Opening Bell: Banks’ Creative Accounting

It’s all legal, and yet…; trouble in dairy land; Microsoft and Yahoo, round II; Chinese workers stay home; etc.

Bloomberg says banks are “hiding” more than $35 billion in losses in (not so) plain sight.

The wire service in an interesting report says they’re taking the losses on their balance sheets instead of their income statements, meaning they’re reporting quarterly losses that are smaller than they really are. It’s all legal under accounting rules, as long as the banks think the losses are temporary, as Bloomberg columnist Jon Weil told us three weeks ago.

Citigroup, for instance, shielded $2 billion in losses in the first quarter that way (“without mentioning the deduction in the earnings statement or conference call with investors that followed”), while ING hid $5.6 billion (but did mention it). Bloomberg reports that the $35 billion would be on top of the already $344 billion banks have written down in the credit crisis. It says they’ve raised $263 billion to cover those losses so far.

The second half of this is our Quote of the Day:

“The smart people are the ones who’ve identified the problems, put them out there in full transparency, and addressed them by raising more capital,” said Michael Holland, who oversees more than $4 billion as chairman of Holland & Co. in New York. “There is still billions of dollars of crap out there that hasn’t worked itself through the system. Banks need more capital to work that all out.”

While the banks consider these specific losses temporary, Bloomberg says that “with that logic” the other $344 billion could swing back, which nobody believes is possible. It quotes analysts saying banks like Citigroup that are using this accounting will have to take hits later, and one professor says it even reminds him of (cue horror-movie music) 1990s-era Japan.

Ignoring bad debt and postponing inevitable losses was one of the main reasons behind Japan’s decade-long economic slump that began in the 1990s, said Boston University law professor Charles Whitehead.

Faced with new capital requirements and a weakened ability to meet them, Japanese banks deferred the recognition of their losses, aided by regulators who refrained from implementing the rules…

“U.S. regulators may be tempted to go soft on banks too,” said Whitehead, who teaches securities regulation, in an interview. “The new capital rules already rely significantly on self-modeling by the banks. So if anything, the risks may be greater in the U.S. today than they were in Japan in the 1990s.”

Check out the nice table at the end with twenty banks that have “hidden writedowns,” including Merrill Lynch’s $5.3 billion one.

A silver lining

The Wall Street Journal also has an interesting accounting (we know, that’s an oxymoron) report on a company whose deteriorating condition caused its liabilities to decrease, boosting its profit by some $410 million. That’s because its own risk of bankruptcy means it’s less likely to have to pay on some insurance contracts it issued.

The irony is that by marking these particular assets to market as the new rule requires, the weaker a company gets, the stronger it may look.

“The most bizarre aspect of this is that if I’m going bankrupt, the market’s diminishing perception of my credit-worthiness fuels my profits,” said Damon Silvers, associate general counsel at the AFL-CIO and a longtime critic of market-value accounting.

Interest payment problems?

The Journal on its Money & Investing cover has more bad news on bad debt.

The paper says payment-in-kind toggles—a kind of debt mechanism that became all the rage with leveraged buyouts in the late stages of the credit bubble—are increasingly being exercised by companies to raise cash. Hang with us here: PIK toggles allow companies “to shut off cash interest payments and issue more debt instead,” which is like bailing water on to the Titanic.

While the seven companies that have toggled their PIK bonds don’t necessarily have “serious problems,” the WSJ says, some, like Claire’s Stores, are struggling under their debt burdens.

Companies that have elected to pay interest with additional debt “are in cash-preservation mode, and, fundamentally, that’s not a good sign as their financials could be deteriorating and there’s not much lenders can do,” said Jamie Farnham, head of credit research at Metropolitan West Asset Management, a fixed-income manager.


The Los Angeles Times posts an incoherent headline for a story on the housing market: “Steep drop in home prices may help economy.” Huh?

As the paper says in its lede:

Nearly two years into a housing decline that has resulted in hundreds of thousands of foreclosures, frozen credit markets and dragged the nation’s economy toward recession, many Americans hope the end is near.

Most economists believe the worst is yet to come.

Clearly, this may help the economy! We assume the paper means a sharp drop will help shorten the downturn. But if that’s the case, it’ll only be because the economy got nastier.

Sour milk

The Journal on its Marketplace front says federal regulators are investigating whether the dairy industry’s biggest co-op fixed prices.

That’s not all the problems facing the Dairy Farmers of America. The feds are looking into “a secret transfer of cash”—$1 million—to a former director, and it’s being sued for holding down what it pays farmers for raw milk. Who knew the dairy industry was such a hotbed of intrigue?

The allegations and the respective government inquiries follow six years of rapid consolidation in the dairy industry, one of the reasons milk prices have risen sharply in recent years. But it is difficult to determine how much the alleged manipulation, if it took place, might have affected consumer and farm-level prices because so many other factors influence them.

The investigation is looking at where the co-op drove up milk prices by trading cheese contracts in Chicago.

Microsoft not done with Yahoo

The papers all report that Microsoft is coming back at Yahoo two weeks after it abandoned its earlier bid, but it’s not necessarily a full takeover bid. This time—days after investor Carl Icahn started rattlingYahoo’s cage, which the LAT says changed the “dynamics”— Microsoft just wants part of the company, though it says it may actually want the whole thing later—or something like that.

The WSJ, The New York Times, and Financial Times all have front-page stories saying that Microsoft is proposing a search-advertisement deal. That’s at least in part to keep Google from pairing up with Yahoo, the WSJ says:

The maneuvering highlights the pressure on Microsoft to find new options to compete more effectively with Google in online advertising. Major media and technology companies are trying to double down on Internet advertising, with the expectation that major advertisers in coming years will further shift their ad spending online from traditional media such as TV commercials.

The NYT says the news shows “Microsoft Needs a Franchise,” and doubts that it can win in the search and ad business on its own.

Chinese workers fear unsafe buildings

The Washington Post on A1 says fear from the horrendous earthquake in China is keeping employees from going to work. They say they won’t return until inspections show that their buildings are structurally sound. The Post says that may lead to “economic aftershocks” that would only deepen the misery.

Early assessments of the disaster’s economic impact predicted that it would be “minimal,” “transient” and “limited.” Economists declared that this was a human tragedy, not an economic one.

But almost a week after the quake, vast swaths of companies are still shut down and millions of people are still not at back at work. There is evidence that all sorts of resources that China needs to continue fueling its double-digit growth—including grains, hydroelectric power and chemicals—are becoming more scarce and more expensive.

Energy, water and food supplies are particular concerns, as is the worry that continuing fear among Chinese workers could drive the most vulnerable aspect of the economy: inflation.

Stock surge

The Journal’s C1 Ahead of the Tape column says stocks are pricey, trading well above where both forecast and trailing earnings ratios historically have been. A separate story on the same page notes that the Dow Jones Industrial Average is up a big 11 percent in the last two months.

Bloomberg reports that energy company profits are masking the pace of declines on the Standard & Poor’s 500 stock index. Without them, the declines would be the worst in a decade, it says.

Maguire ousted

Maguire Properties fired its founder and namesake Robert Maguire III as CEO and chairman, the WSJ says. The office-building tycoon’s company has been a dog for years and he made a terribly timed, multibillion-dollar bet on the Orange County office market (heavy with mortgage lenders) late last winter, right as the bubble burst. The board’s moves came after pressure from hedge-fund investors.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.