without subsequent rule changes by the Financial Accounting Standards Board, earnings at 45 banks and financial companies would have been 42 percent lower than reported, according to a report last month by Jack Ciesielski, editor of The Analyst’s Accounting Observer.

The rule changes allowed companies to sidestep some impact of mark-to-market accounting on securities, many of them backed by mortgages, that have fallen in value for an extended period.

Saved From Losses

The “maneuver saved eight of the firms -- Prudential Financial Inc., SI Financial Group Inc., First Commonwealth Financial Corp., National Penn Bancshares Inc., Bank of New York Mellon Corp., Zenith National Insurance Corp., Sun Bancorp Inc. and American Equity Investment Life Holding Co. -- from reporting first-quarter losses instead of net income,” Ciesielski wrote.

Another rule change allowed companies in some cases to ignore market values and use their own estimates for troubled assets. That helped Wells Fargo & Co. avoid what may otherwise have been a $4.5 billion hit to its capital.

This was all part of ongoing and often unsuccessful efforts to push prices in a particular direction.

Last fall, the Securities and Exchange Commission instituted a temporary ban on selling financial stocks short -- or betting they would decline in value -- to try and prop up the value of bank shares. Talk about reining in speculation in commodity markets, meanwhile, is designed to keep prices for oil and some foodstuffs from rising too high. And all arms of government have tried since the credit crunch began to keep home prices from falling.

Buyers Don’t Play

Efforts to direct prices usually fail because buyers aren’t willing to play along. Financial stocks continued to fall despite the short ban.

And the congressional flip-flop on how banks should value assets shows that such efforts can backfire.

The logjam in the drive to modify troubled mortgages is vexing the Obama administration. It is in some ways a problem of the government’s own making. To try and undo it, the House’s Frank and the Senate’s Dodd wrote late last week to banking regulators complaining about valuations of home-equity loans.

The chairmen said, “We are concerned that the loss allowances associated with these subordinated liens may be insufficient to realistically and accurately reflect their value.”

Fudging Confirmed

Throughout the crisis, investors have worried that banks are fudging their numbers. Now congressional leaders are confirming those fears.

Underlining the political nature of their request, Dodd and Frank didn’t call for an investigation of the supposedly “inflated” values.

That’s no reason for the SEC to stand pat. The agency needs to act, now that it has an allegation from top legislators that potential financial-reporting abuses are taking place at banks.

Failure to follow up will send a message that it is all right for banks to cook their books, so long as the resulting values are seasoned to suit the current political taste.

(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Reilly at dreilly14@bloomberg.net

Last Updated: July 14, 2009 21:01 EDT