The previous post described how Congress coerced the FASB to change accounting methods to make banks look healther.
Floyd Norris at the NY Times gives an aggregate investment of the profits that Wall Street desired accounting changes made possible. The following Bloomberg article gives some estimates about the effects on Citi's and Wells Fargo's profits.
Norris concludes "Both the banks and their regulators see virtue in opacity."
Norris, Floyd. 2009. "Seeking Reality in Bank Balance Sheets." New York Times Blog (5 June).
"David Zion, the accounting analyst at Credit Suisse, is out with a report today on fair value accounting, in which he calculates how many billions of dollars were added to bank "values" by the changes that the Financial Accounting Standards Board (FASB) was forced to make: "We estimate first quarter pretax earnings improved by $4.9 billion as a result of the new other-than-temporary impairment (OTTI) rules for the 20 Financials sector companies that early adopted them, including eight companies where the new rules may have increased pretax earnings by more than 5%. In addition, the FASB's mark-to-market clarification resulted in five of the 20 companies marking assets up from $27 million to $4.5 billion"."
Onaran, Yalman. 2009. "Bank Profits From Accounting Rules Masking Looming Loan Losses." Bloomberg Markets (July).
"Analysts who have examined the quarterly profits and government tests say that accounting rule changes and rosy assumptions are making the institutions look healthier than they are."
"Citigroup's $1.6 billion in first-quarter profit would vanish if accounting were more stringent, says Martin Weiss of Weiss Research Inc. in Jupiter, Florida. "The big banks' profits were totally bogus," says Weiss, whose 38-year-old firm rates financial companies. "The new accounting rules, the stress tests: They're all part of a major effort to put lipstick on a pig." Further deterioration of loans will eventually force banks to recognize losses that their bookkeeping lets them ignore for now, says David Sherman, an accounting professor at Northeastern University in Boston. Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago, says the government stress scenarios underestimate how bad the economy may get."
"FASB also let companies recognize losses on the value of some debt securities on their balance sheets without counting the writedowns against earnings. If banks plan to hold the debt until maturity, they can avoid hurting the bottom line. At Citigroup, the recipient of $346 billion in fresh capital and asset guarantees from the government, about 25 percent of the quarterly net income came thanks to the debt securities rule change, the bank said."
"Another $2.7 billion before taxes came from an accounting rule that lets a company record income when the value of its own debt falls. That reflects the possibility a company could buy back bonds at a discount, generating a profit. In reality, when a bank can't fund such a transaction, the gain is an accounting quirk, Weiss says."
"Without those accounting benefits, Citigroup would probably have posted a net loss of $2.5 billion in the quarter, Weiss estimates. In the five previous quarters, Citigroup lost more than $37 billion."
"Wells Fargo also took advantage of the change in the mark- to-market rules. The new standards let Wells Fargo boost its capital $2.8 billion by reassessing the value of some $40 billion of bonds, the bank said in May. And the bank augmented net income by $334 million because of the effect of the rule on the value of debts held to maturity .... The higher valuations Wells Fargo put on its securities probably won't last, as defaults increase on home mortgages, credit cards and other consumer and corporate lending, Northeastern's Sherman says."
"The Federal Reserve, which designed the stress tests, used a 21 percent to 28 percent loss rate for subprime mortgages as a worst-case assumption. Already, almost 40 percent of such loans are 30 days or more overdue, according to Tavakoli, who is the author of three primers on structured debt. Defaults might reach 55 percent, she predicts. At the same time, the assumptions on how much banks can earn to offset their losses are inflated, partly because of the same accounting gimmicks employed in first-quarter profit reports, Weiss says."