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Banking’s Self-Inflicted Wounds

Morgan Stanley in a free fall. Goldman Sachs at multi-year lows. Citigroup looking Ugly. Bank of America off 50% from recent highs.

You may be wondering what is going on with the major firms in the financial sector. While each of these firms have different problems — vampire squids to Countrywide acquisitions — they all have something in common: Their balance sheets are opaque.

This is no accident. Indeed, it was by design that execs in the banking sector, and their outside accountants, hatched a scheme in 2008 to hide their balance sheets from public view. The bankers had been lobbying the Financial Accounting Standards Board to change the rules that governed “Fair Value Measurements” also known as FAS157 (September 2006).

You may recall during 2008 this was referred to as “Mark-to-market” accounting.

Banks loved m2m during a boom period. M2M made the more unusual balance sheet holdings — derivatives, the mortgage-backed securities (MBS), exotic liabilities, and other assets — look fantastic. The fair value measurements of these items — essentially, yesterday’s closing price — allowed the accounts to show enormous profits. Those were the underlying basis for huge bonuses, stock option grants and of course, company share prices.

The reality was quite a bit different. These were not equities or treasuries or corporate bonds — they were thinly traded items whose prices were ramping upwards on a sea of delusional optimism. As soon as the credit bubble ended and housing began to retreat, these assets would free fall like an Acme anvil in a Roadrunner cartoon — and the bankers were the Coyote.

http://www.ritholtz….rce=patrick.net

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