Monty Pelerin's World

Economics, Finance and Politics Through The Prism of Classical Liberalism

Jimmy Stewart Wouldn’t Run These Banks


Frank Capra’s George Bailey of Bailey Savings and Loan would surely not recognize our banking system or its accounting. However, Mr. Potter, George’s evil competitor, would probably be right at home with what’s going on.

The overhang to any economic recovery is the banking system. There is no way to know how bad the banking problems really are, given the accounting or lack thereof. Banks, with an encouraging wink and a nod from regulators, have refused to realistically value their assets. In some cases, these values may not even be determinable, other than to say they are currently grossly overvalued.

Some believe that the problem is so big that recognition of it would show the banking system to be insolvent, requiring massive bank closings and possibly triggering  a run on the system. Actions taken by the government and the Fed are not inconsistent with this belief. The “pretend and extend” strategy that has been employed is one of desperation. Bank behavior, in terms of the accumulation of massive excess reserves, also appears consistent with this hypothesis. While excess reserves would not protect against a massive run, they do serve as excess capital that can be utilized once banks willingly or are forceably write assets down to reflect market value. The fact that regulators have tightened loan regulations on new loans may be provide additional support,  suggesting that they don’t want the problem to get any bigger at the same time they are unwilling to recognize how big it is.

The following post by George Washington discusses this issue:

Former Managing Director of Goldman Sachs: Accounting Fraud of the Too Big to Fails May Be Worse Than Enron

George Washington's picture

Submitted by George Washington on 12/02/2009 17:32 -0500

Nomi Prins – former managing director of Goldman Sachs and head of the international analytics group at Bear Stearns in London – is saying the same thing that financial bloggers have been saying: The giant banks are manipulating their books to make themselves look profitable.

In fact, Prins says that this might be worse than the fraud which occurred at Enron:

Enron was the financial scandal that kicked off the decade: a giant energy trading company that appeared to be doing brilliantly—until we finally noticed that it wasn’t. It’s largely been forgotten given the wreckage that followed, and that’s too bad: we may be repeating those mistakes, on a far larger scale.

Specifically, as the largest Wall Street banks return to profitability—in some cases, breaking records—they say everything is rosy. They’re lining up to pay back their TARP money and asking Washington to back off. But why are they doing so well? Remember that Enron got away with their illegalities so long because their financials were so complicated that not even the analysts paid to monitor the Houston-based trading giant could cogently explain how they were making so much money.

Surely someone with Prins’ financial background can sort out the accounting of the TBTFs?

In fact, no:

After two weeks sifting through over one thousand pages of SEC filings for the largest banks, I have the same concerns. While Washington ponders what to do, or not do, about reforming Wall Street, the nation’s biggest banks, plumped up on government capital and risk-infused trading profits, have been moving stuff around their balance sheets like a multi-billion dollar musical chairs game.

I was trying to answer the simple question that you’d think regulators should want to know: how much of each bank’s revenue is derived from trading (taking risk) vs. other businesses? And how can you compare it across the industry—so you can contain all that systemic risk?

The giant banks have played so many games of massaging numbers (see this), hiding losses off the books (see this) and – as Prins documents – failing to report core data and shuffling things around so that it is impossible to tell what they are doing.

Indeed, financial writers (like Reggie Middleton, Mike Shedlock, Tyler Durden, Karl Denninger and others) who have dug deep and analyzed the underlying data say that the giant banks are totally insolvent.  This wouldn’t be the first time that the biggest banks went bust and then covered it up over a period of many years.

Prins offers a solution:

The long-term solution is bringing back Glass-Steagall. Being big doesn’t just risk bringing down a financial system—it means you can also more easily hide things. Remember the lesson from the Enron saga: when things look too good to be true, they usually are.

Yes, and break up the too big to fails.