Marketplace Scratch Pad

I’m still not buying it

Scott Jagow Apr 14, 2009

Maybe I’m just being stubborn, but something still doesn’t seem right about these bank earnings. Goldman Sachs followed Wells Fargo with “better-than-expected” profits for the first quarter. New York Times reporter Floyd Norris summed it up while live-blogging Goldman’s conference call this morning: “One answer is that this is a great time to be in the banking business — if you ignore what we politely call legacy assets.”

By ignore, he means — assign new values to the toxic assets, based on the assumption that at some point, they will be worth more than they are now. It certainly was convenient that the Financial Accounting Standards Board relaxed mark-to-market rules just before first quarter earnings started coming out, and FASB allowed the banks to retroactively revalue their assets. It’s also convenient that Goldman reported the month of December apart from any quarterly results. Goldman lost more than $1 billion in December, a number that would’ve been higher had it not been for taxpayer-financed AIG unwinds on credit default swaps.

On Marketplace yesterday, banking analyst Dick Bove pointed out that competition in the banking sector has dried up. The survivors are in a better position to make profits. That makes sense. But he says:

DICK BOVE: You’ve got all these people shooting off their mouth, because of these hallucinogenic dreams that they have about where losses are in the banking system. They simply don’t want to look at what the real numbers show.

What are the real numbers? The truth is, we may never know because of this accounting rules change. It may turn out that the hallucinogenic dream is the value of these assets. Goldman denies it’s playing fast and loose with the books. I guess we shall see.

But even beyond accounting, Goldman’s business model is highly questionable. Clusterstock points out:

The performance of Goldman Sachs last quarter does nothing to resolve the long-standing debate about the viability of the business models of independent investment banks. It remains largely undiversified and highly leveraged, putting in question whether it is equipped to survive a major systemic financial crisis.

Another question: If Goldman is so profitable all of the sudden, why does it need to sell $5 billion worth of shares to raise money so it can pay back its TARP money? It’s diluting its own shareholders to do so.

The answer is: Goldman wants to be rid of the government ball and chain as quickly as possible. From the NY Times:

Goldman did not detail its reasons for wanting to return the TARP money, but the bank’s chief financial officer, David A. Viniar, addressed the topic at a conference in early February.

“We just think that operating our business without the government capital would be an easier thing to do,” Mr. Viniar said. “We’d be under less scrutiny, and under less pressure. Not that we’d be out of the public eye; we’re still going to be in the public eye.”

But Goldman won’t have any restraints on executive compensation. I don’t blame them for wanting to get out from under the government’s thumb. But I’d be pretty ticked if I was a Goldman shareholder. And as a taxpayer, I blame the government for allowing Goldman to get 100% of its money back on the AIG unwinds. A Businessweek column urges Goldman to give some of it back. Too late. The government blew that one:

If (Goldman CEO Lloyd) Blankfein really wants to help US taxpayers out, he can go the extra mile and give back some of that AIG money the firm got too. If the government had allowed AIG to file for bankruptcy, Goldman likely would have incurred an even bigger fourth quarter loss than it reported. So, Blankfein owes a bit of gratitude to Uncle Sam.

There’s just no getting around the asset problem. The real estate market did not improve in the first quarter. Prices are still falling. These mortgage-backed securities cannot possibly be in better condition. From the Huffington Post:

Either Wells Fargo found an amazingly disproportionate number of folks who are making mortgage payments, or some accounting gimmickry is at play.

“You can do all kinds of restructurings, this that and the other thing, to put things off for awhile. And the market they’re in did not do very well at all, so skepticism should be the order of the day,” said William Black, a top federal banking regulator during the S&L scandal.

“In sum, the banks are supposed to use their true best estimate each quarter of the losses,” said Douglass Elliot, a former J.P. Morgan investment banker who is now at the Brookings Institution. “That said, there can be a fair amount of judgment, since it is partly an estimate as to whether a borrower will be able to repay or not.”

It certainly is in the banks’ best interest to not fudge the numbers too much. Down the road, that could come back to bite them. From the WSJ’s Deal Journal blog:

Isn’t it just possible that business is very good for Wells Fargo? That cheap money from the Fed and fewer competing banks have given the big boys like Wells Fargo and J.P. Morgan a license to print profits, especially as the economy recovers?

Isn’t it just possible that a bank is simply telling the truth?

Yes, but it may be a very convenient truth, for now.

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