If a financial position is hidden, disguised, or in some manner unreported, does that mean it does not exist or is not impactful? Will the American taxpayer continue to bear the burden of unsafe and undisciplined lending and investment practices on behalf of our banking system without being able to demand truth and transparency? Make no mistake, these very practices have brought our economy and financial system to its knees and if the banking system continues to get its way, we will remain subject to the massive risks connected with them. Let’s navigate this corner of our economic landscape and see what the implications are going forward.
CFO Magazine highlights the growing pressure from within the banking industry to delay the implementation of accounting rules requiring banks to bring investment positions onto the balance sheet and raise sufficient capital to support them. In short, these accounting rules would strike at the nexus of the off-balance sheet vehicles which crippled many banks. CFO reports:
Bank regulators are set to discuss accounting standards next week, with an aim toward determining the potential affects that off-balance-sheet rules may have on some financial institutions. During the past year, bankers have fretted about new accounting rules that would force them to bring back on their balance sheets billions of dollars worth of assets — a move bankers have argued will throw regulatory capital ratios into chaos.
Bankers may fret, but taxpayers are picking up the tab on an ongoing basis. If these bankers really want to see ‘fretting,’ then they should start talking to the American public.
Why are the bankers concerned about implementing these new accounting rules? They believe it will force them to raise new capital, dilute their stock value (which will most likely negatively impact their own personal wealth), and increase the potential of a takeover or some other form of business transfer, including potential liquidation. The bankers would prefer to continue to operate in an undercapitalized fashion while they ‘hope and pray’ for a turnaround in the housing market which is at the very core of their investment holdings and overall franchise.
CFO addresses these points in writing:
The new standards revise older accounting rules — specifically FAS 140 and FIN 46(R) — changing the way, for example, companies define control over financial assets and liabilities, thereby causing some off-balance-sheet transactions to be consolidated back on to company financial statements. The rule would likely have a large impact on banks, which frequently package up loans into securities.
The impact of the accounting rules on banks came to a head in May, when the Federal Reserve Board released the results of its so-called stress tests, which were performed on the 19 largest bank holding companies in the United States. The unprecedented stress testing, officially dubbed the Supervisory Capital Assessment Program, incorporated several accounting changes into its modeling, including the potential effects of FAS 166 and FAS 167. In its summary report, the Fed concluded that the new FASB rules would require banks to reconsolidate off-balance-sheet assets tied to securitizations and SPEs.
So far, the estimates of how many billions of dollars would have to be reconsolidated vary, with the Fed guessing that an aggregate $700 billion worth of assets would be brought back on the balance sheets of the largest bank holding companies. News reports have estimated the impact to be closer to $1 trillion worth of assets.
What are the practical implications of these past accounting practices which promoted off-balance sheet activities, as well as the FASB’s relaxation of the mark-to-market? We need look no further than the lead article in this morning’s Wall Street Journal, In New Phase of Crisis, Securities Sink Banks:
U.S. banks have been dying at the fastest rate since 1992, mainly because of bad loans they made. Now the banking crisis is entering a new stage, as lenders succumb to large amounts of toxic loans and securities they bought from other banks.
The WSJ is inaccurate in stating the banking crisis is entering a new stage. The problems embedded in the investments and securities held within the banking system (whether on balance sheet or off) are not new. The accounting rules and games played by the banks merely allowed them to be covered up.
We are way past the point when these games should be allowed to continue.