Monday, April 21, 2008

Are banks unrealized losses 'stashed away' in peculiar accounting?

It is always in times of trouble when hidden truth is being revealed. In the words of Warren Buffett it is "only when the tide goes out that you can see who is swimming naked" (loosely paraphrased). Two reports addressing the same issue but about otherwise different problems have caught my attention.

The Big Picture reflects on a Wall Street Journal article about the outsized losses at Citigroup and Merryl Lynch caused by write downs and credit charges which could have been even worse if not for accounting peculiarities.

Citigroup took $15 billion in write-downs and credit charges, leading the big bank to report a first-quarter loss of $5.1 billion. But $2.3 billion in other write-downs didn't hit the company's income statement.

The same was true at Merrill. The broker had $6.6 billion in write-downs, leading to a loss of $1.9 billion. But Merrill took at least $3.1 billion in other write-downs that didn't count toward its loss."

The market value of securities in the available-for-sale category has to be written down or up depending on the market but all losses or gains are being held in the "other comprehensive income"category. At this point the losses or gains are not part of the income statement.

Financial Accounting Standard No. 159 opens up another back door for the beleaguered financial industry to safe a buck for their reputation. Under this rule the firms can book gains when their debt prices plunge. Freddie Mac has said that adopting the standard boosted capital by $1 billion, or 2.6 percent.

It is feared that rule 159, which is also known as fair value accounting, could result in a misrepresentation of the capital position in GSE's.
Ofheo, the GSE regulator, is now considering to prevent the companies from using Fas 159 in situations "where risk management or controls are deficient".

source: Is The Worst of the Credit Crunch Behind Us?
The Big Picture, Barry Ritholtz

source: Fannie, Freddie Regulator Sets `Fair Value' Standards
By Jody Shenn, Bloomberg

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