Archive for May 19th, 2009

Stress Tests Neglect Fair Value

Tuesday, May 19th, 2009

The Fed’s bank stress test results, released earlier this month, found 10 of the country’s largest banks need about $75 billion more in capital to survive another serious economic downturn. The results were met with positive spin from the Obama administration and ”sparked a new round of confidence in the sector.” However, according to Smeal’s Edward Ketz, the results point out the opposite: “The banking sector remains in serious trouble.”

More from Ketz and his recent column:

That the financial industry was and remains in trouble is not revelatory to those who pay attention to fair value measurements.  Take Citigroup for instance.  This firm, once a giant among banks, now gasps for its existence.

Citi’s reported net income was $(27,684) for 2008 (all accounting numbers in millions of dollars).  While this is a smelly number, the odor grows worse when one adjusts it for various items that bypass the income statement. If one adjusts this reported number for unrealized losses on available-for-sale securities, losses on the foreign currency translation adjustment, losses on cash flow hedges, losses for additional pension liability adjustments, actual returns on pension assets, and losses on hold-to-maturity securities, the actual loss becomes $(53,671).  It reveals that Citi lost twice as much as it reported.

Further, we have been hearing how Citi has turned things around and that the first quarter in 2009 returns Citi to the black column with a profit of $1,593.  It isn’t true.  If we make similar adjustments as described above and adjust for “nonperformance risk,” the quarterly results show a loss of $(10,284).

Citigroup suffered a cardiac arrest in 2008, and it remains in critical condition.  Any other conclusion is propaganda or self deception. And forget the stress tests; they are so flawed that Lehman Brothers might pass them.  The Fed says that Citi needs another $5,500 in capital to weather any additional economic crises it might face.  It isn’t true.  Citi needs a lot more capital than that just to weather current conditions. 

If you want to protect your portfolio, don’t listen to the optimistic forecasts coming from Washington and don’t stop at the reported income number.  Look at the fair value disclosures within SEC filings, adjust reported earnings for these fair value gains and losses, and then you will obtain the truth.

Tags: Accounting, Banking, Economic Crisis, Ketz, Politics
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