The Wall Street Journal Finally Catches Up On Its "Jonathan Weil" Reading

Tyler Durden's picture

Two months ago Bloomberg's Jonathan Weil brought up the very relevant topic of fair value divergences on bank balance sheets courtesy of SFAS 107 and lax accounting firm standards (some more lax than others). Zero Hedge immediately followed up on this theme and presented a comparative analysis of various bank asset shortfalls, speculating that certain accounting firms are doing their best to do an Arthur Andersen redux for Generation Bailout. On October 15 we said: "Just what about the economic environment has given Citi auditors
KPMG the flawed idea that the bank's loan can be easily offloaded with
virtually no discount? And just how much managerial whispering has gone
into this particular decision. If one assumes a comparable
deterioration for the Citi loan book as for the other big 4 firms, and
extrapolates the 2.8% getting worse by the average 1.5% decline, one
would end up with a 4.2% Book-to-FV deterioration. On $602 billion of
loan at Q2, this implies a major $25 billion haircut. Yet this much
more realistic number is completely ignored courtesy of some very
flexible interpretation of fair value accounting rules at KPMG. Maybe
Citi and its accountants should take a hint from Regions Financial CEO
Dowd Ritter who carries the FV of his $90.9 billion loan book value at
a 25% discount." Today, finally, after a two month delay, these two articles seem to have finally made the inbox of the financial gurus at the Wall Street Journal, which, in an article named "Accounting for the bank's value gaps," says: "can investors count on consistency when it comes to bank accounting? As
many banks struggle with piles of bad loans, it appears some auditors
are being stricter than others when assessing their true value." Way to be on top of that ball WSJ/Mike Rapaport. Nonetheless, we are happy that this very critical topic, is finally starting to get the due and proper, if largely delayed and uncredited, attention it deserves.

Rapaport says:

Among the top-25 U.S.-owned commercial banks, those five Ernst and
Deloitte clients accounted for five of the six biggest gaps between
fair value and cost as of Sept. 30. The average gap among Ernst and
Deloitte clients in the 25-bank group was about 6%; among clients of
PriceWaterhouseCoopers and KPMG, it was about 2%.

Those differences can affect how investors view a bank's loan
portfolio, and could have a concrete effect on regulatory capital in
the future. The Financial Accounting Standards Board is considering
changes in banks' accounting for loans and may require them to carry
loans on the balance sheet at fair value instead of cost.

If that happened, the current fair-value declines could reduce
shareholder equity and regulatory capital—in some cases, to levels
regulators would find troublesome. At Regions, the $16.9 billion gap
between its loans' fair value and carrying value would wipe out its $13
billion in Tier 1 capital using a fair-value balance-sheet standard.
Huntington, Key and M&I would see Tier 1 capital slashed to low
levels. SunTrust would see a major Tier 1 reduction also.

Rapaport even provides a fancy graphic, which is eerily reminiscent to the one posted on ZH 10 weeks ago.



On the other hand you have Pimco (see prior post) claiming that investors can't go wrong by throwing their money at banks and their thoroughly mismarked balance sheets (and facing massive debt rollover risk: if rates really skyrocket as MS expects, we wish banks the best of luck as they face a maturity crunch. Has it occurred to anyone that banks are hording cash simply to be able to repay debt as it matures instead of refinancing? We will have quite a bit more to say on this topic very shortly). In the meantime, we lament the complete ignorance by the investing public of anything that is based on fundamentals (the government will bail them out after all), with only momentum and mass melt-up hysteria determining investing decisions.

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Anonymous's picture

I am sure KPMG's creativity has the approval of Timmy G and SheBair. Gubmint endorsed fraud. Nothing to see here.

HEHEHE's picture

I am sure KPMG's creativity has the approval of Timmy G and SheBair.  Gubmint endorsed fraud.  Nothing to see here.

MarketTruth's picture

Agree, though would call it massive fraud to cover what little assets the FDIC has. Face the facts, the banksters are beyond broke and the FDIC is knowingly allowing this fraud to continue nearly unabated. It does not take a rocket scientist to realize this fact.

Am sure everyone here at ZH has seen the FDIC numbers when they close a bank how the bank's books/numbers are far off the real (much lower) value.

Daedal's picture

Those who can't do, teach. Those who can't teach, teach gym.

Those who can't do, audit. Those who can't audit, audit financial institutions.

Anonymous's picture

Thought the saying was: those who can't teach become school principals.

Anonymous's picture


One fatal flaw in public accounting (especially big 4) is the army of early 20-somethings that are doing the auditing. The experience to ask the right questions (generally) isn't there. The training is poor (despite all the hype) and the only real concern for most is the long hours (usually imposed by some unhappy middle manager, no fault of the firm itself).

Public = Good times!

deadhead's picture

From the article: "The Financial Accounting Standards Board is considering changes in banks' accounting for loans and may require them to carry loans on the balance sheet at fair value instead of cost."

Is the author reporting that FASB is considering a reversion to the original mark to market concept of FASB FAS 157?

Cognitive Dissonance's picture

If PIMCO and company can pump up corporate (meaning non governmental) debt, it will be to the banks advantage to switch back to mark to market. Mark to model when the value of debt goes down, mark to market when it goes up.

It's called having your cake and eating it too.

BTW deadhead, thank you for your always thoughtful and passionate comments.

deadhead's picture

I always appreciate and read your insights CD.



Giovanni Zucchetti's picture

You know how valuable their loans are?  Seriously?

Should the gap have been consistent across all banks and all accounting firms? If it were, I think I might be mightily more concerned.


rapier's picture

Let's get a grip guys. Honest accounting will destroy confidence. They are lying. We know they are lying. They know we know they are lying. Confidence is maintained. Confidence that lies will be accepted as truth is the lynch pin of all mature political economies.

The storm has passed. The old lies forgotten and new ones made to replace them. Say hello to another up cycle.

Daedal's picture


Don't confuse confidence with blind faith.

If confidence manifests itself out of the need for comfort, and not out of an underlying logical reasoning, then nothing has changed.

Any 'leg up' that you see as a result is nothing more than a paper tiger.

Cognitive Dissonance's picture

"Confidence that lies will be accepted as truth is the lynch pin of all mature political economies."

While I tend to agree with your statement, may I amend or embellish your statement?

Confidence that lies will be accepted as truth is the lynch pin of all mature and corrupt political economies, all of which resort to citizen cannibalism and oppression during their final death spiral.

perpetual-runner-up's picture

let me add to yours....


"all of which resort to citizen cannibalism and oppression during their final death spiral."


is it a stretch to think that when it all comes to a head, given all of the travel restrictions and other things brought forward in teh name of making us safer end up in teh wrong hands as a virtual Berlin Wall???



Cognitive Dissonance's picture

"virtual Berlin Wall???"

It is so much more efficient and profitable when the slaves limit their own thoughts and action. This is why we are constantly presented with the "problem, reaction, solution" method of manipulation through the incremental tightening of the screws.

Take a look at the major cities in Great Britain if you wish to see the direction we're going. Wasn't it Kissinger who said during a speech some years ago that Americans will some day welcome armed (UN) troops in the city centers if they're convinced their freedom is in jeopardy?

Did you follow the latest "terror in the sky" incident over the weekend? I found it interesting that the so called terrorist was described as "dazed" and "confused" when the so called "bomb" fizzled. Another (drugged and/or mind controlled) patsy served up to frighten "we the people" into seceding some more freedom.

SWRichmond's picture

Take a look at the major cities in Great Britain if you wish to see the direction we're going.

Absolutely correct.  Advanced control and surveillance state, degenerating into a two-tiered society with gatekeepers.

Cognitive Dissonance's picture

"Advanced control and surveillance state, degenerating into a two-tiered society with gatekeepers."

I fully agree with you SWRichmond. In fact, based upon what has gone down over the past 10 years, I would say the only difference between where we are currently and where we are going is the word "advanced". Remove that word from your statement and you're describing 2009/2010 USA.

time123's picture

Accounting rules determine what the balance sheet and profitability looks like. Depending on the what the rule used is, the balance sheet can be quite different than what it appears to be. The rule change was a big reason banks became profitable so fast.


Giovanni Zucchetti's picture

It was also a big reason they became losers so fast.  Inaccuracy cuts both ways.

Daedal's picture

Accounting must be normalized by any analyst that is revewing a company. With a company like Wendy's it's fairly straightforward. When it comes to banks, however, the standard models do not adequetely account (normalize) for all the absurd assets and derivitives and off balance sheet activities.

Point being, it's not the accounting rules that are the problem per se, rather it's the type of rules. If you're using LIFO vs FIFO, you can normalize earnings any way you like because you know the rules and the impacts of the rules. What FASB did was suspending the rule of market value, which resulted in increased opacity. Essentially, you can't normalize because you have no frame of reference. 

When John Paulson tells me that BAC is making money, it's of little use to me b/c I still have no idea what's going on with the bulk of its balance sheet. That's like driving a car blind folded on the basis that it has antilock brakes.

dead hobo's picture

Auditors must consider the possibility of fraud in an engagement and they must discuss how to discover it during the audit planning stage. On the other hand, auditors are not fraud investigators. If the find fraud, they must report it to someone who in authority. They do not uncover all stones nor do they investigate like a cop would. They are not guarantors. Generally Accepted Auditing Standards provide a road map for how to audit properly and also provide high cover under the concept of 'due diligence'.

That being said, auditors must also verify that Generally Accepted Accounting Principles (GAAP) are followed. If there are material uncorrected violations, the audit opinion must be qualified or adverse.

Oddly enough, fraud that is properly disclosed in perfectly ok with respect to the auditor's report. Fraud generally involves improper financial reporting, either to cover up the fraud or because the fraud IS the bad reporting. If the fraud is properly disclosed and the financial statements accurately reflect it, an unqualified opinion will be a result. (PCAOB reporting standards require control failures to be reported if material and if the company is publicly traded).

Now, assume a world where GAAP is the fraud, and mark to make believe is an acceptable standard. In this case, you have a corrupt or captured FASB who, in a misguided attempt to protect the world from pervasive financial statement fraud in the form of phony asset valuations, IS the scapegoat AND the problem. Are bank balance sheets accurate? GAAP say 'Yes' so the auditors say 'no problems here' and remain safe in the process.

The truth is the rarest commodity in the world today. Thieves and their flunkys control much of the investment world. The theft is institutionalized when asset valuations are fiction, but this fiction is just fine according to the people who decide what a financial statement should say. (Or if the Fed says you can't audit it the part of their business it wants to hide.)

In a world where HFT stock flippers are the market makers and often the entire market, this is now the place where the average person is asked to put their life savings (for a 2% per year account management fee if you don't do it yourself). Accounting standards are flexible and supportive of the needs of the HFT stock flippers. So is Uncle Stupid. The media is uneducated and opinion driven to the point where opinion is frequently an acceptable substitute for facts. This cabal has been streamlined in 2009 to most efficiently enrich a select few on Wall Street and it's suburbs at the expense of everyone else.

Only an idiot would put their savings into a rigged game like this one. Day traders and range traders are excepted because they know the risk and are just trying to be on the good side of the skim. (I plan to range trade the coming roller coaster market I predicted yesterday). The real economy has left the station and won't return until the government and the markets favor people over financial crooks.

Cursive's picture

@dead hobo

You hit the nail on the head in paragraphs 3 and 4.  The auditors are the fraud enablers.  They just collect their fees and happily move along.  Accounting and auditing standards are a fraud.

Anonymous's picture

The cover-up of the insolvent banks is the most massive fraud ever in America. Aided and abetted by the government.

Cognitive Dissonance's picture

In a world where fiat currency has no basis in reality, it's all about perception. Get the herd moving towards "recovery" (regardless of an real signs of recovery) and people will start borrowing and spending again, creating said recovery.

Sure some cattle will get picked off on the edges and underlying inflation must increase dramatically over the next 10 years to inflate away all that new public and private debt. But perception is reality. If you can think it, you can make it so. Ya just gotta believe.

So fool, suspend disbelief and get with the program. You know how to do it. After all, you've been trained by the TV for 40 years. Think of reality as you think of reality TV. Reality is what I tell you it is. Now, how do I get the banks on board the gravy train?

dnarby's picture

You need at least 51% of the population believing we're recovering.

...Think we got that yet? XD

Cognitive Dissonance's picture


I understand your point but people don't need to believe we are recovering. They just need to act like we are recovering. I have many clients that don't think things are getting better but they're still spending (extra) money they feel they should be saving. When I ask why, the simple answer is because everyone else is.

Mindless cattle following the cattle in front of them over the cliff. It really is as simple as that for many people. Don't assume the average Joe is as aware or independent as you and I are because they aren't.

People often think that the crowd knows what its doing. This is the herd mentality that I talk about, the collective mind that suspends belief in order to be like others. It's almost like a trance.

I was talking to a client today who was very sure the recovery was not taking place. In the same breath, he said he saw a lot of people crowding a local restaurant and he wondered why they would spend money they didn't have. Of course he saw those people because he was having dinner at the same restaurant. His observations didn't apply to himself, just the others around him. People always believe they are the exception. This allows them to follow the herd but not be responsible for the herd, thus making the herd what it is, mindless.

Insanity. Collective insanity. 


Anonymous's picture

Jonathon Weil and David Reilly are the best financial journalists in the business.

Anonymous's picture

Liquidate the Zombies.

deadhead's picture

Auditors must consider the possibility of fraud in an engagement and they must discuss how to discover it during the audit planning stage. On the other hand, auditors are not fraud investigators. If the find fraud, they must report it to someone who in authority. They do not uncover all stones nor do they investigate like a cop would. They are not guarantors. Generally Accepted Auditing Standards provide a road map for how to audit properly and also provide high cover under the concept of 'due diligence'.

FASB FAS 157 modifications last spring gave an enormous amount of leeway to valuations.  Yes, fraud is one thing but valuing an asset worth 60 cents on the dollar at 95 cents is likely not fraud due to 157.  During the 157 debate this past spring, I recall that many of the large accounting firms wanted the revisions if for no other reason than to cover their asses from the directives of their paymasters, i.e. the cfo community of the banks.

Giovanni Zucchetti's picture

Why do you believe it was worth 60 cents on a dollar?  During the S&L crisis I watched the RTC sell property in Dallas for pennies on the dollar.  That was the market.  The people who bought those properties thought the values they were being sold at were insanely low, but that was the market (the buyers who thought the values were dead wrong ended up, of course, being supremely correct).  The market price is often just as dreamed up as the model price.

You think you know the value of these assets.  You don't.  FASB 157 was an adjustment to this reality: if we don't actually know, why are we acting like we do because acting like we do know the value is being supremely stupid. The value of these assets are at best a known unknown.  So if you know it's an unknown, is it prudent to destroy the bank?

dead hobo's picture

Your statements would be true in an active market. If mark to make believe has actual buyers and sellers as an offset, then it serves as an acceptable accommodation.

A temporary lack of buyers due to a massive injection of fear and uncertainty provides a good reason to keep mark to make believe as an accounting standard. It serves as a good backstop that prevents another economic fiasco such as the one promulgated by the naked shorts a couple of years ago.

At some point, reality must return to valuation. So far, this has not happened. There appears to be no plan in the future to allow valuations to honestly rise or fall to appropriate levels.

Commodities are overvalued due to inept market regulation and asset inflation. This has a crushing effect on those who make investment decisions that do not involve the flipping of paper assets. The Fed is said to hold an assortment of collateral that rises in value with the asset inflation it creates. It's value is stated in terms of both mark to make believe and bubble-nomics.

If assets are allowed to be valued by the market and are allowed to be sold at market prices, then mark to make believe should be nothing more than a temporary emergency measure Rather, it had become the status quo. Thus, it is a problem that allows bigger problems to be institutionalized in the economy. It is the tool of thieves.

dnarby's picture

Well, that's the problem you run into when you push inflation off into illiquid assets like real estate (intstead of currency)! XD

Anonymous's picture


First, FASB 157 was a necessary part in an engineered recovery. If we could stop the domino effect, we had a chance at righting the ship (or at least kicking the can down the road). In doing so, we (me and a couple other people) lost a significant degree of confidence in the financial reporting system and accounting profession, hence "stress tests" to restore said confidence (but it didnt work on me or the other people). We (our representatives) simply made the decision that the former was much more important than the latter.

Second, mark to market isn't anything new. Its predecessor was suspended in 1938 by FDR and reinstated in 2007. One might say its reinstatement precipitated the crash (one being the banks). One might also say its failure to be timely reinstated allowed incredible bubbles to form and presented an inaccurate account of the underlying banks' financial status. Tomato tomaato

Third, I'm not sure that we're forced into an either or situation. Many persons have suggested attempting to value many of these assets on exchanges, etc. In other words, maybe we don't need to throw the baby out with the bathwater and we can simply refine the mark to market rules to get a more accurate picture.

Last, as between the valuation of assets based upon mark to market and a post suspension valuation, which do you think would be closer? What is the purpose of financial reporting?

Ripped Chunk's picture

And therefore the principal that used to be called "conservatism" requires that those asset values be reduced to zero or a verifiable liquidation value. 

This game has been on for years. It is under the spotlight now because everyone knows that all loan portfolios are seriously impared across the entire banking AND insurance industries. Refusal to face the reality bolstered by spin is the game. A non performing loan becomes a performing one with "extend and pretend".

Reggie Middleton's picture

If you are holding a 2nd lien loan with a cost of $100k that is collateralized with a property that is worth $80k, what is that loan worth? It is uncollateralized, yet it is priced as if it was collateralized (because at some point, it was).

The market does have erratic shifts, but at the end of the day, when the need to liquidate an asset comes to fore, it is only the market that allows you to do it. There is no way around this. Those underwater second lien loans that are being priced purely off of cash flow models are inherently overpriced, even if payments are up to date. The chances are the loans will take a complete loss (capital), particularly the ones with 20 year maturities and higher that were only written a couple of years ago, thus the only value to be derived would be the cash flows recieved up to that event. While no on knows what that number will be, it is a prudent assumption that it won't be 97% of the cost of the loan.

Giovanni Zucchetti's picture

It depends on the assumptions in the cash-flow analysis.  Are the accounting firms demanding reality-based assumptions?  Probably more so than doom-and-gloom thinkers think.

Obviously horrendous mistakes have been made, but economic suicide is a long-term solution to a short-term problem, and that is, thankfully, one of the reality-based assumptions in the adjusted rule

I do not know how sophisticated pricing models are, but I somewhat feel lightly traded assets that are susceptible to periodic episodes of illiquidity never should have been marked to market in the first place.  There should be some sort of analytical buffer between the valuation of the asset and the emotionally volatile carbon-based processing unit - the human being. 


Cognitive Dissonance's picture

Sir, I take exception with this mess being explained as the outcome of "horrendous mistakes". I understand that there is not a clear cause and effect relationship that can be positively traced back to certain decisions. But those decisions, however they came about, were not "horrendous mistakes".

That's like saying the insurance fraud I tried to pull was a "horrendous mistake" or that date rape drug I slipped into her drink as a "horrendous mistake". I'm not beating you up. I just refuse to let the perpetrators of this disaster receive any slack in the hangman's rope what-so-ever.

Whether you ascribe to the "they let it happen", the "it was just animal spirits and greed" or the "they made it happen" explanation of events, "horrendous" and "mistake" are not the words to use together, at least in this case. This economic disaster is horrendous and it was a mistake for "we the people" to allow this to happen. 

Sorry for the rant.

Cursive's picture


Thanks for offering a look into the mind of a bulltard.  The circular logic in what you posted is unbelievable.  Is it prudent to destroy the bank?  The bank destroyed itself and it is taking the entire economy down with it.  Is it prudent to destroy Middle America to save the banksters?

dnarby's picture

More accurate to say:  Is it prudent to rescue the most incompetent and least productive businesses?

deadhead's picture

Why do you believe it was worth 60 cents on a dollar

I picked a number to use as an example.  Values are all over the place as all of us know.  I imagine the range on all asset classes is anywhere from pennies on the dollar to close to 100 cents on the dollar.

Anonymous's picture

"In the meantime, we lament the complete ignorance by the investing public of anything that is based on fundamentals..."

That says it all. When I first starting investing around 1980, the money supply was much talked about. There were no "hedonic adjustments" to CPI numbers. U-6 wasn't a banned term.

I guess the Aspirational Class can't stomach reality.

bokapita's picture

The entire purpose of accounting was to give a prudent assessment of a business's performance. But the money got to work and suddenly prudence as an accounting concept, profits only be profits when realmised in cash, and the non-inclusion of valuation "gains" in the profit statement all became victims. So the very profession whose job it was and is to protect and guard against stupidity and over-exuberance when commercial firms report their results SOLD ITSELF OUT.

Suddenly valuation "gains" however cobbled together they were became profits (in spite of actual cash generation being non existent) and once you have profits you have bonuses and large salaries and success and ... whoops we have shagged the economy. The accounting profession, had it held to its prudent roots, could have and would have stopped a great deal of the fraudulent "profit" reporting. But it chose to take the money along with everyone else like the rating agencies. Thank you FASB, thank you IASB, thank you leaders of the profession, thank you Big 4 managing partners.

So far the accounting profession has managed to completely escape its culpability, but in fact it is the most responsible, as it and only it, could have agreed to chnage the reporting practices that enabled the whole scam to flourish.

Rainman's picture

Ratings agencies and auditing firms are all over the place with valuations. It is no wonder there is so little faith out there from the knowledgeable investing public.

Nothing new here with the Big Accounting firms. Big clients have been calling the game since the Price Waterhouse/Penn Central shell game of nearly 40 years ago. Since then, the partnerships have been sued, dissolved and merged  routinely after busting out in settlements to angry shareholders and bondholders.

SEC is the controlling Federal agency over FASB. No surprises with the lapses and inconsistencies in financial reporting when you consider Mary's in charge.   

Cursive's picture

I remember when Enron was the foulest company in the history of business.  I didn't see anyone defending Enron.  Now that the banksters are having their turn and outdoing Enron on a magnitude of 40 to 50 times, I think a lot of America owes Enron and, in particular, the Enron employees and shareholders, an apology.

Anonymous's picture


All these companies, including ENRON, are guilty of fraud and as such need to be exposed and their executives proseccuted.

No apology. Ken Lay is dead and that's too bad. I'd like to see him in some Mexican jail along with his henchmen and the likes of Hank Paulson, Bob Rubin, Alan Greenspan, and all the assholes who don't earn more than minimum wage taking out $300,000 mortgages AND those who gave no doc loans to them, along with all the others who got bailed out courtesy of the careful, the diligent, and the savers.

Fuck 'em all.