Secret Weapons of the Big Banks

June 21, 2009

Royal Bank of Canada by Rick OBrien

The huge chess game played in the financial sector by the American government and huge banks has been viewed by the entire world, but the number of people who are able to follow all the moves is declining steadily. Mergers, bailouts, write downs, bankruptcies – even veteran investors have trouble deciding correctly.

In recent weeks, some experts like Keith Fitz-Gerald have been warning the public that key players from the huge banks may use legal, but still not very “kosher” accounting techniques to improve their balance sheets instantly.

We are talking about booking of toxic assets, gained from the zombie banks like Wachovia or Washington Mutual. Some months ago, big banks like JP Morgan bought these bankrupted banks (JP bought Washington Mutual for $1.9 billion). During the acquisition, toxic securities were aggressively written down from their old book value (in JP’s case it was around -25%). Now, the situation changes - with signs of overall economic stabilization, these institutions are allowed to assign new values to these assets – the same ones which were bought just few months ago for a fragment of their “old” price. Now, their book value can jump suddenly in terms of dozens of billions during the lifetime of loans. When the borrowers start repaying their debts, income will shoot into the sky, resulting in huge profits.

Huge profits – that doesn’t sound bad in these times, does it? Well, not exactly. The motivation of the banks is quite clear. Profits and improved balance sheets can create an illusion of stability and potential growth, which will impact the share values and bank’s overall credibility and will smooth its earnings.

The main problem involved is in the value of toxic assets itself. Just using the magician’s stick management can erase and summon billions of dollars on the spot; numbers are not based on any real event. And we are back at the beginning – we have huge financial institutions adding zeros here and there and confusing investors. The possibility of full repayment of toxic assets is unsure and speculative. Instead of general cleaning, finance markets begin to build Potemkin villages again.

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