New rule lets U.S. banks gain even when they're losing

Discussion in 'Wall St. News' started by THE-BEAKER, Jun 4, 2008.

  1. if a man in the street did this with his tax return he would be banged up for 35 years.

    yet another example of wall street stupidity and accounting nonsense.

    i say again.


    everybody speaks of bargain levels for long term share purchases in these banks .


    Merrill Lynch, Citigroup and four other U.S. financial firms have used an accounting rule adopted last year to book almost $12 billion of revenue after a decline in prices of their own bonds. The rule, intended to expand the "mark-to-market" accounting that banks use to record profits or losses on trading assets, allows them to report gains when market prices for their liabilities fall.

    Merrill, the third-biggest U.S. securities firm, added $4 billion of revenue during the past three quarters as the market value of its debt deteriorated. The decline was the result of higher yields demanded by investors who were spooked by the company's $37 billion of write-downs from holdings hurt by the collapse of the subprime mortgage market.

    "They can post substantial gains as a result of a decline in their own creditworthiness," said James Cataldo, a former director of treasury risk management for Federal Home Loan Bank of Boston and now an assistant professor of accounting at Suffolk University in Boston. "It's completely legitimate, but it doesn't make sense by any way we currently have of thinking of net income."

    The paper profits have helped offset more than $160 billion of write-downs taken by U.S. financial services companies during the past year.

    "The piper will have to be paid eventually," said Robert Willens, a former accounting analyst at Lehman Brothers who left the firm this year to become an independent consultant.

    The debate over what is known as Statement 159 adds to the number of accounting techniques called into question as the U.S. debt market unravels. Investors have criticized banks for booking some write-downs in an accounting category called "other comprehensive income" that bypasses their income statements. Accounting regulators are now proposing changes to standards that allow banks to use off-balance sheet vehicles to increase earnings without tying up precious capital.

    Statement 159, formally known as the "Fair Value Option for Financial Assets and Financial Liabilities," was issued in February 2007 by the Financial Accounting Standards Board, which sets U.S. accounting rules. It was adopted by most large Wall Street firms in the first quarter of last year and becomes mandatory for all U.S. companies this year, although they have wide latitude in how to apply it, if at all.

    The rule was enacted after lobbying by New York companies, led by Merrill, Morgan Stanley, Goldman Sachs and Citigroup, which wrote letters to the Financial Accounting Standards Board arguing that it was not fair to make them mark their assets to market value if they could not also mark their liabilities.

    Companies are allowed to decide for themselves which of their outstanding bonds, loans and other liabilities will get mark-to-market treatment. That is an unprecedented degree of leeway, said Willens, who is also an adjunct professor at Columbia University in New York.

    "It's kind of a dumb rule," Willens said. "In the entire panoply of accounting, this is the most flexible and elective and optional rule that we have."

    Richard Bove, an analyst at Ladenburg Thalmann, a securities firm, provided an example of how it works. A company designates $100 million of its subordinated bonds as subject to mark-to-market accounting. The price of the bonds drops to 80 cents on the dollar from 100 cents. So the firm books $20 million on the "presumed savings that you have on your liabilities," Bove said.

    "In the real world you didn't save a dime," he said. "You still owe the $100 million."

    The Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision objected to the rule before its passage, saying in a joint letter to the Financial Accounting Standards Board in 2006 that it would "have the contrary effect" of increasing a bank's net worth at the same time its "financial condition is deteriorating."

    The regulators remain so skeptical that they refuse to let banks apply the phantom revenue toward minimum capital requirements, according to reporting rules posted on the Web site of the Federal Financial Institutions Examination Council. Deborah Lagomarsino, a spokeswoman for the Federal Reserve, declined to comment.

    "The statement was thoroughly discussed with users and preparers" in advance of its publication, said Neal McGarity, a spokesman for the Financial Accounting Standards Board, based in Norwalk, Connecticut. A March survey by the CFA Institute, a group in Virginia that administers a financial-analyst designation program, showed that 74 percent of investors believed the standard "has improved market integrity," he said.

    Merrill has said its gains from the liabilities did not add to true earnings power. On its Web site, Merrill says that investors who want a "more meaningful period-to-period comparison" should exclude the $2.1 billion of revenue recorded in the first quarter.
  2. Great post
    "The piper will have to be paid eventually,"
    - sure will, and you can bet that the Fed will bail them out and the general public will ultimately do the paying.
  3. Great post - keep them coming