Count me as a skeptic, but a realistic one.
Bank profits were supposedly way up during the first quarter of this year, causing bank stock prices to soar. According to an article published on Bloomberg on June 7, 2009, the 5 largest US banks declared a profit, and a healthy one at that, during the year’s first quarter. This occurred (supposedly) in the quarter immediately after the quarter in which banks suffered record losses. The KBW Bank Index has doubled since March 6 on the news.
Treasury Secretary Tim Geithner conducted stress tests on 19 banks during the quarter and declared in early May that Americans can have confidence in the banks’ stability and resilience.
However, there are a few sharp banking analysts who are raining on Mr. Geithner’s parade claiming that changing accounting rules and rosy assumptions are making these institutions look healthier than they really are.
Economist Joseph Stiglitz of Columbia University in New York was cited in the Bloomberg article as saying the government probably wants to win time for the banks, keeping them alive and operating to give them a chance to earn their way out of this mess. Stiglitz also mentioned the danger in doing this, since the weaker banks will still be reluctant to lend, hurting the efforts of the Obama administration to pull the nation out of the current recession.
Martin Weiss of Weiss Research, a 38-year old firm that rates the financial strength of banks and insurance companies, stated Citigroups $1.6 billion first quarter profit would disappear if accounting rules were tighter. “The big banks’ profits were totally bogus,” said Weiss. “The new accounting rules, the stress tests: They’re all part of a major effort to put lipstick on a pig.”
Weiss is not alone in his opinion. David Sherman, a professor of accounting at Northeastern University in Boston, believes further deterioration of loans will eventually force banks to recognize those losses their current bookkeeping is allowing them to currently ignore. Janet Tavakoli, president of Tavaloki Structured Finance Inc., says the government stress scenarios underestimate how bad the economy might get.
What?
You mean the profits banks made in the first quarter might not have been profits at all?
From where I sit, that’s exactly where we are.
On April 2, 2009 an accounting rule changed. The Financial Accounting Standards Board gave companies greater latitude in how they establish the market value or ‘fair value’ of assets. Some lawmakers complained the ‘mark to market’ rule worsened the financial crisis. So, in order to appease lawmakers, the mark-to-market rule was suspended. (Bloomberg June 7, 2009)
I happen to agree with the suspension of the rule; however, just because the method used to report asset values changed, that doesn’t mean the assets have changed. Bad assets are still bad assets; the only thing that’s changed is when the banks are required to recognize them as bad assets. Mr. Weiss estimates that Citigroup would have posted a $2.5 billion loss in the first quarter of this year if it wasn’t for the accounting rule changes.
Sherman, a former Securities and Exchange Commission researcher says, “These changes will help the banks hide their losses or push them off to the future.”
And, don’t assume the stress tests conducted on the banks necessarily came to the correct conclusion about the health of the banks. This from Bloomberg:
The Federal Reserve, which designed the stress tests, used a 21 percent to 28 percent loss rate for subprime mortgages as a worst-case assumption. Already, almost 40 percent of such loans are 30 days or more overdue, according to Tavakoli, who is the author of three primers on structured debt. Defaults might reach 55 percent, she predicts.
Bottom line is this: Changing the method used to report bad assets doesn’t change the facts. The banks are still hindered in making new loans to companies and individuals to help fuel a recovery because bad assets still exist on their books. As I’ve written before, this recovery won’t be permanent until the debt is dealt with. While changing the accounting rules to let banks survive makes sense, the debt still needs to be dealt with. Ignoring the debt, in my opinion, simply prolongs the recession.
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