Guest Post: "Extend and Pretend": Where Are We After One Year Of The Suspension Of FASB Rules?

Tyler Durden's picture

Submitted by Gonzalo Lira

"Extend and Pretend": Where Are We After One Year Of The Suspension Of FASB Rules?

In 1982, many of the banks hit by the Latin American debt crisis were effectively insolvent. Paul Volcker, as the then-Chairman of the Federal Reserve—charged with overseeing the banking system—effectively cast a blind eye on this banking insolvency.

Volcker’s reasoning seems to have been that the US banks were not broke—they were just getting temporarily squeezed. Volcker seems to have concluded that time would heal the balance sheet wounds caused by the Latin American defaults. Therefore, to hold the banks to the letter of the accounting rules would likely drive one or more of them broke, to no useful purpose—and it could potentially cause a bank panic and general financial crisis. But to pretend (for a while) that all was right with the US banks would avoid a potential panic—so long as the crisis sorted itself out and the banks repaired themselves by writing off and renegotiating their toxic Latin American debt.

Volcker gambled, and won: The US banks indeed took the Latin American debt hit, but grew their way out of their hole. None of the large American banks were pushed to bankruptcy in 1982, and by 1983, the worst had passed. By 1984, the biggest chunks of Latin American debt had either been renegotiated or written off—so far as the American banking system was concerned, the crisis was over, with not a single name bank going broke. And most importantly, stability and calm reigning all the while.

Score for Volcker and what we could say was the Volcker Call.

In 2008, when Lehman went bankrupt because of all the “toxic assets” on its balance sheet, the severe credit crisis that happened as a result was because everyone realized that Lehman was the canary in the coal mine. All of the American banking system was insolvent, for more or less the same reason: Assets on their books simply were not worth anything close to their nominal value. These assets were clustered around CDO’s, mostly in the real estate and commercial real estate markets.

To relieve the credit crunch that peaked in September, 2008, the Federal Reserve Board opened the money spigots—all kinds of lending windows were opened, with a dizzying array of acronyms, all of them doing basically the same thing: Lending out wads of cash at zero interest to the American banking system, all in an effort to keep it from going broke.

Between September, 2008, and March 2009, the Fed backstopped the entire US banking system—but it still wasn’t enough. The losses were too great, the holes in the balance sheets too big.

So on April 2, 2009, a key FASB rule was suspended: Specifically, rule 157 was suspended, related to the marking of assets to market value—the so-called “mark to market” rule.

Essentially, the mark-to-market rule means marking an asset to the value it can fetch in the open market at the date of the accounting period. If I own a share of XYZ stock which I purchased at $100, but today it’s quoted at $60, I mark it on my books at today’s market price—$60—not at the purchase price—$100. The reason is obvious: By marking the asset to market value, I’m giving a realistic picture of the financial shape of my company or bank.

However, ever since April 2, 2009, when the FASB rules were suspended, the American banking system has been floating on nothing by air. By suspending rule 157, none of the banks have had to admit that they’re insolvent. With the suspension of mark-to-market, accounting rules are now basically mark-to-make-believe.

Why was FASB rule 157 suspended?

Geitner, Bernanke and Summers seem to have been trying to duplicate what Volcker did so successfully in 1982. This period since March 15, 2009, when the suspension of the rule went into effect, has been called “extend and pretend”.

Has it worked?

Prima facie, it would seem so. The banks seem to be stable, and have been raking in the big bucks ever since the rule was suspended. The markets—from their March ’09 lows—have rocketed onward and upward. In fact, Citigroup stock has quadrupled, Goldman Sachs has doubled—everything is wonderful! Nothing hurts!

However, the basic problems in the banking system remain: The banks are still broke, because of the same reason—the toxic assets on their books.

The banks have taken “extend and pretend” to heart—they have lobbied to extend the suspension of FASB, while they have pretended to repair their balance sheets, when in fact, they have not.

In fact, compared to the write-off mania of ’08, the banks have not written off any of these non-performing assets. They sit like dead weight on the balance sheets of the banks—we still do not have a clear grasp of even how much of this garbage is still lurking out there, like turds in the Venice canals, because of the obfuscation of the basic accounting rules—an obfuscation which the banks insist on perpetuating.

The banks still have the holes in their balance sheets which caused the crisis in 2008.

But then, how have the banks made such staggering profits during the last year?

By trading. Instead of being banks, since March of ’09, the Big Six US banks have effectively become hedge funds. They have been trading themselves into profitability. Worst of all, these banks qua hedge funds have been making money by trading with each other. Price-to-earnings ratios bear this out—their general upward trend, across sectors and industries, even as the economy has been severely weakened, is indicative of a speculative bubble. A massive bubble—the kind that makes the Hindenburg look puny.

All of the markets have risen from their March ’09 lows because of what I would term musical chair trading—everyone makes money so long as the music doesn’t stop. The “music” of this metaphor is a combination of Uncle Ben’s easy money, relative calm in the world, and good ol’ “extend and pretend”, courtesy of FASB.

But when the music does stop, the banks are going to realize that it’s not that there’s one less chair in the circle. There are no chairs left.

That when the next crisis will hit—when the music stops, and everyone rushes to get out of their musical chair trading positions.

To continue with the analogy, when will the music stop? When will everyone rush to find a seat—and find that there are none left? My guess is, it will be something from left field, something in-and-of itself not particularly earthshattering: A punitive Israeli airstrike against Iran, say, or Somali pirates sinking a big oil tanker. A lousy consumer sentiment number, or a surprise burst of unemployment.

Why hasn’t Team Obama’s version of the Volcker Call worked? Simple—because Paul Volcker made it clear to the banks in ’82 that he would declare them insolvent, if they didn’t repair their balance sheets. Volcker scared the bankers, scared them enough to make then do what was necessary—which was to clean up their balance sheets.

What did Team Obama do 27 years later? Did they twist bankers’ arms, and force them to write off the garbage on their balance sheets?

No they did not. Instead, they bowed and scraped at the banksters, as if they were truly Masters of the Universe, instead of what they really are—scum of the earth dressed up in really nice suits.

In 1982—unlike 2009—the banks had a reason to try to renegotiate and write off the bad Latin American loans: Volcker was breathing down their collective necks, and the banks were scared of him. Volcker had a credibility then that Team Obama today does not have now—Volcker showed himself willing to bring the entire US economy to a halt, in order to purge inflation. What was putting a few big banks out of business, compared to that? Nothing—catnip for Volcker.

But Geitner, Bernanke and Summers have shown themselves willing to do anything for the banks—they’ve become twisted around, and come to think of the banks as ends-in-themselves, rather than means-to-ends, within the economy.

What should have happened starting in March of ’09 was for the banks to take the suspension of mark-to-market and used it to purge their balance sheets of all the crap they are still carrying.

But they did not. Nor will they. Because no one is forcing them to. No one forced them in April of ’09, no one is forcing them now in April of ’10.

Therefore, once the era of Musical Chair Trading ends with some ridiculous non-event that will send everyone panicking, the banking sector will be right back where it was on Septmber 18, 2008—the only difference, of course, being that Bernanke has already shot his wad, and politically, it will be impossible to pass another TARP.

That’s when the world ends—the second crisis will be loads worse than the one in the fall of ’08. Loads worse, even, than ’29.

When will it happen? I don’t know. Then again, I don’t know when the Yankees will next win the Pennant—but I’m pretty sure it’ll happen.

“Extend and pretend” could have been used to do what Volcker did in ’82—the Volcker Call. But Geitner, Bernanke, Summers, and ultimately Obama himself lacked the will or the gumption to force the banks to do what needed to be done—clean up their balance sheets. Write off all that crap.

So get ready: The countdown to oblivion was paused by “extend and pretend”—but it wasn’t suspended, much less averted. I don’t know if the end will be hyper-inflationary or mega-deflationary—all I know is that it’s gonna really suck.

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Sam Clemons's picture

The S&P is now chock-full of Enron's.  We tried spending our way to prosperity.  Lying will work better.

rubearish10's picture

Truth be Told. Lower lows forthcoming soon after this article reaches God's ears!

asteroids's picture

Doesn't FASB apply to every company not just the banks? How can you trust anything coming out of any company?

monopoly's picture

Excellent post. Will we ever see the truth in the mass media or does Brian Williams just keep smiling as the country disintegrates. When will the sheeples march with their pitch forks. I cannot believe America is lost, but it appears so.

BS Inc.'s picture

I really want to agree with the author's conclusions, but, come on, a Somali pirate sinking an oil tanker or a bad consumer confidence number (which of them hasn't been bad?) is going to do the trick?

I think it's going to take more than that. Something in the interest rate derivatives realm seems most likely at this point, given what I've seen written here. Who's leaning the wrong way on rates and super-levered up?

msorense's picture

I agree.  Only when the Fed is forced to raise interest rates will this sucker go down.  With 4.0% on the ten year we are close but we're not there yet.  I want to see it get up another 20-30 basis points at least. 

jschurchin's picture

I think the 10 yr will be the tipping point. When the auctions this week fail, which they will, the 10 yr will rise more then you think.

Sovereign debt will be the catalyst. Greece is buying the farm today, and so will we. The failure of Bernanke and this administration to reign in the fucking financial criminals, will lead to some very hard times for all of us.

percolator's picture

No doubt BS. 

The way the market has been reacting those events would cause stocks to explode higher.  I'm not sure even an interest rate derivative blowup can tank this market it might be good for a loss of say 0.00001% only if its not a Monday then of course stocks will be up!


if's picture

I would guess the final straw will be when we try to cure the global trade imbalances that support the current scheme of things.  As the imbalances with China and other Asian creditors fade they will no longer be amassing Dollar mountains that must be plowed into Treasuries.  That would lead to a very fast rise in long term rates and a subsequent re-pricing of Dollar denominated assets to reflect the now higher cost of capital.  If the Fed intervenes forcefully on the short end the Dollar craters.  

Bear's picture

Thanks so much for this great, simple, and concise post ... I'm forwarding it to others

Cookie's picture

'scum of the earth dressed up in really nice suits'

The best description yet for the banksters


Bear's picture

Well call them the ... the Ass ... Armani Squid Squad ... Led by the Great Donkey

Aeternus's picture

How do we know whether or not the banks have or have not been cleaning up there balance sheets since the rule was suspended?

Havn't they made enough money playing the stock market from the march lows till now to cover all of the toxic assets anyway?

rubearish10's picture

Well,they're many mortgage derivatives of which the pools are still mostly foreclosed and late paying. In addition, home prices are still depressed. So, my best guess is that the product is still in the muck!

Chito Campo's picture

It's inaccurate to say housing prices are depressed.  Prices are regressing to the mean after endless liquidity caused such distorted values.

As far as the article goes, I think the conclusion is flawed.  The system has been tweaked to allow all the cleansing of these bad assets from balance sheets.  Time is on their side, the longer they can keep another catastrophic failure from happening, the better the chance for overall success.  Foreclosures, bank owned sales, and short sales are happening as we speak - yes, it will be a long protracted process but there's a good chance it will be orderly.

docj's picture

The system has been tweaked to allow all the cleansing of these bad assets from balance sheets.

That has to be the most polite description of the massive, blatant and bold-faced government-sanctioned fraud we've witnessed over the last 2-years or so I've yet seen.

Extend and pretend, forever.  Swell.

nedwardkelly's picture

"The system has been tweaked to allow all the cleansing of these bad assets from balance sheets"

Or the government has just outright bought them.

All the 'toxic' assets that have been bought by the federal reserve are no longer on these banks balance sheets. So without a doubt they're in a better position than they were... So they're only still up the creek if the toxic assets that have been taken off their hands are a small proportion of what is out there.

Chito Campo's picture

Yeah, you're right, the government has bought them.  But remember 'toxic' means non-performing or underwater - the government buying them is a temporary measure in order provide some time for liquidation.  Go try to buy a short sale - they'll tell you it takes forever because the seller needs to sign off (they always do on a short sale), then the bank has to process your offer and decide if they want to realize the loss, and then they have to run it by the investor (i.e. the holder of the MBS or other security).  It's a long painful process, they can take months.

I'm not saying it's necessarily going to work, but the toxic assets won't sit on the bank or Fed balance sheet forever.

Attitude_Check's picture

And when they sell them at a 50% haircut, then what?

Chito Campo's picture

Then they lose.  But FASB suspending mark-to-market allows that to happen in a more controlled, predictible way.  They can sort out all their assets and get what they are actually worth.

Attitude_Check's picture

If the banks had been using their "profits" to deleverage you may be right -- except they aren't!  if the delever they make less money, so they have been paying out big bonuses to the "geniuses" that run them, and buying each other's junk.


They are all completely busted.

Chito Campo's picture

I'm not sure that's totally accurate.  I'm not defending the egregious use of bailout funds for bonuses - it's a deplorable breach of taxpayer's good faith.  But foreclosures are happening, banks are taking ownership of properties, and they are trying to sell short.  That's orderly.

If your argument is that banking should be re-regulated, I concur.  They should not be able to avoid deleveraging by other shenanigans.  Shadow banking is what created the whole mess.  I think that is a separate idea though from dealing with the toxic assets that are currently on the books.

delacroix's picture

we know they haven't sold the crap, because no one wants to buy it. ( except the fed )

PierreLegrand's picture

Why would they? Uncle Sugar using our hard-earned labor keeps bailing them out. Why would they spend money clearing up all this bad debt. These clowns will be long gone when the shit hits the fan. Even if they aren't they can talk their way out of any shit.

Keyser Soze's picture

And what about the government spending a trillion on MBS? Isn't that aimed at cleaning up the banks' nappies?

Matto's picture

While i dont disagree with the author, im wondering who he is?? im planning to pass this along to a few friends and family members and i know they'll be asking...

mikash99's picture

Now, if even one of the three monkeys (see no, hear no and especially speak no evil), could read and comprehend there might be a faint glimmer of hope.  But then again PIGS may fly.

George Washington's picture

This is a great essay.

junkyard dog's picture

The music will end when we verify that the US has only 800 tons of gold. The dollar will sink out of sight, the stock market will collapse and a loaf of bread will be $ 15.00.

Bear's picture

A multigrain gourmet loaf or Wonder bread?

msorense's picture

"What should have happened starting in March of ’09 was for the banks to take the suspension of mark-to-market and used it to purge their balance sheets of all the crap they are still carrying. "

Not true - they are dumping the shit onto the Fed's Balance Sheet and refinancing crap mortgages (ie. getting full value) through Fannie/Freddie.  They are cleaning up their balance sheets and dumping it all on the government/taxpayer.  The dollar in your pocket is now backed by their garbage.

Bear's picture

This is true; but, the Black Hole may be so large that the dumping of a few trillion does not put a dent into the 15 trillion (major portion of the reduction of American home values) insolvency problem.

williambanzai7's picture

We are going to learn first hand what it is like to experience what we warned the Indonesians, Koreans, Thais etc to avoid at all costs. A banking system filled with methane gas.

SofaPapa's picture

Nothing has changed in the past six months.  This was the argument then, and it is still the argument now.  I have agreed with it all along, but the miraculous bubble (at least in equities) just will not be popped.  The author doesn't add that the Fed may very well have a direct hand in inflating equity prices in addition to the private banks trading with each other.  This no-volume melt-up is quite a site to behold.  Terrifying, really.  And now back to our regularly scheduled "waiting for the trigger that brings this charade down".  Carry on.

excellent's picture

15000 more like it.

sweet ebony diamond's picture

it makes me sick.

someone has to force the banks to value their assets using common-law metrics.

Bear's picture

I agree ... every bank with which I deal forces me to state my assets at market value when I submit a balance sheet to them. Yes even the real estate holdings.

The FASB is so corrupt and weak ... Frank and Co cajoled and threatened them with annihilation if they did not cave ... they did 

Squid-puppets a-go-go's picture

Awesome article. But as for when the music stops, it still comes back to the $US as fiat global currency and without an alternative (sure aint gonna be the euro as we thought 2 years ago) the bubble's 'pop' is more likely going to be a slower tyre-puncture

CookieMonster's picture

The Resurrected markets are a hologram of Fiction, while Truth is crucified on a cross of Arrogance.

Hope your Easter (if you were one to celebrate it) was meaningful.

jmc8888's picture

Yep this author gets most of it. 

chindit13's picture

Not too much new here for ZH habituates, but reminders never hurt.

Two points to add: toxic asset levels, even if what existed back in late 2007 has been covered by gifts/trading profits (redundant?), the levels are not static. Things in both domestic and commercial RE, plus seconds related to both, have further deteriorated. Even the supposed stability in home prices as of late is an illusion based on the fact that banks are dragging their feet on foreclosures. Every single non-mortgage paying Free Renter is holding another bit of supply off the housing market. This is a second Shadow Inventory, joining those already foreclosed properties banks are holding back. Housing has a lot more to fall.

The second point is that the next step for banks will be trading toxic paper with each other at some above market price, taking whatever hit they have to take to qualify for the new mortgage assistance program, then writing a new mortgage with FHA backing. Thus, what's left rotting on banks' balance sheets will soon be rotting in the pockets of US taxpayers, as if we don't have enough already.

HEHEHE's picture

Perfect summary.  The new government "housing aid" is just a way to get the gubmint to swallow more bad bank loans.  The sheeple don't understand this because it's "too complicated".  Maybe if somebody responsible bought some ad space in the middle of Dancing With The Stars or American Idol and told the true story they'd WTF up.

Grifter's picture

Not too much new here for ZH habituates, but reminders never hurt.

Actually, I've been waiting for something concise & relatively easy to comprehend to come around so that I could use it as an intro to ZH for family & friends.  Much of what is discussed on this site is admittedly over my head, but I voraciously consume the content in an effort to promote a little dendrite growth.

Truth be told, I glean more from folks like yourself, Miles Kendig, Apocalypse Now, Cheeky, Cognitive D, Howard Beale, DeadHead, Cougar_W...I have a "Gang of 50" or so in the comments section that I usually scan for to get your take on the topic at hand, and as I'm at work and shouldn't even be typing this, apologies to the remaining 40 or so commenters that I can't immediately recall.

Anyway, I'll return to lurking now.  Thank you all, contributors and commentors alike, and of course TD(s)/Marla(s).

billwilson's picture

Yo...for Volker substitute Bernake! Why is Bernanke not down their throats. (I certainly don't remember Reagan being down the bankers' throats).

feeb's picture

I'm attending a lecture tomorrow night at GWU with FASB Chairman Robert Herz and IASB Chair Sir David Tweedie...any questions that the ZH community wants me to ask of either of them? Post them here, I'll check in tonight to see if there are any burning questions that just need to be asked. Right now the one question I plan to jump in with has to do with the coercion/influence posed by Congress (see Herz testimony on 3/12 I believe) along with the blatant conflict of virtually every single ITAC member.

sweet ebony diamond's picture

ask them what it is like to be complicit in the biggest theft in the history of mankind.

SofaPapa's picture

Phrase this as diplomatically as you like, but the question to me is whether they now intend for mark-to-myth to be permanent policy.  Was this suspension meant to be a temporary measure? If it was meant to be temporary, what's the timeframe?  Spitting in the wind, I suppose, but I'd be curious to hear their answer.

Alethiometer's picture

Of course the Obama administration didn't attach any bite to the bark of suspending MtoM, Wall St. and major corportate banks were some of his largest contributors!

I agree with the premise that the U.S. should have collapsed a few years back.  It should be collapsing now, but it isn't.  The U.S. isn't a country.  It's an empire.  A more proper designation for the United States would be Imperial America.  By virtue of our global reserve currency, our influence stretches across the earth in a manner only dreamed of by the Roman emperors.

What harkened the fall of Rome was a growing inability to finance empire.  We have no such problem.  Need more money, create more debt.  Sell the debt to your enemies.  Every decade our sprawl grows larger, and seemingly, no one is the wiser.  By 2030, trends continuing, we'll have conquered the Middle East.  Puppet regimes will slowly erode hundreds of years of culture and tradition.  Chai and hookahs will be replaced by Coca-Cola and Malboros.  Donkeys will be replaced by F150s.  Isreal will act like the eye of Saromon, it's gaze ensuring obedience and smooth transition.

aint no fortunate son's picture

Right before the fall of the Roman Empire there was the Colosseum and the gladiators. Today we have cage fighting. I have often gotten a good laugh out of that... and who says history doesn't repeat?