Level 2 is more worrisome. Level 3 is hair-raising.

January 14, 2013 6:12 PM

"We decided to go on an adventure through the financial statements of one bank [Wells Fargo], to explore exactly what they do and do not show, and to gauge whether it is possible to make informed judgments about the risks the bank may be carrying. We chose a bank that is thought to be a conservative financial institution, and an exemplar of what a large modern bank should be."
posted by vidur (14 comments total)

A decent response


Another decent commentary
posted by JPD at 6:23 PM on January 14 [4 favorites]

[Folks, do not try to insta-derail this thread with barely related hot button comments, please. Thank you.]
posted by jessamyn at 6:51 PM on January 14

that's an odd argument by Salmon:

Basel III isn’t perfect, but it’s as good as we’re going to get, and is actually significantly better than most people dared hope when it first started being negotiated. And the technocrats who put Basel III together are not some group of knaves, deluding themselves that they’ve magically fixed all the problems with the banking system. They’re smart and well-intentioned regulators, who know full well what the problems are, and who are implementing the best set of patches and solutions that can be implemented in reality. Or if not the very best, then something damn close. They too would love to tear everything up and start from scratch with a much simpler system featuring much smaller banks. But, unfortunately, they can’t.

he starts out by introducing an overly facile dichotomy: principle vs. ruled based regulation. suggests that what we have is the best we can get and then adds that the smart people think we *should* have a simpler system and ignores the elephant in the room which is regulatory capture, or political capture and the fact that even someone as insulated as Bernanke (to pick a regulator out of a hat) feels enormous political pressure.
posted by ennui.bz at 6:59 PM on January 14 [1 favorite]

except accounting standard capture and regulatory capture are completely different things. What you or I get to see in a 10-K or a set of IAS accounts is much much much less precise than what the OCC or the Fed or the country level regulators outside the is US get to see in the institutions they regulate.

When you or I see what Tier one capital is for a bank we can only guess about the underlying assumptions are. The regulator can actually see and question those assumptions - and if needed demand changes. The problem with regulatory capture is that they don't, but that's not related to accounting issues. Same thing with regulatory arbitrage the accounting standards permit to exist. The regulatory knows what's going on, they just choose not to act.
posted by JPD at 7:11 PM on January 14

When you or I see what Tier one capital is for a bank we can only guess about the underlying assumptions are. The regulator can actually see and question those assumptions - and if needed demand changes. The problem with regulatory capture is that they don't, but that's not related to accounting issues.

I think that illustrates that they are intertwined. You can't trust what's in the statement if the regulatory apparatus can't or won't "demand changes" when necessary, regardless of what accounting standards are in force, whether they are rule (heavily subject to arbitrage) or principle (heavily subject to capture) based.
posted by ennui.bz at 7:19 PM on January 14

except they are subject to rule, and your argument was about capture.

I'm not rejecting regulatory capture, I'm just saying the degree to which accounting standards are or are not subject to manipulation by big business just doesn't impair the regulators willingness or ability to regulate.

They are bad at their jobs because they are captured, not because the standards they have to rely on are captured. Because they don't have to rely on those standards.
posted by JPD at 7:25 PM on January 14

Show me a retail depositor who decides whether to keep her money at Wells Fargo based on the footnote disclosure in its annual report and I—after I pick my lower jaw up off the floor—will show you a hot January.

Hi there and nice to meet you, Mr. Epicurean Dealmaker. You might want to spend some time thinking on the phrase 'obfuscation through verbosity' and how it relates to your writing while you're picking your jaw up off the floor.

I like Salmon's rebuttal, especially the part about it being impossible to regulate by principle rather than rules, but I do think the overall point of the Atlantic article stands: the largest banks in the world are both badly understood by investors and highly leveraged in trading schemes that have before and may in the future go wrong.

Worth mentioning: my dislike of large banks stems from that very nervy September four and a half years ago when I nearly made a run on my own bank (WaMu) despite knowing why that's a bad idea--and it hasn't been appreciably diminished by the fact that my current bank is Wells Fargo.
posted by librarylis at 9:15 PM on January 14 [1 favorite]

Like a retail depositor gives a shit about where they stash their money. FDIC along with the full faith and credit of the USG has them backstopped to $250K.

If the full faith and credit of the USG is brought into question getting access to your new toilet paper is going to be somewhere below "obtain food and clean water" and "build a shelter and find some guns".
posted by Talez at 9:27 PM on January 14 [4 favorites]

... Level 3 assets is that banks might have errantly recorded them at values that were inflated to begin with. There is no way to check whether reported values are accurate; investors have to trust the bank’s managers and auditors...

I understand that the point of this article is to raise fear and make 'the people' mad at the banks again, but I think they are missing the forest for the trees here. Level 1 assets are basically 'things you can get a quote on'. Level 2 assets are tougher to find a market in and level 3 are simply assets that there is no real market for, and thus the price of those assets is very difficult to determine. These are not 'levels of hell', just the reality of the market that everyone expects the banks to operate in.

Dude goes to the bank to get a loan to run his car-wash business. Bank loans him $1000, what is that "worth" today? Lets say its a dusty summer, is it somehow worth > $1000? If there is noone offering to buy the loan, what does it even mean to say its worth something?

Or lets look at it from another angle - suppose banks had all their assets in "level 1" marketable securities, and they deny the dude at the car wash the loan, because they are not allowed to hold assets that an independent 3rd party cannot price easily? Is that what we want?
posted by H. Roark at 12:06 AM on January 15

To Learn Or Not To Learn, That Is The Question

The independent panel that investigated the Teton Dam failure recognized that causality is complicated in dynamic systems where the outcomes are the result of the interaction of numerous systems and variables. Despite a financial/economic system that was more complex and dynamic than any dam, the financial authorities promoted two ideas;

1. That weaknesses in the regulatory system coupled with financial institutions that evaded and avoided existing regulations was a complete explanation for the crisis; and

2. The recession of 2007 was an unforecastable inexplicable “black swan” event.

It is clear that many financial institutions had engaged in unethical and criminal behavior. It is also clear that they had exposed the financial system to unjustifiable risks. No one can argue that regulation has been satisfactory. However, unlike the parties to the design and building of the Teton dam, the financial institutions were not in a position to mount a defense of any kind. Who would believe that a defense was anything but self-serving? In addition, the financial institutions were not in a position to point a finger or shift any of the blame to policymakers or regulators, as they were dependent on the same policymakers and regulators for their continued existence.

posted by the man of twists and turns at 12:49 AM on January 15 [2 favorites]

When you write such a long article in favour of principles based regulation you might find the space for a sentence or two on how such systems (like that of the UK) fared over the last few years. They didn't do noticeably better than the American, rules based, system.
posted by atrazine at 2:39 AM on January 15

JPD: "A decent response

The epicurean dealmaker is fighting a strawman. He says, and I quote
"It is not meant to be a real-time profile of the actual business operations of an individual firm"

I dont think Partnoy and Eisinger want to find out how a bank runs. All they want is to know if a bank is managing its risks properly and is healthy. And they are saying is that by going through the annual reports, one cannot figure out what type of risks banks are taking and consequently how healthy is the bank.

As a confirmation P&E's methods, Epicurean says that annual reports are "meant to be an intermittent report on the health and progress". And the annual reports are not working.

The problem is that the annual reports today don't give an honest view into the health of the bank.

Epicurean has no answer for this problem raised. He/she is just happy sighing, patronizing (rookie mistake) and generally dismissive.


Another decent commentary

Salmon's response is better. He acknowledges that Partnoy and Eisinger are right about the problem "So while Eisinger and Partnoy and Onaran are absolutely right when it comes to diagnosing the problem"

I agree that principles based regulations are not likely to succeed,especially when there is regulatory capture.

What is needed is more transparency and information. In an complicated system where principals have differing objectives, the only way to have a stable system is to have as much transparency as possible between the stakeholders and to prevent corruption (euphemistically known as regulatory capture).
posted by TheLittlePrince at 4:57 AM on January 16

Regulators have absolute transparency. GAAP has nothing to do with what they do and do not know.

A problem with giving investors complete transparency is how you present the data. A regulatory filing would have to be 100k pages. It becomes impossible to find signal in the noise. Any set of accounting standards has strengths and weaknesses.

BTW lets note that Partnoy and Eisinger were big supporters of marking to market all assets on a banks balance sheet - an idea terminally flawed, as it assumes the market is usually correct, when in reality that sort of logic is massively pro-cyclical.
posted by JPD at 7:47 AM on January 16

Also the best criticims of P&E piece is that for all their complaining about how bank accounting scare off investors, WFC trades at 1.8x tangible book.

P&E seem incapable of appreciating the fact that any accrual based accounting system has a degree of uncertainty, and that investing is about understanding and underwriting that uncertainty.
posted by JPD at 7:49 AM on January 16