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Banks use rules to their advantage

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Kai Ryssdal: The subject readily at hand today in official Washington was the nomination of Sonia Sotomayor to the Supreme Court. But as it’s been for the past year or so, the subtext of a lot of the political discussions was the economy. Today in particular the financial system and how it ought to be regulated. A group led by a one-time Bush White House economic adviser, and commentator on this program named Glenn Hubbard weighed in today.

Hubbard’s group — the Committee on Capital Markets Regulation, it’s called — said the Federal Reserve ought to be the one keeping an eye on threats to the financial system, not a panel of regulators. Of course, that presumes that anyone can really see what’s really going on inside the banking and finance industry, given some of the complicated rules that govern them. Things like the purchase accounting rule. As Marketplace’s Jeremy Hobson explains now from New York, it’s making bank earnings look a whole lot sweeter than they otherwise would.

JEREMY HOBSON: First of all, in case purchase accounting isn’t part of your daily vocabulary, here’s an example from last fall.

STACEY VANEK-SMITH: Washington Mutual failed last night. Federal Regulators seized the bank and sold it to J.P. Morgan for just under $2 billion.

When that happened, J.P. Morgan was able to take advantage of an accounting rule and mark down all of the loans on WaMu’s balance sheet. And now, as the market improves, J.P. Morgan can start marking those loans right back up again. And make its own earnings look pretty great. Wells Fargo is doing the same with Wachovia’s assets. And PNC is doing it with National City. Will Schwartz at the rating agency DBRS says each institution uses its own criteria to value the loans at the time of purchase.

WILL SCHWARTZ: They try to estimate, and obviously the institution is motivated to be as aggressive as possible to mark down those assets upon closing, when they purchase the institution.

Schwartz says it’s not cheating. It’s just the way the accounting rules work.

SCHWARTZ: As long as people are aware of it, and as long as there’s disclosure, there shouldn’t be a problem.

Joshua Ronen, an accounting professor at NYU, agrees. But he says.

JOSHUA RONEN: I think we should approach this with professional skepticism. We should be careful to scrutinize these models. We don’t have access to them as outside investors, but the auditors do.

Ronan says it’s up to those auditors to keep shareholders well-informed. So they can tell the difference between good earnings, and an accounting trick.

In New York, I’m Jeremy Hobson for Marketplace.

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