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.
Uh-oh, this was gonna be a problem. So the bankers began to lobby FASB to change the rules governing Fair Value Accounting. Sure, it was hugely helpful on the way up, but now, reporting actual holdings — previously marked at all time highs — was becoming problematic.
To their credit, the accounting board resisted. What Bankers were proposing — marking to their models — was patently absurd. These were the models that told them these purchases were good ideas in the first place. Changing Mark-to-Market to Mark-to-Model was a free pass to practically allowed banks to NEVER have to write down their liabilities. Some people began calling the proposed accounting changes “Mark-to-Make-Believe.”
In the midst of the 2008-09 collapse, however, Congress was in a panic. They mandated that FASB accept Mark-to-Make-Believe accounting in the Emergency Economic Stabilization Act of 2008. It gave the Securities and Exchange Commission the authority to “Suspend Mark-to-Market Accounting.” In March and April of 2009, that is precisely what occurred.
It was yet another example of an industry lobbying Washington, D.C. to get precisely what they want — and then having that legislation blow up in their faces. (I detailed other examples of this in a chapter of Bailout Nation — you can see that chapter here: Strange Connections, Unintended Consequences).
The bottom line is this: Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell.
And that is exactly how the bankers wanted it.
But given the trouble in Europe, and the likely problems in housing if the US goes into a recession, Investors have decided they cannot take the risk of a holding an opaque, possibly under-capitalized probably over-leveraged financial firm blindly. They are telling the banks no thanks, we are not interested, we are going to be prudent and we have to assume the worst. Hence, for the second half of 2011, they have been selling off their holdings in these opaque, potentially insolvent too big to succeed entities.
Bankers, enjoy your beds. You made them, now lay in them . . .
Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data, ability to repeat discredited memes, and lack of respect for scientific knowledge. Also, be sure to create straw men and argue against things I have neither said nor even implied. Any irrelevancies you can mention will also be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.
Absolutely true. But here is what is really scary – the bankers and their servant politicians are so locked in to their world of wealth extraction that they will let the economy crash and people live on the street rather then change their ways. They couldn’t care less that they are destroying our economic future. It’s openly discussed that politicians are bought and paid for and the bankers are getting everything they want. But nothing changes. That says everything.
sure,
bank stocks are a big unknown and people are selling, but imagine where they would be if folks knew the truth and FAS157 wasn’t scuttled?
the last 2.5 years have merely been an exercise in make believe
Opaque balance sheets, you say?
Welcome to Japan, honorable bankster-sans!
Sayonara!
Or better yet — Seppuku!
Surely B of A, Citi, GS and MS all have headquarters buildings tall enough to leap from. JUMP!
But it’s just the banks. Government has applied an opaque gloss to the whole of the US economy.
So what happens when the rest of the world loses faith in the almighty dollar ? Or is that currency just to big to fail ?
And now they label the new capital requirements of Basel III as ‘anti-American’.
this is a pretty picture (but maybe not for those heavily invested in emerging markets)- Hang Seng 1 year chart
And may these beds that the bankers lay in have bed bugs in them!
BR lectured:
Bankers, enjoy your beds. You made them, now lay in them . . .
reply: ———- Imagine a world where bankers, mostly investment and ginormous money center bankers, altogether stopped lying all at once and completely. Then they lobbied Congress to do the same on their behalf. Can you imagine how much individual wealth would vaporize on that day? Can you envision the confusion, terror, befuddlement, despair, and rancor that would result if all honesty broke loose in the banking trades all at once? The S&P would probably go negative for a while until the shock passed. The world’s financial systems rely on lies and deceit. We benefit from the lies when they work and we benefit from the bailouts if we managed the lies prudently as they exploded.
Economically speaking, one could argue that we would not have so many lies from bankers if, as a societal whole, we weren’t better off with then than without them. If murders were as common as lies from bankers and their supporters, we would all be living in an apocalypse as a matter of everyday life. Yet we do our best to limit murders but we do far less to limit bankers’ lies, even knowing full well the financial apocalypses that continually result. Thus, one could reasonably conclude we want bankers to lie and accept the bad results as a part of an overall good that transcends the bad.
I suppose this situation might be different if Uncle Stupid weren’t always there to bail out the world via money printing and deficit spending. But Uncle Stupid IS there and Uncle Stupid will bail out the bankers again, just like they always do.
To come to the point, we wouldn’t have so many banker lies if we didn’t really want them or their consequences.
You gotta love the link to the Roadrunner cartoon! And thanks Barry, for your candid insights into this difficult market. I, and certainly many other plain folks, greatly appreciate the opportunity to benefit from your outlook on these situations.
nitpick alert. Isn’t it, “…now lie in them?” (Did you catch ‘lie’ has a double meaning, Barry?)
How’s about the minority view?
All a bank is doing is giving a client or a business entity access to capital. It’s up to the borrowing party to make the right decisions with the capital they are given.
If the “bank” is left holding the bag for a bunch of short time, silly little in and out, have to work a deal wankers, why was the bank at fault?
I don’t like the fact that banks can operate their own trading accounts to the detriment of their clientele and I completely understand how market participants can get to hating but in all honesty MOST of the bad actors are so underwater with the stuff they got involved in on the real estate side that it serves very little purpose poking them in the ribs on their descent to hell.
Just enjoy their demise. They’ll continue to exist. In that odd “american” corporate way of saying “I’m still here but I don’t really matter” but other than that besides the really big players who for some unknown reason continue to be lumped with the real estate tycoons of the world, some of the entities cited will simply be non factors in the decades to come.
It’s like concerning yourself with Novell while Microsoft took over the world. Who cares?
A “bank” is not extracting wealth from anyone. If you borrow a bank’s money to buy a house in your suburban sprawl and then rationalize yourself into some frenzy where you feel completely justified in not returning their capital, that’s a personal choice. But the bank didn’t do anything wrong They tried to do business with you.
It’s not their fault that you wound up being a deadbeat. And if you’re a justified deadbeat, bully for you. Go get im.
Everybody just needs to get back to playing the hands they are dealt. Worrying about whether or not the suit across from you stacked the deck serves very little purpose. It just makes the suit smile to know that he or she is in your head.
Articles like this are what makes this site worth a daily visit.
The analogy to the Roadrunner cartoon is unfortunately very apt.
In real life, falling off a cliff and having an anvil fall on you means that you are done and gone. In the Roadrunner cartoons, Wile E. Coyote is simply dazed and then gets up to go do something foolish again, just like our financial sector.
I think we have an opportunity to resolve this over the next couple of years, although it will not be pleasant. I believe that the government will need to step in and stabilize the financial sector again; however, when they do this they should be “resolving” insolvent companies so that the shareholders are wiped out, management is replaced, and debt holders take a haircut.
When the Coyote stops getting up with nothing more than a bump on the head, then this era will be over, and we will get a restart in a new era of growth.
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