FINANCIAL HOUSE OF CARDS |

Previous Post: BUY NOW, SAVE LATER
Next Post: Our Race to Retirement

FINANCIAL HOUSE OF CARDS

Financial House of Cards

BLOGGER: BEN PIERSON

We have just seen earnings reports come from many of the major financial institutes and I thought it would be worth discussing their results. Frankly, they scare me a bit. The numbers they are reporting – especially the headline earnings per share numbers – are misleading. Based on how their stocks have reacted, people don’t generally seem to care either (update: up until today, that is). The system is now stacked to encourage this as well. We love watching our 401k accounts go up, not down. Politicians around the globe and the Financial institutions all want the public to believe the stimulus programs are working (to some extent they actually are) great, the banks are on the mend, and there’s light at the end of the tunnel. That way may prove correct, but the way companies have been slick-talking their earnings makes me wary this light might in fact be another train… and this whole process reminds me a lot of how we got into this mess in the first place.

I will try to take a tip from fellow blogger Arin Goldman’s piece, “Financialese Simplified” (http://blog.imagineage.com/financialese-simplified/) and keep this discussion so non-financial folks can understand. In other words, I’ll try to avoid using the kind of convoluted language and expressions the CEOs of these firms have been using. For example we have this gem from Citigroup’s CFO Ned Kelly:

“My suspicion is, and somebody will quickly correct me if I’m wrong, I think the marks by and large are basically booked in New York. The European results reflect the fact that the marks are booked in New York so the relative out performance of Europe on one level given that in terms of that $4.2 billion of traditionally disclosed marks is what drives that.”

Wow. If you’re reading that and thinking, ‘is this English?,’ the answer is no. It’s gibberish. More importantly the earnings numbers many of these firms presented are suspect as well.

Among the great headlines of the last week: Goldman Sachs reports $1.8 billion in earnings; Citigroup declared their Q1 2009 revenue exceeded that from Q1 2008 by a staggering 99%; Wells Fargo says they completed their most profitable quarter… EVER.

Does anyone care?

This optimism has been reflected in the stock market. As you can see here, since the market bottomed on March 9^th, financial shares have moved up at an incredible pace.

Now, I’m not saying these banks are doing anything illegal. However it’s important to understand some of what is going on under the hood. As the government has progressed through all these TALF, TARP, PIPP programs they’ve realized banks needed additional help. This help comes in the form of accounting regulations however, not cash. I won’t rehash Arin’s discussion (in the post linked to above) of mark to market accounting changes, but to summarize: the banks now have more discretion to price their own ‘toxic assets’. Some of these assets may be priced more accurately now, but some may also be marked worse. The point is that banks used huge changes in the way they priced their own assets to create some of the many gains in profit they are quick to brag about.

Jonathan Weil writes a great piece on Wells Fargo for Bloomberg.com: http://tinyurl.com/c3q2xa . This is a fairly understandable piece and worth a quick read. The crux of Wells Fargo – they reported great earnings, the stock went up 30% in one day (!), but these numbers were filled with more junk than a, errr, junk yard.

From Goldman Sachs:

Happy times! They reported $1.8 billion in earnings for the first quarter in 2009. Interesting, they decided to report their December earnings in a completely separate press release. Also of interest, they lost $800 million in December. So they report their bad month in a separate release and the good press release gets all the headlines. Coincidentally, they are also selling $5 billion in new stock now, thus a higher share price is much better for them.

Now contrast all these glowing earnings reports from Wells Fargo, Citigroup, Goldman Sachs to the candor coming from UBS. They reported a loss of $1.8 billion and their CEO admits that, “it will be a long road back to success without any quick fixes.” Now, I’m proud to be an American as well, but it’s not like UBS is much dumber than everyone else and that’s why they lost money this quarter. No, they are just being more straightforward.

Update: Bank of America’s numbers came out today and the market fell hard with the S&P 500 losing 4.3%. Bank of America dropped nearly 25% and many other banking stocks followed. Even though Bank of America had good earnings, they significantly increased their loan loss reserves – the amount of loans they don’t expect to get their money back on – to $13.4 billion.

Dangerous Times:

We’ll probably see this type of ebb and flow for a while, especially now with earnings numbers coming out. What Bank of America said, and what they reported in their finances, was not much different from what the other companies said…. Just today the market decided they were more fearful then greedy. Please don’t take this as investment advice. While I believe the banks are all in bad shape, the deck is also stacked in their favor. Hearken back to my post on incentive systems (http://blog.imagineage.com/?s=incentive+systems). Right now every global leader wants banks to look and act healthy. Every bank also wants to look and act healthy (UBS’s candor being an exception). As the numbers on the chart above show, these are very powerful cards.

Bottom line – or ‘net net’ as we say – the banks are very far from being out of the woods. These headlines on their earnings are misleading. This cavalier attitude of deception reminds me way too much of some reasons we got into this mess. There are many positive developments in the system, but this new course of deception is not one of them.

To find out more about Ben, click here.

To subscribe to get ImagineAge Updates, enter your email in the “subscribe” box on the left side of the screen. Your email will NOT be sold!