Apr. 14--It's hard to believe that a simple accounting change could dramatically change the fortunes of an entire industry. In the case of the nation's banks, however, investors seem to believe in the power of the debits-and-credits folks.

The KBW Index, which includes 24 leading bank stocks, has risen by 25 percent since April 2, when the Financial Accounting Standards Board gave banks more flexibility in valuing their assets. The broader market, as measured by the Standard & Poor's 500 index, is up about 6 percent.

The bank rally isn't all about accounting, says Edward Jones banking analyst Tom Kersting. It's also about an improved profit picture.

When Wells Fargo said last week that its first-quarter profit would be a record-breaker, investors started anticipating good results from other banks, too. Then Goldman Sachs reported Monday a $1.8 billion first-quarter profit that beat analysts' predictions.

Banks are profitable again because the cost of their raw material -- borrowed money -- has dropped sharply. "You can get deposits pretty cheaply, and you can lend at a pretty good rate," Kersting said. "This is a pretty good time to be a bank."

The catch is that banks are still booking losses from bad loans and other investments. That includes writeoffs when a home builder or local manufacturer falls on hard times and can't repay what it borrowed. The biggest losses, however, have been on investments in mortgage-backed securities, and that's where the accounting change comes into play.

Before, those securities were supposed to be marked to market each quarter. During the financial panic, prices of mortgage-backed paper dropped precipitously. That led to big losses and to worries that further losses would make the banks insolvent.

Now, the FASB says the banks can make judgment calls. If the underlying loans are sound and the bank treats the security as a long-term holding, it can ignore the fire-sale prices that such securities are fetching today.

For some banks, the accounting change may make the difference between life and death. "It will give the bankers a little more confidence that the bank regulators are not going to rush in the door and shut them down," says money manager Joe Terril, who's been buying shares in Wells Fargo and Bank of America for his clients at Terril & Co. in Des Peres.

The accounting change shouldn't be much of a factor in the first-quarter earnings reports we're seeing this month. Looking ahead, Terril says, "Quarter by quarter it will definitely help. In addition, it will make the earnings more predictable."

Investors like predictability, but they also like transparency. Who's to say the accountants are right about the value of these securities and the market, as panicky as it can be, is wrong?

"There's certainly some risk in that," Kersting acknowledges. "People could question, are they carrying these assets at the right value, if they want to take the bearish scenario."

As an analyst, he will pore over the banks' reports to see what assumptions they use in valuing the securities. Kersting has a "buy" recommendation on several banks, including Wells Fargo and US Bancorp, and a "hold" on others, including Citigroup.

If bankers start using this new accounting flexibility to save their jobs or avoid criticism, we could be headed for dangerous times. If all bankers use it sensibly, though, both they and our economy should be better off.

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