Blog on the Run: Reloaded

Thursday, August 13, 2009 8:20 pm

Reality gap

Filed under: We're so screwed — Lex @ 8:20 pm

I qualify as an economics expert, if, by “expert,” one means, “someone who can generally balance his checkbook each month with the help of some very sophisticated proprietary software.” So maybe I’m not even qualified to ask this question. But because one of the big rules of journamalism is that there’s no such thing as a stupid question, I’ll ask anyway.

Let’s say there’s this bank. And let’s say that in its report to the SEC for the quarter ending June 30, the bank reports that the actual market value of loans on its books is $22.8 billion less than what the company’s books say they’re worth. Let’s further say that shareholder equity in this bank is — oh, let’s be generous and say $18.7 billion.

So if not for the accounting gimmickry — current rules don’t require bank directors to value such loans accurately until the underlying losses are considered “probable,” even if, as Bloomberg’s Jonathan Weil dryly notes, that time comes long after the losses are foreseeable — our bank would be worth … um, eight minus seven, borrow a one, subtract the eight … looks like negative $4.1 billion.

My question is: Why is this bank still in business? How is this not like Wile E. Coyote running off the edge of the cliff and continuing to run … until his feet stop moving and he looks down?

Since I’ve already got my hand up, I’ll also ask: Is this sort of thing common?

And, not for the first time in my life, I’m sorry I asked:

While Regions may be an extreme example of inflated loan values, it’s not unique. Bank of America Corp. said its loans as of June 30 were worth $64.4 billion less than its balance sheet said. The difference represented 58 percent of the company’s Tier 1 common equity, a measure of capital used by regulators that excludes preferred stock and many intangible assets, such as goodwill accumulated through acquisitions of other companies.

Wells Fargo & Co. said the fair value of its loans was $34.3 billion less than their book value as of June 30. The bank’s Tier 1 common equity, by comparison, was $47.1 billion.

The disparities in those banks’ loan values grew as the year progressed. Bank of America said the fair-value gap in its loans was $44.6 billion as of Dec. 31. Wells Fargo’s was just $14.2 billion at the end of 2008, less than half what it was six months later. At Regions, it had been $13.2 billion.

Other lenders with large divergences in their loan values included SunTrust Banks Inc. It showed a $13.6 billion gap as of June 30, which exceeded its $11.1 billion of Tier 1 common equity. KeyCorp said its loans were worth $8.6 billion less than their book value; its Tier 1 common was just $7.1 billion.

And unfortunately, it’s not just the big banks, either:

Another useful data point is the disclosure on the total Level 3 Asset Exposure at March 31, 2009. Compliments of the FASB, over $650 billion in “assets” are being marked-to-model, and most likely overestimate the true worth of these assets by about 50%. That’s $300 billion in hot air on the banks’ balance sheets.

I’d really, really like to believe that these numbers do not mean we’re screwed, particularly inasmuch as Bank of America and Wells Fargo/Wachovia employ a lot of people in this state. But Rule 5 of investigative reporting is do the math, and the corollary to Rule 5 is that when the math doesn’t add up — and you know your own (lack of) math skills aren’t the reason — there’s almost never a benign explanation.

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