18 January 2012
The lies which got us to the purgatory we are in are being told all over again, right now, inside every bank in the Western world. Not by accident but on purpose, by men with calculators and university degrees, in the full knowledge of what they are doing, why, and for whose benefit.
Every religion has its holy days. The days when the priests face their God and perform the rituals that renew the covenant between them. For believers, it is the renewal of their faith, of their promise to believe in and to serve their chosen God, in return for which God will protect them. Global finance is no different and these days before and after New Year are their holiest of holies.
The Jews have Yom Kippur – the Day of Atonement; the Christians have Christmas and Easter – marking the birth and resurrection of their Saviour. Bankers have the Day of Reconciliation – when the financial statements for the previous 12 months must be reconciled. When all their deeds must be accounted for, all their actions weighed and a final reckoning made.
So spare a thought this New Year for the auditors of Deloitte, Ernst & Young, KPMG, and PWC as they, in solemn convocation with the chief risk officers and chief finance officers of the world’s largest banks, perform the Ritual of Reconciliation and reveal, by the grace of creative accountancy, number massaging and rank but ordained lying, the great Miracle of Solvency once again. Sing Hallelujah!
Deep inside every bank, dealers have been sitting, staring at their phones hoping that the bank’s risk manager won’t call them to ask what a certain trade they made this year was actually worth, what value should be booked for it and what risk-weighting should be applied to it? For as we approach the Day of Reconciliation the dealers must call up the details of the deals they did, the assets they bought and sold or lent or borrowed, and account for them.
The Bank’s CRO (chief risk officer) must then, by law, satisfy him or herself that the numbers presented are true and the valuations fair and honest, and sign them off accordingly. Whereupon the CFO (chief finance officer) must look upon the assembled accounts of all the actions of all the traders on all the trading and lending desks and compile the bank’s accounts for the last year, showing capital adequacy (sufficient capital to cover the bank’s liabilities as laid down by Basel) and then these accounts must be passed to the “independent” auditors for them to check and scrutinize till they too are wholly satisfied that the accounts present a true and fair picture of the health of the bank.
You might be tempted to think, given the magnificence of the glass and steel temples of global banking and their auditors, and given the number of people with important-sounding job titles and the size of the fees and bonuses they award each other, that this process would be be rigorous and testingly honest. You’d be wrong.
Once, a long time ago, the purpose of this ritual might have been to sort the solvent from the insolvent, the strong from the weak, the saints from the sinners. Today however the Day of Reconciliation serves a different purpose – to declare that all banks are saved. All are declared solvent, none with the slightest stain upon it. You might think I’m being flippant but I’m not.
Ask yourself how many of the auditors will find their clients insolvent? Or how many banks will appear in public in the coming weeks with accounts that show them to insolvent or even in trouble (with ‘going concern‘ warnings or other qualifications to the accounts)? That is no longer what the ritual is about. The ritual is about proving that everyone is just fine. Regardless of the fact, played out year after year, that within months, sometimes only weeks, of the miracle of solvency being proclaimed, some banks will ‘unexpectedly discover’ a sudden need to raise more capital. These days the miracle can wear off fast.
Not long ago I spoke to a senior risk manager of a German bank who described a particular incident from a year-end reconciliation. He found a particular derivative trade that had to be accounted for, but the trader who had made the deal had left the bank some years earlier. No one knew the details of the trade and no one could value it. So the risk manager sought out the counter-party to the trade. Perhaps given that these were people to whom the bank owed money, they would know, at the very least, how much they were owed. It turned out to be a very large Swiss bank. Sadly for his New Year holiday, the risk manager found the trade had been booked in Singapore. He waited up and called. The Swiss Bank at first denied any knowledge of the trade. It was so long ago, they had no recollection either.
However our risk manager couldn’t simply pretend the trade had never happened. There was an accusingly empty box on the spread sheet. Eventually the risk manager said, well my best guess – and it was a guess based on the imperfect paperwork of the original deal with no subsequent details of risks or changes in value – ‘My guess is we owe you X.’ To which the hugely brilliant and highly paid bankers who were owed this money said, ‘Yeah, fine. Let’s call it that’, and hung up. This isn’t hearsay. It is what happened.
The figure was duly inscribed in the ledger, the risk officer signed off, the CFO signed off, the auditors signed off, obligingly, for the clients who were paying them handsomely for this service, and the accounts were declared true and fair. They did the job they were designed for – to show the bank in its best possible light and obscure any irregularities or blemishes. And bonuses were lavished right and left. As it turns out this particular bank was anything but alright – not that you would ever have told from those accounts – and eventually needed a vast bailout from the taxpayers of the nation it was parasitizing.
And let’s be clear about how serious the lies we are talking about are. The accounts are what investors use in order to decide if it is safe to invest in or lend to a bank. It wasn’t safe. But that fact was nowhere in those accounts. As it will not be in the accounts of any of the major banks of the western world this year, like last year, like the year before and the year before that. The culture, the religion, of lies and liars, is too powerful. The auditors are not there to reveal anything unpleasant about the banks. They work for the banks. They are paid by the banks, and look forward to many more payments for many more accounts.
Last year Michel Barnier, the European Union’s internal market commissioner proposed tough reforms that would have broken the cosy relationship between banks and their auditors and weakened the cartel-like grip of the ‘Big Four’ auditors who between them audit almost all the world’s large banks. He proposed that banks should have to have two auditors examine their books, one of which should be a smaller firm, and that auditors would no longer be able to audit a banks’ books year after year after decade. He proposed a limit of nine years. After which the bank would be obliged to change.
But many of Barnier’s proposals were dropped or watered down following lobbying from auditors, banks and even some EC commissioners. Too much personal and corporate power and profit was at stake, too much ugly truth brought too close to public awareness.
The auditors are not there as guardians of truth-telling, working for you and me – or even for investors. They are there to keep the banks and bankers hard and thrusting for the year ahead. The auditors do their work on their knees.
And what of all the many thousands of risk officers and risk and the audit committees of the banks themselves? This is after all where the ritual of Reconciliation mostly takes place. Can we look to them for honesty and integrity?
Let me put it this way. On December 23rd, 2011 Bank of Ireland (not to be confused with the Central Bank of Ireland) appointed a certain Patrick Mulvihill to its board as a non-executive director AND to its audit committee and risk committee. Mr Mulvihill spent much of his career at Goldman Sachs where he was on the board of Goldman Sachs Europe and on their audit committee. Make of that what you wish. One thing’s for sure, he will be perfectly suited for the job that he’ll be expected to do.
He, like all those working for and around him, will decide if the sovereign bonds of Italy and Spain, for example, are to be booked as risk-free AAA-rated sovereign bonds, or risky bonds which the market won’t touch for much less than 7%. Despite all the recent evidence to the contrary, sovereign bonds are still considered virtually risk-free in the part of the bank which considers which assets count as solid capital to underpin liabilities. But they are traded as risky and therefore lucrative in another. Will the banks book the profit of the risky version but assess the risk weighting from the risk-free version? It’s like Quantum mechanics for liars. You get to have it be a wave or a particle depending on which suits you at a given moment. Which will it be? Are sovereign bonds risk-free or lucratively risky?
And what about mark-to-market valuations? Will the risk committees and audit committees give a clear valuation of the bank’s assets? Or will they do what they did earlier this year, and move any ‘risky’ assets, that they have valued at ‘mark-to-model’ fantasy prices and which would surely lose a lot of ‘value’ if ever they were marked to market – from the ‘available to trade’ column where mark-to-market valuations are required (‘the trading book’), over to the ‘hold to maturity’ column (‘the banking book’) where mark-to-model is just fine? What do you think? Will they go for honesty and transparency or press a few keys and move billions from one column to another?
And remember that assets hidden from view like this won’t be ‘held to maturity’ if the bank gets in trouble. At that point the bank will move them back again, sell them and it will become clear that the accounting fiction was a lie.
This year the banks are in no better shape than they have been since the debt bubble burst. In fact many are in worse shape because the nations they depend upon for endless bail outs have been bled dry by the banks and are having to enforce more and more savage cuts to social spending of every sort – education, health and welfare, and people are beginning to feel the pain.
This year, the banker’s propaganda machine will have to move up a gear or two. Those who question the official party line will perhaps have to be positively demonized. Certainly the barrage of ‘there is no alternative’ will have to become louder. And the bloodcurdling threats of doom if we don’t do what we are told will doubtless become even more dire.
This year the Miracle of Reconciliation will do its job for the bonus seekers but will then wear off quickly, leaving behind a smear of threats and anti-democratic thuggery.
This article written by Golem XIV was originally published on the Golem XIV website under the title “The Myth of Solvency” on December 29th, 2011. h/t Philip Duval.