Ken Lewis on Bank Accounting: Sensible Talk from a Surprising Source

Bank of America (BAC) CEO Ken Lewis and I have had our share of disagreements over the years. Still, Lewis’s comments on bank accounting, made at the Charlotte Chamber of Commerce’s Economic Outlook Conference yesterday, couldn’t be more on-point.

As reported in Thursday morning’s Charlotte Observer,

Lewis said two financial policies have contributed to the banking crisis. Market-to-market accounting rules require banks to value their assets based on a price they could immediately fetch, rather than their long-term value. That’s resulted in absurd short-term valuations, Lewis said.

Another problem is capital provisioning policies. ‘This idea of building reserves in the bad times and reducing reserves in the good times…. I don’t know how big a squirrel’s brain is, but a squirrel knows better than that,’ he said.”

Exactly right! Both mark-to-market accounting and the FASB’s ridiculous, upside-down rules on loss provisioning have served, to no good purpose, to unnecessarily depress bank earnings in 2008 and will continue to hold back bank earnings in 2009. Then those same rules will help drive an (also semi-artificial) earnings explosion later in 2009, 2010, and 2011.

If only Lewis had also mentioned that the behavior of the rating agencies during the credit crisis has been disgraceful and irresponsible and that the agencies should be stripped of their status as Nationally Recognized Statistical Rating Organizations, he’d have hit my trifecta, and I would have offered to buy him a beer! As it is, Lewis made a lot of sense yesterday, and raised some issues which more banking CEOs should be talking about, a lot more often.

Comments

[hwood007:]

After the fact, I could figure this out for myself. What we needed was some oversight, Congress or agencies, to see this coming and tell the press about what was going to happen. Congres has a brain bigger than that of a Squirrel but I hope one of them can think and pray it is not the squirrel. I know a social security crisis is coming and coming soon, like 2017 because the trust fund only has IOUs in it.

2008 Dec 05 09:38 AM

[Pj568:]

It seems quite rational that earning increase in good times and decrease during bad times. Why does Lewis and Brown think otherwise? The twisted squirrel analogy is weak.

There's nothing in the accounting rules that prevent companies from increasing capital during good times, when available & cheap (fall) and saving it for the bad times, not available and costly (winter). Isn't this really the message behind squirrel analogy?

What's sad is that the bankers seem to believe that the problem is in the accounting and not in common sense.

2008 Dec 05 10:53 AM

[M-P:]

Per other comments that Lewis has made, he often seems to be blaming things external to his firm and himself for BAC's issues. I'm not sure I find this comforting (cf. the language of Buffett in his annual reports). Bottom line, the mark to market is an issue because he bought highly risky assets that the firm didn't understand, with high levels of correlated risk. The reserve piece is not so atypical for a firm that is significantly impacted by the business cycle. The issue is to assume we will have "fat tails" and a black swan will happen. All reserves should have a contingency for those improbable events. Also, statements at one point in time are meaningless - let's look at the behavior and trail of statements to understand the real theme and message. A more holistic perspective and evidentiary base is needed.

2008 Dec 05 11:09 AM

[HBWOW:]

I am amazed Mr Lewis still has a job in light of his past and present management disabilities. The derivative gambling of excess bank funds in the past (known for years by him, fellow bank gamblers, Congress, analysts, brokers, Paulson, the Fed, etc.) has finally brought about the
financial mess we see today. Further Mr. Lewis most recently takes $5 billion of $18 billion bailout monies GIVEN him by Paulson/Ben on a NO
STRINGS attached basis and sends this money over to China (they don't have enough of our dollars as is) for investing in a China "bank" stock.
DOES he have that authority from the company, directors, and stockholders??? I humbly continue this action one of being unpatriotic.
Any wonder the public distrusts management, Wall Street, and government.
Tom, I would like to see your comments on this.

2008 Dec 05 11:25 AM

[Bonanza36:]

The only alternative to mark to market is mark to myth. That is what got us here in the first place. You can only play hide the weenie for so long. We know the crap sandwiches are there. Denying they exist thru elimination of mark to market is disingenuious at best.

Keep it up Tom, your pollyanish bleating on behalf of these deadman walking banks will be the financial death of your followers.

2008 Dec 06 10:21 AM

[User 305589:]

@Bonanza36: you have no clue about banking, do you? banks by definition of their economic purpose lend long, and mostly less liquid if not illiquid and borrow short and highly liquid. that transformation of maturities and liquidity is their major task. of course, these assets gets priced down BIG in a liquidity crisis and extra big in a full blown financial crisis like todays. imagine you had a home and a mortgage that would require mark-to market accounting for the value of your house. if that value falls below , say, 90% of the loan, you have to put up more money or have to repay the loan instantly. now, assume your neighbor has to sell his house, but as often these days, finds no buyer. the nouse gets sold for 50%. next thing you know, your bank calls you for repaying the loan or putting up an additional 100k in cash. because the bank, has to mark-to-market accounting, too.
genius, now tell me about the wisdom of universally enforced mark-to-nonfunctioning... again.

2008 Dec 10 09:15 AM