Worse Than Enron?

Enron was the financial scandal that kicked off the decade: a giant
energy trading company that appeared to be doing brilliantly-until we
finally noticed that it wasn't. It's largely been forgotten given the
wreckage that followed, and that's too bad: we may be repeating those
mistakes, on a far larger scale.

Specifically, as the largest Wall Street banks return to
profitability-in some cases, breaking records-they say everything is
rosy. They're lining up to pay back their TARP money and asking
Washington to back off. But why are they doing so well?
Remember that Enron got away with their illegalities so long because
their financials were so complicated that not even the analysts paid to
monitor the Houston-based trading giant could cogently explain how they
were making so much money.

After two weeks sifting through over one thousand pages of SEC
filings for the largest banks, I have the same concerns. While
Washington ponders what to do, or not do, about reforming Wall Street,
the nation's biggest banks, plumped up on government capital and
risk-infused trading profits, have been moving stuff around their
balance sheets like a multi-billion dollar musical chairs game.

I was trying to answer the simple question that you'd think
regulators should want to know: how much of each bank's revenue is
derived from trading (taking risk) vs. other businesses? And how can
you compare it across the industry-so you can contain all that systemic
risk? Only, there's no uniformity across books. And, given the
complexity of these mega-merged firms, those questions aren't easy to
answer.

Goldman Sachs and Morgan Stanley, for example, altered their
year-end reporting dates, orphaning the month of December, thus making
comparison to past quarterly statements more difficult. In the cases of
Bank of America, Citigroup and Wells Fargo, the preferred tactic is
re-classification and opaqueness. These moves make it virtually
impossible to get an accurate, or consistent picture of banks 'real
money' (from commercial or customer services) vs. their 'play money'
(used for trading purposes, and most risky to the overall financial
system, particularly since much of the required trading capital was
federally subsidized).

Trading profitability, albeit inconsistent and volatile, is the
quickest way back to the illusion of financial health, as these banks
continue to take hits from their consumer-oriented businesses. But,
appearance doesn't equal stability, or necessarily, reality. Here's how
BofA, Citi and Wells Fargo play the game:

Bank of America: The firm reclassified its filing categories
upon acquiring Merrill Lynch, but it doesn't break down the trading vs.
investment banking revenues of Merrill. This either means the firm
doesn't truly know what's going on inside its new problem child, or
doesn't want to tell. (No wonder no one's jumping for the upcoming CEO
vacancy.) That said, despite the obvious information clouding, new
acquisitions generally don't have their activities broken out, which
makes it a lot harder for regulators, shareholders, or we, taxpaying
subsidizers, to know whether the merger was a success or not.

According to Scott Silvestri, Bank of America's spokesman, "On our
second quarter's earnings release, there was a note explaining why we
changed reporting structure. But, with every quarter that passes, it's
harder to unscramble the egg. It's been a merged entity since January
1, 2009."

He added that "we have an earnings supplement. Every quarter, we put
out a standalone Merrill 10-Q that shows its profitability." True, but
what's the point of issuing a separate Merrill report, without
delineating Merrill's contribution in its main books so that you can
clearly see how specific parts of Merrill's business impact similar
ones in the merged entity? Furthermore, we can't even figure this out
ourselves-the Merrill results in the 10-Q don't map directly to those
of BofA's books. This all just creates more complexities for a bank
that still floats on $63.1 billion in various government subsidies.

When it wants to, it appears that BofA can merge and then break out
Merrill's numbers. Under the "Global Wealth & Investment Management
" classification, we discover that Merrill contributed three-quarters
of the $12 billion BofA took in over the first nine months of 2009.
According to Silvestri, "The numbers of the old Merrill are there
because the brand name was kept, vestiges of the old Merrill Lynch
exist."

Talk about semantics. Why not also break out the area where revenues
tripled and trading account profits jumped significantly (from a $6
billion loss in 2008 to an almost $14 billion gain in 2009)? Something
is clearly going on there: the best measure of trading risk, VaR
("value at risk" or a firm's daily trading variation) doubled between
2008 and 2009. If I was the CEO, I'd want to see this critical
comparison on my merged company filing.

Elsewhere, the sum of Bank of America's quarterly figures doesn't
quite add up to the nine months totals. (A few hundred million of
discrepancies between friends.) Another item "all other" is off by
nearly a quarter of a billion dollars. And so on. The firm also
declared, that it "may periodically reclassify business segment results
based on modifications to its management reporting methodologies and
changes in organizational alignment." In other words, whenever it feels
like it. Comforting, isn't it?

Citigroup: Another balance-sheet renovation, this time
because of a sale (Smith Barney, which it offloaded to Morgan Stanley)
rather than a purchase, and another trading miracle. Citigroup's main
trading arm, housed in what it calls the Institutional Clients Group
(ICG), made $31.5 billion in net revenue for 2009, compared with a $7.8
billion loss in 2008. Its average daily value at risk jumped too,
though "only" by 15 percent or so.

That's a huge and extremely fast trading rebound for the main
recipient of government subsidies (at $373.7 billion). But, there is no
overall breakdown present in the summaries of Citigroup's latest
filings. And the sum of the trading totals doesn't equal the parts,
because the firm also noted that certain numbers deemed an "integral
part of profitability" weren't included in those computations, without
giving any apparent reason. (After adding the missing number, it still
didn't add up.)

Again, it's "just" a couple billion of discrepancies, but with books
this massive at banks this big and risky, accuracy matters. Plus, such
nuances make it extremely difficult to understand its books for
regulators or the public.

Citigroup's Danielle Romero-Apsilos said that they periodically
change reporting. "ICG existed, but after Smith Barney, we decided to
divide it-we call one part securities and banking, one part global
transaction services, etc."

That describes the chain of events, but doesn't get closer to
determining trading related revenue. Romero-Apsilos said, "We don't
break up the financials specifically for those businesses. Over the
years, we may have broken out different things."

Wells Fargo: Yet more innovative accounting maneuvers. For
example, the innocuous sounding category, "wholesale banking" which
provides traditional lending, finance and asset management services,
was expanded (following the Wachovia acquisition that completed on
December 31, 2008) to include more speculative activities like
fixed-income and equity trading. But, those activities aren't broken
down in the firm's SEC filing, making it difficult to determine which
portion comes from trading vs. commercial or investment banking.

Wells Fargo spokesperson, Mary Eshet (who still has a Wachovia email
address) confirmed there is no separate Wachovia 10-Q (like there is
for Merrill Lynch), but that it wasn't the case that "Wells Fargo broke
out trading related revenue previously either."

In fact, Wells just provides totals for their four main business
segments, each of which increased sharply, Community banking rose from
$33 billion in 2008 to an annualized $59 billion in 2009. Wholesale
banking shot up from $8.2 billion in 2008 to $20 billion in annualized
2009. And, wealth, brokerage and retirement quadrupled from $2.7
billion in 2008 to $11.6 annualized for 2009. (The fourth segment is
called 'other.') Yet, all these rosy numbers come with no specific
breakdowns for their various trading business areas.

Separately, Wells states in its filing that its management
accounting process is "dynamic" and, not "necessarily comparable with
similar information for other financial services companies." This
statement should give lawmakers pause: if banks are so complex as to
constantly fluctuate their own reporting, deciphering figures just
before a crisis won't exactly be a walk in the park.

With taxpayers now on the hook, we need an objective, consistent
evaluation of bank balance sheets complete with probing questions about
trading and speculative revenues, allowing for comparisons across the
banking industry. This lack of transparency leaves room to misrepresent
risk and trading revenue.

The long-term solution is bringing back Glass-Steagall. Being big
doesn't just risk bringing down a financial system-it means you can
also more easily hide things. Remember the lesson from the Enron saga:
when things look too good to be true, they usually are.