Big Banks Still Manipulating Numbers To Make You Think They're Safer And Better Than They Are
Posted May 26, 2010 11:38am EDT by Henry Blodget in Investing, Banking
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In the wake of the collapse of the Lehman Brothers and the forced taxpayer rescue of most of Wall Street, bank accounting practices have come under increased scrutiny. And one major discovery has been that banks routinely manipulate their numbers at the end of each quarter to make themselves seem safer and less indebted than they are.
Specifically, studies have shown that most of the major banks often reduce the amount of money that they're borrowing at the end of each quarter, in order to make their balance sheets look prettier. Once the new quarter begins, they then crank up the leverage (and risk-taking) again.
A balance sheet provides a snapshot of a company's financial position at a single point in time--the last day of the quarter. So, in an extreme example, if a bank borrows (and bets) $30 for every $1 of capital for 89 days of the quarter but reduces its borrowings to $10 on the last day of the quarter, the balance sheet will only show the 10-to-1 debt to equity ratio, and not the 30-to-1 ratio.
As the banks are quick to point out, this manipulation is perfectly legal. It just provides a misleading impression of the actual riskiness of the bank. It also makes the bank appear to have a higher return on capital than it actually does (because the quarter's earnings, which are produced with the higher debt through the quarter, are then compared to the capital the bank has on hand at the end of the quarter).
A recent study by the Wall Street Journal reveals that, not only are banks still engaging in this practice, it has actually gotten worse in the past few years. Bank of America, Citigroup, and Deutsche Bank are among the worst offenders. Given that two of these banks took so much risk and did such a lousy job of managing their businesses that they had to be rescued by the taxpayers, we shouldn't be surprised.
Buen aporte.
