Banks Need to End $1 Trillion Kick the Can Game

Discussion in 'Economics' started by ByLoSellHi, Sep 5, 2009.

  1. Banks Need to End $1 Trillion Kick the Can Game: David Reilly
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    Commentary by David Reilly

    Sept. 3 (Bloomberg) --
    Banks have known for a while that they would eventually have to face up to some of the assets they had stashed in off-balance-sheet vehicles. Now that day is looming, and regulators are concerned that lenders might need even more time to deal with such items.

    Enough already. It’s time for banks, and their regulators, to stop playing kick the can. Either banks have -- or can get -- the capital they need to support assets on their books, or government watchdogs should take action.

    Instead, regulators last week raised the prospect of giving banks a one-year, phase-in period to fully recognize for capital purposes what may be about $1 trillion in assets coming back onto balance sheets next year. This breathing room may ostensibly help some banks avoid having to quickly beef up regulatory capital, the buffer that helps them absorb losses.

    Such a delay is unwarranted. Banks have had almost two years to prepare for accounting-rule changes adopted this spring that will place greater restrictions on the use of off-balance- sheet vehicles.

    And it was just such hemming and hawing that helped get the banking system into its current mess. After the implosion of Enron Corp., accounting-rule makers tried to shut down off- balance-sheet games.

    Bank Fight Back

    Banks fought back, and the Financial Accounting Standards Board watered down the restrictions. That helped fuel both the rise of off-balance-sheet lending vehicles during the credit- bubble years as well as the so-called shadow-banking system.

    These vehicles allowed banks to shuffle assets off their books -- everything from mortgages to credit-card debts to auto loans -- even though they often still bore some risks from them. By seemingly shedding these assets, banks were able to hold less capital. That helped boost returns and profit. It also allowed risks to build up out of the sight of investors, regulators and in some cases the banks themselves.

    As Federal Deposit Insurance Corp. Chairman Sheila Bairsaid in an op-ed article in the New York Times this week, “the principal enablers of our current difficulties were institutions that took on enormous risk by exploiting regulatory gaps between banks and the non-bank shadow financial system.”

    Those gaps were exposed when the financial crisis hit, and many banks were saddled with assets, and losses, from those previously out-of-sight, off-balance-sheet vehicles. The best- known case involved Citigroup Inc., which suddenly had to absorb about $25 billion in collateralized debt obligations.

    Strained Balance Sheets

    Even smaller banks such as Zions Bancorporation had to help off-balance-sheet vehicles, straining already-stretched balance sheets.

    This spring, the FASB tightened the rules. In light of that, bank regulators -- the FDIC, Office of the Comptroller of the Currency, the Federal Reserve and the Office of Thrift Supervision -- have to decide how these returning assets will be treated for capital purposes.

    Regulators allow banks to hold different amounts of capital against different kinds of assets, which is why regulatory capital can differ from a bank’s stated shareholder equity, or net worth. Those deliberations gave rise to the possibility of the year-long phase-in period.

    A year may not seem like a long time; it is certainly less than the three-year grace period sought by some banks.

    Don’t Dilly-Dally

    Yet regulators, including the FDIC’s Bair, acknowledge that the new accounting rules are needed. More than that, in a television interview last week, Bair said if banks had faced stricter treatment for off-balance-sheet vehicles “a few years ago, I think there would have been more capital in the system.”

    If these rules would have helped to prevent the current crisis, that is all the more reason not to dilly-dally.

    Bair and other regulators haven’t said whether they would support a phasing-in of capital requirements. Bair has said, though, the 2010 start date for the new rules “is a little troublesome.”

    Big banks in particular should have to face up to reality from the get-go since the government’s stress tests of 19 large institutions acted as if about $700 billion in off-balance-sheet assets had already returned.

    The big four banks -- Citigroup, JPMorgan Chase & Co.,Bank of America Corp. and Wells Fargo & Co. -- are expected to see about $550 billion in assets return to their books under the accounting-rule changes, Barclays Capital analyst Jason Goldberg estimated in a recent report.

    Besides having had time to prepare for the changes, there is another reason to avoid delay. Any postponement opens the possibility that banks will use the phase-in period to argue for further forbearance.

    That is a time-honored tradition in Washington -- if you can’t kill something outright, just delay it into oblivion.

    Bank lobbyists shouldn’t be given that chance. Banks need to take their off-balance-sheet medicine now, without delay.