Wednesday, 13 August 2008

Richard Murphy is sometimes right

Richard Murphy sparked an interesting debate over at Tim W a year ago; he claimed that if banks etc had issued bonds that had fallen in value (because the bank's credit rating had fallen), they were allowed to reduce the value of that debt on their balance sheets, and hence book the difference as a profit, which I immediately dismissed as twaddle.

My bad!

It turns out that UK banks are now actually doing this, as evidenced by the two negative expense items of £584 million and £224 million buried away in Note 2 on page 49 of The Royal Bank of Scotland's 2008 interim results.

Altho' it seems bizarre to book this as a profit, and thoroughly underhand to bury it away like this, that is just the way that double-entry booking works, and, to be fair, at least it flags up the issue to the discerning reader.


Anonymous said...

It's a shame that the discerning readership only consists of yourself, your cited FT journalist, and a couple of contrarian financial US websites where I’ve seen similar practices described in the USA.

I don’t get too upset about this bit of financial chicanery, because this fictional plus to the balance sheet might buy them time to recapitalise themselves, and could lead to fewer bank failures than would otherwise occur. If sovereign wealth funds or other large investors are stupid enough to fall for this, then they deserve all they get.

I say “might” buy them time because I don’t think many banks will be saved by such tricks. I think it’s more likely their bankruptcies will just be postponed for a bigger crisis in 2009-2011.

Graeme said...

what's the problem? It's a logical consequence of marking to market. if you want to try to use a balance sheet as a valuation tool, then you need to capture these things whether they are good or bad. a system which lets you show unrealised losses but not unrealised gains is just daft.

Anonymous said...

A good point, but we don't have a system that marks to market. If we did most of the banks would be seen to be insolvent. Weekly they are revealing bigger and bigger holes in their balance sheets, with some influential commentators claiming that the US banks alone still have $0.5 trillion (IMF) up to $1.5 trillion(Nouriel Roubini) still to write down.

I don't see in the current climate how anyone would dream of using the current balance sheets as a valuation tool for the banks.