Lies, damned lies, and bank profits

Remember the good old days when “creative accounting” was an oxymoron?

Ever since Citigroup last month projected a profit for the first couple months of the year, big banks have been startling the Street with better-than-expected quarterly earnings reports.  And for a while, the Street was overjoyed and stock prices shot up for banks and overall.  But um, shouldn’t we have been taking these profit figures with a big grain of salt?

  • Advance manipulation (read: lowering) of expectations so that you can miraculously beat those expectations is an old, old game.
  • Accounting chicanery played no small part in getting us into the current mess.   Covering up losses to impress the market, just like covering up profits to thwart the taxman, is legal and commonplace, under generally accepted accounting practices.
  • An excessive focus on short-term profits also played a big part in getting us into this mess.  Shouldn’t we be looking at other factors, too?  In particular: Bank share prices were way down because of the widespread belief that the banks were either insolvent or headed that way.  Positive short-term profits (cash flow) and solvency (assets greater than liabilities) are two different things, and can coexist at least for a little while.
  • The federal government has subsidized the big banks to the tune of tens of billions of TARP money apiece.   Shouldn’t that make it easier for them to be profitable?  (The whole point was that the banks would loan that money out profitably.  Granted, that hasn’t happened to the desired extent — I just heard on the radio that total lending is lower now than before the TARP legislation — but banks are surely using their TARP money for something that generates income, like T-bonds, no?)

The Street may be catching on, as with Bank of America’s 24% slide yesterday despite world-beating profit news.  The Charlotte Observer reports that the bank’s overall profit masks weakness in its traditional lending, such as with mortgages and credit cards, both of which are experiencing high default rates which could easily worsen.  This seems to be the pattern at other big banks as well.

As usual, Paul Krugman says it better than I can:

‘Some of the good news isn’t convincing. The biggest positive news in recent days has come from banks, which have been announcing surprisingly good earnings. But some of those earnings reports look a little … funny.’Wells Fargo, for example, announced its best quarterly earnings ever. But a bank’s reported earnings aren’t a hard number, like sales; for example, they depend a lot on the amount the bank sets aside to cover expected future losses on its loans. And some analysts expressed considerable doubt about Wells Fargo’s assumptions, as well as other accounting issues.

‘Meanwhile, Goldman Sachs announced a huge jump in profits from fourth-quarter 2008 to first-quarter 2009. But as analysts quickly noticed, Goldman changed its definition of “quarter” (in response to a change in its legal status), so that — I kid you not — the month of December, which happened to be a bad one for the bank, disappeared from this comparison.

‘I don’t want to go overboard here. Maybe the banks really have swung from deep losses to hefty profits in record time. But skepticism comes naturally in this age of Madoff.’

Andrew Ross Sorkin of the NYT says it even better, in today’s “Dealbook” column (“Bank Profits Appear Out of Thin Air”), though I think he overstates things when he says the Street wasn’t buying these glossed-over quarterly reports for a minute.  My recollection is that the Street mostly was, until yesterday.

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