Posted by Karl Denninger
Jonathan Weil of Bloomberg has woken up to what I’ve written about for nearly three years now in The Ticker – that so-called “balance sheets” are and have been a pure act of fiction, yet it is impossible to find a cop anywhere.
Other banks, Paulson wrote, balked at an industry-backed rescue because “they knew that to make the math work, they would have to make a loan secured by assets worth much less than their stated value.” In describing one pile of bad investments, Paulson said these “had been carried by Lehman at $52 billion, but after their analyses the firms estimated their value at closer to $27 billion to $30 billion.”
In short, Paulson said, “the investment bank had been loaded with toxic assets worth far less than the value at which they were carried, creating a capital hole.”
Paulson’s account is as lucid an explanation of why Lehman blew up as anyone has written. It does leave you wondering, though, if it ever occurred to him to tell anyone at the Securities and Exchange Commission or the Justice Department that Lehman’s accounting might need to be investigated. His book provides no indication that he did.
Of course not.
That’s because Lehman is not the only bank involved here. Indeed, not only was this a past transgression it is clear that it’s a present transgression.
Was not the entire purpose of getting rid of “mark to market” accounting in early 2009, without which we were told the entire financial system would turn to slag and melt around our ankles, all about balance sheet fraud? About financial institutions that were carrying “assets” at values that could not then (and still cannot now) be justified based on their market price?
What else is “mark to market” but a demand that one’s balance sheet accurately reflect the market value of what you hold?
The requirement that publicly owned corporations disclose complete and accurate financial reports is part of the bedrock of U.S. securities laws. Just as important is the promise that the government will enforce those laws when they’ve been broken. Undermine the public’s faith in either of those functions, and confidence in the capital markets crumbles.
While I applaud Jonathan for coming to this conclusion he is nearly three years behind those of us who have been screaming about this very issue since 2007 – or even before.
Indeed, The Ticker began publication in no small part because this “little bitty bank” called Washington Mutual was paying dividends out of capitalized interest – that is, negative amortization – on loans to homeowners in California that were already underwater in 2007, and thus were rather unlikely to ever be paid – never mind that capitalized interest isn’t cash, it’s an accounting entry, yet you have to pay dividends with actual money!
This is at the root of why I have said for the last three years that it is not possible to invest in today’s capital markets, because it is not possible to trust a balance sheet.
Even companies that are allegedly “Strong” and have “No material exposure” are doing tricky things – witness CISCO’s recent disclosure that it is funding customer financing at below-market interest rates (zero!) with off-balance sheet vehicles.
We have learned exactly nothing from MCI/Worldcom and ENRON. We not only learned nothing we have allowed corporations to repeat the precise same sins that detonated both of those firms, we have papered over the losses and fictions that were hidden from investors and we have failed to hold executives and boards to account for committing this sort of trickery.
What’s worse is that we’re still doing it, nearly three years into this mess, and if anything the fictions that infest our corporate balance sheets in America have gotten worse, not better, in the intervening three years.
It is a fundamental tenet of the capital markets that one’s financial statements must accurately reflect all material income streams, exposures, liabilities and assets to which a firm is exposed in a form and fashion that they can be independently analyzed. Without this it is absolutely impossible to form an opinion that can be defended on the value of that entity, and thus their stock price and even their status as a going concern is nothing more or less than a casino game where the dealer has marked cards unknown to the player and can deal off the bottom of the deck besides – all with the knowing and willful blindness of the alleged authorities that are supposed to prevent this sort of raw abuse.
Update: Jonathan has taken apparent umbrage at my suggestion that he’s “late to the party” and has sent me a host of articles of his (some of which I’ve opined on in the past) representing his opinion on same. I maintain that this is the first time I recall him talking about The Justice Department – that is, possible criminal charges.
Lest one think that recognition is a bad thing I will say for the record that it most certainly is not and I hope it continues. I simply note that there have been damn few people asking where are the cops on any sort of consistent basis, and civil lawsuits (e.g. “Where’s the SEC?”) with their nearly-always-settled complaints that inevitably wind up being charged back to the shareholders, thereby abusing them twice, may be a good start but is nowhere near as good a tonic for the outrages we have suffered as a people as would be orange jumpsuits.