So, what do all the $12.7bn (€9.8bn, £8.7bn), and counting, in first-quarter profits from what used to be known as Wall Street add up to? Have the past two years been one giant head fake, despite what we have been led to believe? Is the global meltdown we have been subsidising with trillions of taxpayer dollars over? Is the investment bank back?
Not so fast. While global banking activity has picked up considerably since the financial ice age that followed the collapse of Lehman Brothers – the nadir was September 29, the day the US Congress failed to pass the first version of the troubled asset relief programme and the market plunged 778 points – the thaw has been aided and abetted by some very clever schemes.
First was the decision by the Federal Accounting Standards Board on April 2 to modify what many bankers considered the FASB’s onerous mark-to-market rules forcing securities firms to write down the value of their assets as they lost value in the increasingly illiquid market. (Seems like a reasonable idea to value assets at what they are really worth, no?) The FASB had been reviewing this change and received much commentary from the financial community “that asserted that fair value is not as relevant when financial markets are inactive or distressed”.
In other words, the rules were killing the banks’ balance sheets. A stroke of the pen could fix that. FASB’s decision – which allowed financial institutions to re-mark upwards the value of their portfolios of troubled assets– was retroactive to March 15, two weeks before the end of the first quarter of 2009.
Then a steady stream of first-quarter bank profits came in. On April 9, with very few specifics, Wells Fargo announced it had made $3bn in the first quarter . Goldman Sachs later pre-announced it had made $1.8bn. Then JPMorgan Chase said it had made $2.1bn. Citigroup, the biggest of the zombie banks, reported profits of $1.6bn. Bank of America logged profits of $4.25bn, while also conceding that nearly half the profit came from a mark-to-market gain at Merrill Lynch.
FASB does not get all the credit for helping to manufacture these profits, but it surely gets some of it. “We are an independent standard-setter and it’s important that we maintain our independence,” FASB board member Lawrence Smith told the Wall Street Journal, “[but the board can’t] ignore what’s going on around us” – a clear nod at the plaintive pleas from banks.
(What all this marking up of toxic assets on the banks’ books will mean for the US Treasury secretary Tim Geithner’s plan to encourage trading in these assets is another matter.)
The Federal Reserve has also been listening carefully to the banks’ pleas. It has lowered the cost of money it charges banks – and since all the big Wall Street securities firms are either gone or have become banks, this means virtually everyone – to close to zero. As one of the two largest costs a bank incurs is what it pays for money – the other being compensation, which has also been greatly reduced – it is not surprising the big banks found a way to make profits when their raw material costs shrank. Airlines could make money too, if jet fuel were free.
Then there is the sleight of hand, at least in the case of Goldman Sachs, which, when it converted from a securities firm to a bank holding company last autumn, changed its fiscal year-end to December 31 from November 30. Its first-quarter numbers, for the three months ended March 31 2009, did not include its horrific December results – into which Goldman threw everything but the kitchen sink – of a loss of more than $1bn. During the past seven months – including December (there was Christmas, right?) – Goldman in fact lost $1.5bn.
The problem with artificial stimuli and technicalities is not only that they do nothing to help capital markets recover in an honest way, but also that they mask what has been a trickle of genuine activity in the past few weeks. There were signs of life in mergers and acquisitions, with some $27bn of deals announced on Monday. Last week the long-dormant junk bond market saw $4bn of new issuance – from the likes of such leveraged credits as HCA, Crown Castle International and Seagate Technology. There were two initial public offerings as well; Rosetta Stone, a language software company, rose nearly 40 per cent on its first day of trading. Also, JPMorgan Chase, took the unusual step – for the first time in eight months – of issuing $3bn of 10-year bonds without the guarantee of the FDIC. Goldman made a similar move on January 29, when it sold $2bn of debt without government backing.
A true return of profitability on Wall Street will come with the return of public confidence in the way it does business. Concepts such as honesty and transparency are key, not a bunch of accounting gimmicks designed to manufacture profits and send markets soaring. The public will remain sceptical of the recovery – and the return of the investment banks – until then.
The writer is a contributing editor at Fortune and is the author of ‘House of Cards: a Tale of Hubris and Wretched Excess on Wall Street’
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