Fair-value accounting has been blamed for destroying bank balance sheets and aggravating the credit crisis. Now, the two-year-old accounting rule has a new reason for financial institutions to deride it -- it is forcing them to abandon acquisitions.

New business-combination rules require companies to apply fair value to financial assets and liabilities. According to Chuck Maimbourg, director of accounting policy at Cleveland's KeyBank, that application recently scuttled the bank's plans to buy another financial institution.

Maimbourg made his comments Oct. 29 during a Securities and Exchange Commission roundtable on fair value.

"Our biggest challenge has been at the intersection of 141R and 157," he said, referring to FAS 157, the rule on fair value when used in concert with FAS 141R, the revised standard for mergers and acquisitions.

KeyBank decided not to acquire the other bank after applying fair value to that bank's loans. FAS 141R requires acquiring companies to value a target's financial assets and liabilities under FAS 157 as of the acquisition date, when traditionally they were measured at historical cost. For KeyBank, applying the new fair-value regime amid the credit crisis would have resulted in "huge markdowns" that would have hurt KeyBank's balance sheet and forced it to increase regulatory capital.

He said that even though the transaction would have made economic sense, "we just couldn't make it work."

"The capital ratio and other transaction ramifications of this accounting conclusion caused KeyBank to not pursue this particular acquisition as well as others throughout the balance of the year," Maimbourg said.

"I believe our experience with 141R and 157 highlights the fact that there are more consequences of 157 that have not been felt by the financial markets at this time," he noted.

Maimbourg added that it doesn't make sense to value assets using fair value if the acquiring company intends to keep and manage the assets and not to trade or sell them.

But proponents of fair-value rules say Maimbourg's complaints are overblown. The bank managers have discretion to choose how to mark their assets to market. There is no rule saying that a bank has to mark down assets to the latest transaction prices, they say, especially if the market is distressed.

David Larsen, managing director at financial advisory firm Duff & Phelps LLC and a member of the Financial Accounting Standards Board committee that advises the board on fair-value issues, says it's certainly true that fair value is affecting banking deals but that "doesn't prove that fair value is wrong."

Larsen says it's not the standard but the "application of fair value" that needs improving. "The guidance is clear: It says to use judgment, but many people are still stuck in a rule-based world."

Lewis Ferguson, a partner at Gibson, Dunn & Crutcher LLP in Washington and previously first general counsel of the Public Company Accounting Oversight Board, says that while the SEC and FASB have provided some latitude in valuing assets in disruptive markets, preparers worry that regulators will hold them liable and subject them to shareholder suits if their judgments are later reversed.

This, says Larsen, is where FASB and the SEC can issue further guidance and make minor changes without narrowing the rules' scope. He says one common misperception centers on what happens when a recent trade has been at a fire-sale price. Fair-value rules don't force holders of similar securities to use those same prices as their mark, Larsen says.

He suggests regulators consider creating a safe harbor that would permit accountants to make difficult securities-valuation judgments without the risk of major sanctions.

Donna Block covers accounting regulation for The Deal.