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Here Comes the Flood of Lies and Obfuscation



July 13, 2010 – Comments (5) | RELATED TICKERS: BAC , GS , JPM

Earnings season for the all-powerful financial giants is an exercise in trickery and opacity. I have decried for years now the blatant deception inherent in the accounting practices of the financials ... and indeed of all the corporate holders of toxic derivative exposures that have been permitted to lie their way out of crisis by marking those assets to fanciful notions of presumed value under normalized conditions rather than writing them down to the pennies on the dollar the would fetch on the market even this many months into the OTC meltdown. All they have done is kick the can down the road, and permitted trusting investors to essentially forget about their very existence.

When insight emerged into Lehman's repo practices and other accounting tricks used to mask the true nature of its exposure and ultimate insolvency, I pointed out how far-fetched it would be to presume that Lehman would have been alone in such practices. As we now know, such activities remain the industry standard, and no one seems to care.

You may recall this rare gem of investigative reporting from the WSJ

Here's the same story in graph form.

"A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters."

Good ole BOA had this to say: "The efforts to manage the size of our balance sheet are appropriate and our policies are consistent with all applicable accounting and legal requirements," a Bank of America spokesman said." Well... that's comforting. As David Weidner reports in one of the best financial commentaries I've seen in a long time: "Late last week, Bank of America Corp. became the latest big financial firm to cop to manipulating end-of-the-quarter earnings. In a letter to the Securities and Exchange Commission, B. of A. said it masked debt levels between 2007 and 2009 by making six trades designed to shine up the numbers on earnings day." So which is it BOA? Were your accounting practices "appropriate"? ... or were they specifically designed to obfuscate the degree of risk-taking underlying those golden profits that bank investors have been so enamored with in recent quarters? I think it's pretty clear ... use of the word "appropriate" was grossly inappropriate.

I can't say enough good things about this article from Weidner. I find his hard-hitting, no nonsense approach very inspiring. Here are some of the juiciest excerpts, but please be sure to click to the article for a full read ... it's well worth your time.

Wall Street banks and brokerages are readying second-quarter numbers for mass digestion. They'll show healthy balance sheets, tolerable risk levels and have all the trappings of well-run companies.

Don't believe a word of it.

You would think this kind of window dressing would raise the ire of analysts whose rosy analysis of Wall Street firms including American International Group Inc., Bear Stearns, Lehman Brothers and Merrill Lynch were made to look foolish by opaque and misleading balance sheets. Think again. Most analysts still read the suspect financial data they're handed every three months and take it as gospel.

Take a look at the usual suspects. Since the start of the year, analysts have issued six ratings upgrades to Citigroup, six to Goldman, four to Morgan Stanley and nine to Bank of America, according to FactSet. Combined, analysts have only issued five downgrades.

Regardless of Eliot Spitzer's personal failings and his lasting impact as a reformer, at least he had the gumption to challenge practices on the grounds of common sense and evenhandedness. Unfortunately, no one seems to have taken up the mantle of championing fairness in the markets. [So True!]

Even after the financial crisis, financial firms still take short cuts behind the scenes, the analysts keep playing it straight, investors continue to follow the analysts and credit ratings agencies. Not only does the emperor have no clothes, no one in the kingdom cares.

Maybe lie is too strong a word for the game big finance plays at the end of the quarter. It is, after all, trickery played inside the lines. But here's something you should refuse to call it: the truth.


5 Comments – Post Your Own

#1) On July 13, 2010 at 9:39 AM, RaulChapin (< 20) wrote:

This is a very interesting article. It reminded me of an experience I had when working in the micro loan sector.One day the CFO of one of our client "banks" called me for help. Apparently there was something wrong with their reporting program, as his % of loans in default went from 2% on one report to about 8% the next. Of course IT guy that I was, I went on to examine the processes of calculating when payments were due, what was considered in default, etc.Eventually together we came to find the reason for the "problem": There was a large proportion of debtors who would pay their installment exactly one day before the next installment was due, this kept them from having two payments due at the same time (thus flagging them in default) but it also allowed them an extra 6 days of credit. The CFO had decided to "see how things were going" a couple of days earlier than when the reports were normally presented to him, and thus found all the people that would normally pay "just in time" to be in default. How is this relevant?:a. the people taking the loans were, normally, uneducated individuals, however they easily found a way to extend the financial rules to take a bit of extra advantage of the measuring system. So it could follow that when you are hiring highly educated individuals, with the explicit purpose of "bending the rules", the shenanigans can skyrocket, specially if they do not need to also use their time to do something useful (such as running a business, like in the case of the micro loan clients)b. a system of control based on periodic snapshots can easily be manipulated to tell a better picture than reality. When doing an analysis of a company, non numeric data is as important as the "cold hard data". The Fool always takes this into consideration when doing their analysis (one of the reasons i have been coming back for about 10 years)c. not told in the previous part of the story, but a good CFO will not try to mask the risk by doctoring the reports, my client and  friend decided that it would be a more realistic picture to take the average of the two reports' default rates and use that in his reporting to regulators, with a footnote as to why it looked different and why the new way of calculating default rates would be used. (Of course, micro loan institutions are based on good will and honesty rather than greed and bonuses...thus why Grameen, and not the CEO of BOA, won a Nobel peace prize LOL)


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#2) On July 13, 2010 at 9:41 AM, RaulChapin (< 20) wrote:

Sorry for the long paragraph... it looked so pretty in MS Word... but I did not realize that it had all gotten all bunched together when I copied it here... so much for an IT guy know how to use a computer!!!!

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#3) On July 13, 2010 at 9:58 AM, silverminer (29.87) wrote:


I appreciate the comments in whatever form they appear. :)

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#4) On July 13, 2010 at 10:16 AM, Turfscape (< 20) wrote:

+1 rec...mostly because I happen to LOVE the word "obfuscation".

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#5) On July 13, 2010 at 10:19 AM, catoismymotor (< 20) wrote:

+ 1 Rec.

Good find. Thanks for the links.

As a former banker I have a learned distrust of the way they work. Sadly this only serves to cement my opinion. At this point I would suggest vast amounts of DD with an endoscope before buying into a bank.


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