The banks should give a full, fair, and accurate account of their financial positions and they are failing that test.”
-Kevin Warsh, former Federal Reserve Board member

After serving on the [FASB] board, I no longer trust bank accounting.”
-Don Young,  Financial Accounting Standards Board

Do I trust Bank Accounting? Absolutely not.
-Ed Trott, Financial Accounting Standards Board member

There is no major financial institution today whose financial statements provide a meaningful clue” about its risks.
-Paul Singer, Elliott Associates



This month’s must read cover story of The Atlantic was written by two of my favorite writers: Pulitzer Prize winner Jesse Eisinger of Pro Publica (and Portfolio, WSJ, and TSCM) and Frank Partnoy of University of San Diego School of Law, author of F.I.A.S.C.O., Infectious Greed, The Match King, and – most recently – WAIT: The Art and Science of Delay.

They discuss an issue I have talked about here repeatedly — that banks are essentially opaque black boxes; banks have purposefully concealed what’s on their balance sheets; that they are not merely complex, but actually deceptive; investors have no idea what they are buying when they own one of the behemoth money centers like Citigroup (C), Bank of America (BAC), Wells Fargo (WFC) or JP Morgan (JPM).

Of course, no bank article would be complete without at least a mention of the bank frauds and illegal actions that are now merely a cost of doing business: Helping Mexican drug dealers launder money (HSBC); funneling cash to Iran (Standard Chartered); LIBOR fraud (Barclays and a cast of dozens); falsifying mortgage records/improperly foreclosing on borrowers (all the giant banks); routinely misleading clients (Merrill, Morgan Stanley, Citi); Selling securities known to be garbage (Goldman Sachs, Merrill); secretly betting against clients to profit from their ignorance (Goldman Sachs).

Two discussion lines in the article stood out: The first is the number of former bankers now calling for a break up of the giant money center banks: Philip Purcell (ex-CEO of Morgan Stanley Dean Witter), Sallie Krawcheck (ex-CFO of Citigroup), David Komansky (ex-CEO of Merrill Lynch), and John Reed (former co‑CEO of Citigroup). Sandy Weill, another ex-CEO of Citigroup.

The second is the heart of the article: How opaque, misleading, non-disclosing and — WTF, let’s just say it — fraudulent bank balance sheets are.

Perhaps the most damning quote in the entire column comes from former Federal Reserve Board member Kevin Warsh. He suggested that the financial statements a big bank files with the SEC are worthless:

“Investors can’t truly understand the nature and quality of the assets and liabilities. They can’t readily assess the reliability of the capital to offset real losses. They can’t assess the underlying sources of the firms’ profits. The disclosure obfuscates more than it informs, and the government is not just permitting it but seems to be encouraging it.”

That is a damning statement.

If the first rule of investing is know what you own, than how can anyone credibly own a major money center bank? The answer, at least for me, is that you cannot — owning bank stocks is not investing, it is pure speculation.

Who wants to make a bet that insiders are going to act in good faith on what is an investor’s best interests?

Not me. If that means I miss a sector that did well last year, it is something I have to live with. . .



What’s Inside America’s Banks?
By Frank Partnoy and Jesse Eisinger
ATLANTIC MAGAZINE, January/February 2013

Category: Bailouts, Credit, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

23 Responses to “Big Banks Are “Black Boxes,” Disclosure is “Woeful””

  1. TLH says:

    The only solution is to cut their leverage.

  2. PeterR says:

    Always remember the Golden Rule: “He who has the gold makes the rule!”

    Or, at the risk of an echo here, as HAL said (2001 A Space Odyssey), “I am putting myself to the fullest possible use, which is all I think that any conscious entity can ever hope to do.”

  3. newton says:

    Great image (Jacqueline Martin/AP) leading the article. Left hand doesn’t know, or even cares, what the right hand is doing.

  4. Orange14 says:

    Warren Buffet seems pretty comfortable with his Wells Fargo investment (I am as well though I don’t have nearly the holding amount he does).

  5. mwbugg says:

    Warren Buffet has stated he only buys things he understands. He owns large stakes in Wells Fargo and Bank of America. Their financial statements appear incomprehensible to mere mortals. How to square this circle? Warren Buffet must be immortal.

  6. Petey Wheatstraw says:

    Drag it all into the light of day for the perusal by anyone, and the scam can be untangled. The source of the dangers to our economy aren’t too difficult to expose – its the resulting claw-back of “wealth” that would be lost by those who perpetrated the crime(s) in the first place, that TPTB are protecting.

    “No, American people, we will not let you check the evidence, because it’s far too difficult for our “experts,” much less the the likes of you, to understand. It our fiduciary responsibility to keep you in the dark. Trust us, this is all in your best interests.”

  7. AHodge says:

    bingo bingo
    i wont repeat my rants of the last three years
    except to say
    look at the individual derivative deals especially between two banks
    which like any counterparty transaction
    should be accounted equal and opposite on both sides?
    the regulators have the right to do this-
    no one bothers i kid you not.

    bad accounting is the dark heart of bad “banking”

  8. Jim67545 says:

    Banks deal in all sorts of speculative activity. Even small, simple, community banks engage in lending which is nothing more than speculation (understanding that speculation can be conservative or not.) Of course, one can perhaps grade the condition of a loan at a given point in time and mark the value to market but an infinite number of things happen as time moves on rendering any such momentary value obsolete. But, inability to accurately predict the future value of banks’ assets is the nature of the beast, not a failing. Come up with an accurate method to determine the future value of any asset (in banking assets or investment assets or horse races) and own the world.

  9. AHodge says:

    As to my former hero warren buffet
    i dont like the way he backs big banks either
    but for risk managment he may be mostly trading on govt backing?
    as a fun trade you can play with these guys
    i still own Fannie- the worst company in the world by certain metrics-on similar principals
    related to todays bank accounting article
    further proof warren has no interest in enlightening the unwashed on accounting
    even if he gets it
    would be his frequent lack of interest in marking, even traded equities.

  10. 70 Boy says:

    To a great extent, regulators encourage and enable the black box nature of all banks’ accounting. There is very little of a qualitative nature regarding asset quality in bank’s financial disclosures because regulators fear if the truth were known, it would lead to runs against weak banks. This long standing approach has some how been applied to other kinds of risk. The TBTF banks are repositories of such immense, convoluted and interrelated risks (credit, currency, sovereign, counter party, basis, interest rate, liquidity – to name a few) that they are only marginally manageable from a risk perspective.


    BR: Your only error is thinking of the regulators as outside, independent entities. Instead, consider them a wholly owned division of the banks. Once you accept that fate, you can understand whats really going on . . .

  11. AHodge says:

    to be clear
    Im talking about Warrens bad accounting
    and not marking his own Berkshire hathaway assets when he should.

  12. ConscienceofaConservative says:

    A couple of comments spring to mind.
    First suddenly the banks are considered dividend plays according to Chris Whalen. When did they become solvent? It seems the longer we repeat the lie, it suddently becomes true or perceived as true.
    Second, it seems to me the opacity originates in part by the complex ways regulators allow banks to classify and value assets and the entire fractiona reserve system at the heart of our banking system.
    Third even today we don’t have pricing transparency of finanical instruments. As an example FINRA trace on the reporting of mortgage backed and asset backed security pricing allows the banks to so genericize the instrument as to make the price meaningless.

  13. AHodge says:

    Warsh apparently from quote above
    forgot to mention
    regulators are subject to exactly the same accounting induced ignorance blindness or being outright misled
    that the investors he is worried about are

  14. constantnormal says:

    … you can add “accounting is fraudulent” to that list … courtesy of FASB 157 …

  15. rd says:

    The financial system will not be stable until the individuals in it believe that fraud and money laundering will get you indicted and sent to jail. We will have to wait for a future Administration before this might occur since Obama, Holder, and Geithner have shown themselves unwilling to even investigate fraud and have refused to prosecute crimes such as money laundering (sorry – hitting bank investors with a “cost of doing business” fine is not prosecution).

  16. carleric says:

    I don’t own any financials and don’t want any. Why would anyone own something they don’t understand or can even decipher? Oh that’s right some sell-side clown (see Dick Bove) recommended them to the unwashed and unaware…how pathetic

  17. 873450 says:

    Illegally conspire with a 3rd party hedge fund to assemble, rate, recommend, sell, bet against and obscenely profit when the synthetic debt instrument it engineered to fail fails. (Goldman Sachs)

    Stop whining when a vampire squid makes a mess and tell it how much a civil penalty without acknowledging malfeasance will cost so it can get back to doing God’s work.

  18. [...] Quote of the morning re: banks and fraud Posted on January 3, 2013 by thecrosspollinator From here: [...]

  19. Gary says:

    Interesting that this article came out. Andrew Haldane from the Bank of England mentioned some time ago that banks were essentially black boxes. It makes one wonder, as TYI, LLC blog has argued extensively, whether Basel III level of capital have any real meaning. After all, if the balance sheets are indeed black boxes, then of what consequence is the stated level of capital, which is nothing more than an accounting construct?

    Field has a blog entry on this article that is interesting by the way:

  20. pdtrader says:

    ConscienceofaConservative – I agree completely with what you’re saying; however, I also think there’s a difference between the solvency (or lack thereof) of banks and how their stocks are traded.

    I always laugh when I hear analyst after analyst parade through CNBC, talking about how banks have shored up their balance sheets. When you have trillions in liabilities, your balance sheet is a pile of toxic garbage. The markets, however, seem to think otherwise.

    Personally, I believe that just one crucial step can significantly reform the banking sector.

    Outlaw all OTC derivatives, period. While they have their uses, they are far too dangerous, too opaque and utterly impossible to police. Exchange-traded derivatives require the putting up of margin and twice-daily position marking. In other words, you have to eat your losses. Immediately. Instead of burying them in some off-balance sheet SPV even Stephen Hawking couldn’t understand.

    Banks would no longer be able to lever up on opaque trades that don’t have to be recognized. Losses would have to be paid for every single day, rather than marked to some mythical model. Currently, banks not only can bury losses, but they can mark their trades as “assets” which can then be used as collateral to take on even more leverage. And the only thing backing the entire operation up is customer deposits.

    The whole thing is insane. The banking sector has far outgrown its usefulness. It is intended to finance real economic activity, not to be that activity all by itself.

  21. Jim67545 says:

    I wonder if accountants, asked if any huge corporation (GM, GE, BA, etc.) is to them a black box, might not concede that it is. How much knowledge did the accounting firm for WMT have of the use of funds for bribery? The bigger the firm and the greater the moving parts the less the accountants (or regulators) explicitly know.

  22. [...] Rithotz, CEO and director of equity research at Fusion IQ, commenting upon the article summed up investor’s skepticism in the banking sector succinctly: Banks are essentially opaque black [...]