Quote of the Day: Accounting Magics

Back then, just as today, few people really understood it. And those who did were often clever enough to find loopholes in the system to hide their fraud. Especially banks.

There are some really stunning (and sometimes hilarious) examples of early banks who learned how to cook their books and misstate their capital using Pacioli’s system.

Curiously very little has changed. Banks still use accounting tricks to hide their true condition.

Bloomberg showcased one such technique last year, exposing the way that many US banks are rebooking their assets from “available for sale (AFS)” to the “held-to-maturity (HTM)” designation.

This is a very subtle move that means nothing to most people.

But to banks, it’s a highly effective way of concealing losses they’ve suffered in their investment portfolios.

Banks ordinarily buy bonds and other securities with the purpose of generating a return on that money until they have to, you know, give it back to their depositors.

That’s why they’re called “available for sale,” because the bank has to sell these assets to pay their depositors back.

But here’s the problem– many of these investments have either lost money, or they soon will be. And banks don’t want to disclose those losses.

So instead, they simply redesignate assets as HTM.

It’s like saying “I don’t care that these bonds aren’t worth as much money as when I bought them because I intend to hold them forever.”

Thing is, this simply isn’t true. Banks don’t have the luxury of holding some government bond for the next 30-years.

This is money they might have to repay their customers tomorrow, which makes the entire charade intellectually dishonest.

That doesn’t stop them.

JP Morgan alone boosted its HTM mortgage bonds from less than $10 million to nearly $17 billion (1700x higher) in just one year. This is a huge shift.

Nearly every big bank is doing this, and is doing it deliberately. This is no accident. And there’s only one reason to do it—to use accounting minutia to conceal losses.

But the accounting tricks don’t stop there. And in many cases they’re fueled by the government.

One recent example is how federal regulators created a new ‘rule’ which allows banks to consciously reduce the risk-weighting they assigns their assets.

The Federal Financial Institution Examination Council recently told banks that, “if a particular asset . . . has features that could place it in more than one risk category, it is assigned to the category that has the lowest risk weight.” 

This gives banks extraordinary latitude to underreport the risk levels of their investments. 

Bankers can now arbitrarily decide that a risky asset ‘has features’ of a lower risk asset, and thus they can completely misrepresent their investments. 

Bottom line, it’s becoming extremely difficult to have confidence in western banks’ financial health.

They employ every trick in the book to overstate their capital ratios and understate their risk levels.

This, backed by a central bank that is borderline insolvent and a federal government that is entirely insolvent.

It certainly begs the question—is it really worth keeping 100% of your savings in this system?

(bold mine)

This is from Simon Black from his website the Sovereign Man.

Such statistical charade can be epitomized by the recent experience of Hong listed Kaisa Group. As I wrote last weekend:

The camouflaging of debt reminds me of the Kaisa Group, a property and shopping mall developer in China but whose shares are listed in Hong Kong.

The once “fundamentally” strong company suddenly surprised the market when they announced of their inability to pay interest rates on foreign denominated loans. So the Chinese government worked behind the scenes to find a buyer to bailout the beleaguered company.

Last week, the company’s debt suddenly DOUBLED. Since the company didn’t disclose why the debt has swelled, media has been speculating on its possible causes. They point out that “home buyers may have unwittingly turned into lenders” where advance proceeds and deposits were converted into debts. They also attributed the possibility of debt from trade credit (credit to suppliers and contractors) and from legal actions, or even from off balance sheet debts.

The obvious lesson is that credit booms have always masked the disease. It’s when the loans have been called in, when the proverbial Pandora’s Box gets to be opened.

Beware of those embellished statistics.