In 2007, the FASB, who sets the accounting rules for US companies, issued FAS Statement 157, “Fair Value Measurements” and mandated companies to adopt the rule. I believe this rule had a devastating impact on the banking industry and the overall economy. The rule requires companies to mark their securities based on the exit price (for an asset, the price at which it would be sold (bid price)) rather than an entry price (for an asset, the price at which it would be bought (ask price)), regardless of whether the entity plans to hold the asset for investment or resell it later. There is a fundamental flaw with this approach because it assumes that markets are efficient. The truth is that markets are enormously inefficient despite what the academics believe. To understand How FASB Madoffed the US banking system, you first have to understand what money is, and what banking system is.

What’s money?

If you are a merchant, accepting credit and debit cards is a must. After all, more and more Americans are paying with plastic nowadays. As a merchant, you can get free decals from Discover (DFS), AmEx (AXP) or Visa (V). But depending who you order your decal from, the order of the networks on the decal might be different. Can you guess where these decals they come from?

When management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it's the reputation of the business that remains intact.
- Warren Buffett

Eddie Lampert has a simple strategy when it comes to investing: Buy a large portion of stock in a particular company in which he can influence the management, cut expenses at the company and use the money to buy back stocks. He has been successful so far. Autozone (AZO) is a great example.

Bubble. It’s a word used often, but seldom defined. In economic textbooks, the term bubble never appears. Most academics don’t believe the existence of a bubble, since the financial markets are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information.

But in reality, for a market hypothesis to work effectively, we must have free flow of accurate information. And the critical piece of accurate information we never had, and never will have. The market is rather cyclical and emotional, but not efficient. I can list many instances of new media fabricating news, and exaggerating some story out of proportion. Chairman Mao once said, "a pen is more powerful than a gun". The Wall Street Journal and New York Times have been consistently fabricating “news”. Do you remember the New York Times “reporting” in late June  that US planned to attack Iran before Bush leaves office? That’s false, but it sent oil prices skyrocketing. And the Wall Street Journal “reporting” that Citigroup (C) lost $179 million in its Credit Card Master Trust Monday this week. In reality, Citigroup marked down its I.O strip in its trust by $179 million to reflect higher charge-off expectation. The Citigroup trust is on pace to earn $4 billion dollars for Citigroup this year.

The best time to buy is when we have a negativity bubble. This great nation of ours is in a deep pessimism. We have not seen consumer sentiment this low for decades (see following chart).

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Accounting is the language of business -- Warren Buffet

Bradley Keoun of Bloomberg just published a report on its website, "Citigroup Posts Loss on Credit-Card Securitizations", saying Citigroup Inc. (C) reported its first loss since at least 2005 on credit-card securitizations, signaling that risks may be growing in a business that generated $3.5 billion of revenue in the past three years. The biggest U.S. credit-card lender lost $176 million in the second quarter packaging card loans into securities, the company said  on August 1. The firm's results may portend similar losses for rivals.

It's very hard to find winners from the mortgage mess that we are currently in. Losers are well known - they are:

1. Mortgage lenders, e.g. Indymac (IMB), Countrywide (CFC). Majority of them are gone.

The Wall Street Journal and other media outlets have talked about the demise of the credit card industry for decades now. Yet credit card businesses are truly one of the best businesses I have ever seen. I can't find a single person in the news media positive about the credit card industry. And those people who are bearish on the credit card business simply never understand the economics of the business.

The credit card industry is one of the most profitable industries in the United States with annual earnings in the $30 billion range.  Many people might be surprised to learn that a single credit card issuer -- MBNA -- earned 1.5 times more profit than McDonald's (MCD) in 2004.  Citibank (C), another major credit card issuer, earns more profit than both Microsoft (MSFT) and Wal-Mart (WMT).

Most people religiously believe that Visa (V) and MasterCard (MA) are much better investment than Discover (DFS) and American Express (AXP). The consensus views are here:

1. Visa and MasterCard don’t have credit exposures to American consumers.
2.  Visa and MasterCard hold very large market share. In fact, Visa and MasterCard enjoyed over 80% of credit and debit card transactions
3. The economy is in a toilet, and more and more consumers fall behind mortgage and credit card payments. Why touch Discover and Amex?
4. Card payment transactions have increased double digits year after year, even during the economic slump.

All these arguments are true, except one small issue that most people overlooked: just how exactly each company makes its dough.