Does Anyone Else See This As A Problem?

Nomi Prins has gone through the SEC filings of three major banks, Bank of America, Citigroup and Wells Fargo. (The Daily Beast, "Worse Than Enron?" by Nomi Prins, 12/1/09) She’s been looking to see how much of the banks’ revenues are derived from trading (taking a risk) vs. other businesses. She’s found it difficult to get an answer, or at least she’s not finding what she thinks she should be finding. She accuses the banks of striving for opaqueness, rather than being transparent about how they are making money. She suspects that they are moving money around their balance sheets to make it appear like they are making a profit. She invokes the Enron scandal, where people didn’t understand how the company was making money. And in fact, it wasn’t.

“With taxpayers now on the hook, we need an objective, consistent evaluation of bank balance sheets complete with probing questions about trading and speculative revenues, allowing for comparisons across the banking industry. This lack of transparency leaves room to misrepresent risk and trading revenue.”

She may be right. (Not holding my breath here, waiting for companies to embrace transparency). However, the companies are (probably) faithfully following updated accounting rules, which the post-Enron changes were meant to address. She hits on something that I think is more revealing, however. She looks through the BOA/ML merged filings and is unable to find a breakout of trading account profits, which jumped from a $6 billion loss in 2008 to an almost $14 billion gain in 2009. Value at Risk (VaR) doubled between 2008 and 2009. “If I was CEO, I’d want to see this critical comparison on my own merged company filing.” She questions whether management has any idea of what is going on in their company.

I heard a regulator say the other night at an industry association gathering that he thought that boards of directors for financial institutions were full of people who didn’t have any idea of what risk really was. And he had talked to management at these companies who have basically said, “Why should we waste time trying to educate them about risk?”

There are at least two naked emperors here. First, the fact that accounting methods continue to be a game to be played instead of a reporting method that enables apples to apples comparisons and straightforward analysis is such an accepted fact that no one thinks to question it. But at least everyone plays the game, and, as Nomi provides an excellent example of, there are at least people critiquing the way some of the players behave, so we’ll leave this one for further discussion down the road.

Secondly, and this is actually fairly new: No one at the upper management level or the board of directors level really understand either the nature or the magnitude of risk the entire institution is taking, and no one wants to admit it. As the institutions get bigger and bigger, the certainty that there is no way to know the aggregate risk across the enterprise is even greater. And that doesn’t address the fact of whether the individuals in charge or sitting around the board table have a grasp of what risk means to that institution. And pretty much everyone in the industry knows it.