Weekend Economists Ring in the Old, Wring Out the New: Dec. 30, 2011 to Jan. 2, 2012

[Demeter]

142. The Miracle of (BANK) Solvency By David Malone

http://www.informationclearinghouse.info/article30140.htm

...Bankers have the Day of Reconciliation – when the year’s accounts must be reconciled, When all their deeds must be accounted for, all their actions weighed and a final reckoning made. So spare a thought this New Year for the auditors of Deloitte, PcW, Ernst & Young and of course, Ireland’s favourite, KPMG as they, in solemn convocation with Chief Risk Officers, Chief Finance Officers, of the world’s largest banks, perform the Ritual of Reconciliation and reveal, by the grace of creative accountancy, number massaging and rank but ordained lying, the great Miracle of Solvency once again. Sing Hallelujah!

For it is crunch time for year end accounts.

Deep inside every bank, dealers have been sitting, staring at their phones hoping the bank’s Risk Manager wouldn’t call them to ask what a certain trade they made this year was actually worth, what value should be booked for it and what risk weighting applied to it? For as we approach the Day of Reconcilliation the dealers must call up the details of the deals they did, the assets they bought and sold or lent or borrowed and account for them. The Bank’s CRO (Chief Risk Officer) must then, by law, satisfy him or herself that the numbers presented are true and the valuations fair and honest, and sign off on them accordingly. Whereupon, the CFO (Chief Finance Officer) must look upon the assembled accounts of all the actions of all the traders on all the trading desks and compile the bank’s accounts for the year, showing capital adequacy (enough capital to cover the bank’s liabilities as laid down in international law) and then these accounts must be passed to the ‘Independent’ Auditors for them to check and scrutinize till they too are wholly satisfied that the accounts present a true and faithful picture of the health of the bank...Once. long ago, the purpose of the ritual may have been to sort the solvent from the insolvent, the strong from the weak, but today it is about declaring that all banks are saved. None shall be forsaken. They are all to be declared solvent, none of them with a stain upon them. You might think I am being flippant but I’m not. Ask yourself how many of the auditors will find their clients insolvent? Or how many banks will appear in public in the coming weeks with accounts that show they are insolvent or even just in trouble? That is no longer what the ritual is about. The ritual is about finding how everyone is fine. Regardless of the fact, played out year after year, that within months, sometimes only weeks, of the miracle of solvency being proclaimed, banks will ‘unexpectedly find’ they need to raise more capital. These days the miracle does not last and wears off.

Not long ago I spoke to a senior risk manager of a German bank who described a particular incident from a year end reconciliation. He found a particular derivative trade that had to be accounted for, but the trader who had made the deal had left the bank some years earlier. No one knew the details of the trade and no one could value it. So the risk manager sought out the counter-party to the trade. Perhaps as the people owed the money, they would know, at the very least, what they were owed. It turned out to be a very large Swiss bank. Sadly for his New Year holiday, the Risk Manager found the trade had been booked in Singapore. He waited up and called. The Swiss Bank at first denied any knowledge of the trade. It was so long ago, they too had no recollection. However our Risk Manager couldn’t simply pretend it never happened. There was an accusingly empty box on the spread sheet. Eventually the Risk manager said, well my best guess – and it was a guess based on the imperfect paperwork of the original deal with no subsequent details of risks or changes in value – ‘My guess is we owe you X.’ To which the hugely brilliant and highly paid bankers who were owed this money said, ‘Yeah, fine. Let’s call it that’, and hung up. This isn’t hear say. It happened as described....The figure was duly inscribed in the ledger, the Risk Officer signed off, the CFO signed off, the auditors signed off, obligingly, for the clients who were paying them handsomely for this service, and the accounts were declared complete and perfect. They did the job they were designed for – to show the bank in its best possible light and obscure any irregularities or blemishes. And bonuses were lavished right and left. As it turns out this particular bank was anything but all right - Not that you would ever have told from those accounts - and eventually needed a vast bail out from the tax payers of the nation it was parasitizing.

And lets be clear about how serious the lies we are talking about are. The accounts are what investors use in order to decide if it is safe to invest in or lend to a bank. It wasn’t safe. But that fact was nowhere in those accounts. As it will not be in the accounts of any of the major banks of the western world this year, like last year, like the year before and the year before that. The culture, the religion, of lies and liars, is too powerful. The auditors are not there to reveal anything unpleasant about the banks. They work for the banks. Are paid by them and look forward to many more payments for many more accounts....

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