Goldman Sachs' magic trick - December disappears!

[Berkut]

Could you go over that again, but use simple words?

[The Minsky Moment]

Could you go over that again, but use simple words?

Borrow at 0.5%, lend the money out at 5%+ ---> make money.

I do share some of Martim's suspicions.  I agree that weakening mark to market risks making accounts more opaque and gives excuses to avoid further write-downs.  I do think there are still huge unrecognized losses lying around.  I am concerned about the very large goodwill assets that are still sitting on bank balance sheets when it should be clear these need to be written down.

But singling out Wells and Goldman is  . . . odd.  They are stronger than their competitors, and there is definitely a competitive advantage to that.  Kitchen sinking losses in late 08, while an obvious ploy to flatter later earnings result, is a much better approach than not doing the writedowns and sticking one's head in the sand.  It's not like anyone was fooled by Goldman's orphan month - the stock is down in anticipation of their planned equity offering -- investors know how to read a balance sheet.   I am far more worried about the continuing viability of the weaker players, whose stock has all gone up significantly in the last few months despite the fact that they live day-to-day on the sufferance of the Fed and Treasury.

[alfred russel]

I do share some of Martim's suspicions.  I agree that weakening mark to market risks making accounts more opaque and gives excuses to avoid further write-downs.  I do think there are still huge unrecognized losses lying around.  I am concerned about the very large goodwill assets that are still sitting on bank balance sheets when it should be clear these need to be written down.

So we finally get some insight into the impact of the accounting rule changes--Citi spelled them out in their press release announcing earnings (I believe they are the first financial institution to do so, though everyone will have to in their 10-Q).

Citi wrote:

"Citi adopted FASB's recent rule changes regarding fair valuation (FAS 157) and other than temporary impairments (FAS 115). The adoption of the changes to FAS 157 had no impact on Citi's financial results. The adoption of the changes to FAS 115 resulted in approximately $631 million pre-tax of lower impairment charges recorded in revenue in the current quarter. Additionally, the cumulative effect of the changes to FAS 115, which did not impact revenues, led to a $413 million after-tax increase in retained earnings and an offset in other comprehensive income on the balance sheet. "

My interpretation of this is as follows:

FAS 157 (the change in the fair value standard): no impact.

FAS 115 (the change in the recognition of losses for fair value): This is a bit less clear, but my interpretation is as follows:
a.) $631 of new asset impairments in the current quarter effected by new guidance (unchanged by the accounting rule change)
b.) The tax effected loss related to the $631 impairement: previously recorded in net income, now recorded in other comprehensive income
c.) The $413 million switch between retained earnings and other comprehensive income: this is a switch between two components of shareholders equity. It may have some significance for regulators, I don't know, but it is basically a balance sheet wash.

Bottom line: you get a reclass in P&L accounts between net income and other comprehensive income, and a reclass between two shareholder equity accounts. I don't see this as an earth shattering change.

[The Minsky Moment]

1)  Did FAS 157 have no impact because there is really no impact or because Citi was on the edge of skirting the rules before, and FAS157 gave then more breathing room?  The issue is that evaluation of assets is a continuous process.  Maybe you can convince your auditor to give you a pass in time X, but the auditor is going to be less forgiving in X+1.  But if rule clarifications give you cover in X+1 then a corrective that might have otherwise happened doesn't happen.  From the outside world's perspective, it looks like there is no change.

The real concern here is the corrosive effect of uncertainty - one can't really be sure what is going on under the hood, and comparability between similar institutions is compromised.

2)  Re FAS 115 I admit confusion.  The first line seems to indicate that the change resulted in $631M less in impairment charges than would have occurred absent the rule.  But I don't understand the offset to other comprehensive income.

[alfred russel]

1)  Did FAS 157 have no impact because there is really no impact or because Citi was on the edge of skirting the rules before, and FAS157 gave then more breathing room?  The issue is that evaluation of assets is a continuous process.  Maybe you can convince your auditor to give you a pass in time X, but the auditor is going to be less forgiving in X+1.  But if rule clarifications give you cover in X+1 then a corrective that might have otherwise happened doesn't happen.  From the outside world's perspective, it looks like there is no change.

The real concern here is the corrosive effect of uncertainty - one can't really be sure what is going on under the hood, and comparability between similar institutions is compromised.

2)  Re FAS 115 I admit confusion.  The first line seems to indicate that the change resulted in $631M less in impairment charges than would have occurred absent the rule.  But I don't understand the offset to other comprehensive income.

1) On 157, who knows. The clarified rule gives objective criteria for when a market is deemed not to be orderly. The standard before was much more subjective (the reason for the supposed need for new guidance was that auditors were insisting on the most conservative interpretation). Maybe they were pushing the limits of the more subjective standard before, all we know is that they say it didn't have an effect, and presumably they got their auditors to buy off on that statement. My take is that while I'm generally skeptical of the changes that are taking place, this one will improve comparability as it does remove some subjectivity.

2) It is because of the way the rule change was put in place. Their net income will be $631 million higher (less applicable taxes). This is going to boost their headline earnings number. However, the revised rule says that their assets still must be written down by $631 million. The accounting treatment under the revised rule is to run this writedown through other comprehensive income (net income plus other comprehensive income equals comprehensive income). That is more opaque, and if you only look at the earnings number (or PE ratio) will be misleading. However, on the balance sheet assets and liabilities won't be changed and all components of comprehensive income are disclosed.

[DGuller]

This discussion reminds of me of the actuarial exam I took that dealt with accounting.  I hope you two can live with yourselves for triggering suicidal thoughts in me.

[The Minsky Moment]

2) It is because of the way the rule change was put in place. Their net income will be $631 million higher (less applicable taxes). This is going to boost their headline earnings number. However, the revised rule says that their assets still must be written down by $631 million. The accounting treatment under the revised rule is to run this writedown through other comprehensive income (net income plus other comprehensive income equals comprehensive income). That is more opaque, and if you only look at the earnings number (or PE ratio) will be misleading. However, on the balance sheet assets and liabilities won't be changed and all components of comprehensive income are disclosed.

I understand now.

That is - I understand what you just said.  Not why FASB chose to do it this way.

[alfred russel]

I understand now.

That is - I understand what you just said.  Not why FASB chose to do it this way.

I don't think they wanted to--I think their take was that Congress was going to intervene if they didn't do something, and it was hard to do something constructive when the original basic premise was sound.

I do think it is a poor set of changes, btw, but ones we can live with and see the effects of.