November 10, 2011
Distortions In Baffling Financial Statements
By FLOYD NORRIS
This has been a bad year for banks. With sovereign debt no longer trusted and widespread fears of a new recession in Europe, share prices of banks have fallen sharply.
But in some cases, the financial statements look ever so much rosier. JPMorgan Chase reported net income of $15.3 billion during the first three quarters of this year, 22 percent higher than in the period a year earlier and a record for the first nine months of any year.
There are explanations for that — and JPMorgan Chase deserves praise for calling attention to reasons to think the numbers are misleading. But at base the problem is a simple one: Accounting for financial institutions is a mess.
And it is getting worse.
Under the rules, banks have a choice of three ways to report the value of identical securities. Even if two banks are using the same valuation method for the same security, they can come up with different values, and it is very difficult for an investor to get any feel at all for just how optimistic, or pessimistic, a bank’s estimates might be.
This year’s strange financial reports are being caused, in large part, by an accounting rule that has the counterintuitive result of increasing reported profits — and revenues — just because people are losing faith in the ability of the bank to meet its obligations. I’ll get into the details later.
The banks hate that rule now, but a few years ago they pushed for it. They did not foresee there would be a day when banks’ own creditworthiness would be called into question.
Sometimes the worst thing that can happen is that you get what you ask for.
And it is not just the earnings numbers that can be misleading. Bank leverage can be obscured by allowing totally unrelated positions to offset each other, so that rather than showing the bank has placed two bets, the financial statements seem to indicate there is no bet at all.
Revenue figures can also be all but meaningless. Did a bank’s revenues soar? If so, that could mean what it would mean in a normal company — that it is doing more business, and possibly gaining market share on its rivals. But it could mean nothing of the kind. It could reflect the good news that the bank is making money from trading, or the bad news that investors are growing worried that the bank may collapse
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