There’s an old saying:
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“If you can’t blind them with your brilliance, then baffle them with your bull.”
This has been the guiding mantra of the financial industry since the economic crisis began dominating global headlines.
You already know the global recession was triggered by the collapse of bank balance sheets that led to the implosion of the credit markets.
The fall of major investment banks like Bear Stearns and later Lehman Brothers was precipitated in large measure by off-balance sheet financial vehicles that allowed the banks to look more solvent than they actually were.
The jig was up when investors began to demand redemptions as the value of their mortgaged-backed securities started to erode. Bear Stearns and Lehman Brothers simply didn’t have the cash to meet their guarantee obligations, and they buckled under the weight of investor claims.
From that point, it was a domino-effect.
The Start of Going Wrong
To lure investors, the banks got underwriters like AIG to issue collateral debt obligations (CDOs) to insure the value of their portfolios against loss of value or default. This device allowed banks to increase their leverage or their risk well beyond prudent limits. By insuring their portfolios with other than their own assets, the banks were able to keep these investments off the books and away from the watchful eyes of federal regulators.
Once the first domino fell, the entire scheme crumbled.
Banks complained that they were undone by the marked-to-market rules, a fair-value accounting standard that forced them to readjust the value of their portfolios and holdings as housing prices began to recede.
Marked-to-market has been a method of assigning fair value since it was incorporated into the Generally Accepted Accounting Principles in the early 1990s. The use of the market-to-market method of fair value measurement has increased steadily over the past decade, primarily in response to investor demand for relevant and timely financial statements that will aid them in making better informed decisions.
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Now, the financial services industry is trying to stiff arm rule changes that would force banks and others to bring some of their off-balance-sheet vehicles back onto their books as early as next year. If these changes are implemented, banks could be compelled to raise even more capital in order to meet federally-mandated solvency standards.
A bank lobbying front known as the “Fair Valuation Coalition” has spent millions to convince members of Congress to delay the implementation of these new standards. They have also pressured the Fair Accounting Standards Board, the agency responsible for setting national accounting rules, to change the marked-to-market approach to asset valuation.
Will Restraints Vanish?
Through this rear guard action, the banking industry is fighting to keep trillions of dollars in assets hidden in vehicles that would not otherwise show up on their books. If this happens, investors and taxpayers will again be the losers because it will permit the banks to continue fudging their true financial condition.
In all fairness, some banks like JP Morgan, Chase and Goldman Sachs have not opposed the rule changes. But unlike their competitors, most analysts believe that JP Morgan and Goldman have adequate resources to consolidate their assets without having to raise additional capital.
With all the panic and confusion that has surrounded the financial meltdown, lawmakers and regulators have been searching for solutions to prevent this from happening again.
It was the banking industry excess and unchecked appetite for risk that created this financial system hangover. Now in their post-binge haze, the banking lobby is trying to convince Congress and the regulators that they know more about the value of their investments than the markets.
If Congress caves in, and these dodgy methods become a permanent part of the national accounting landscape, then there will be nothing to prevent these shady practices from continuing to put our financial system at risk even after the American taxpayers have spent trillions to put it back on track.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
