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.

D’oh!

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 rc2538@columbia.edu.