Think Twice Finance

Is FASB Finally Standing Up to the Fed?

FASB (The Financial Accounting Standards Board - rule-makers for the accounting profession) announced possible rule changes for banks today (May 1st). This event got little attention in the financial press. It rated a sidebar in the Money and Investing section of the Wall Street Journal. As far as I could determine the New York Times didn’t cover it at all. Such is the clout of New York’s large financial institutions and regulators.

It should have been front page news. For if this proposed accounting regulation had been passed in 2002 when FASB first proposed it, there never would have been a Credit Crisis of 2007-8. “How did an accounting rule of this magnitude ever become necessary?” you might ask, And if FASB has proposed it before, why would the Federal Reserve have taken up the cudgel of the big New York banks and squelched it?

Good questions. The fundamental underlying answer is that there is a problem in the banking system so big that regulators have basically despaired of solving it. Instead they paper it over with increasingly abstruse accounting scams that everybody is told are financial engineering innovations.

The problem is that the large banks have become, with few exceptions, obsolete. The exceptions are so few, that I can name them: Wells, HBOS, and, perhaps, whoever is left standing when Australia’s “four pillars” policy is finally abandoned. These banks have adopted a WallMart approach to banking: do retail, do it cheap, and don’t put on airs.

There are, on the other hand, many thriving financial institutions. They have one thing in common. They hide from the regulatory gods. My favorite example is Macquarie Bank in Australia. Macquarie recently announced that it was no longer in the interest of the stockholders to conduct its more profitable operations under the bank regulatory umbrella. It split them into a separate subsidiary. The decision attracted $8 billion dollars in new money, largely from large regulated banks, in spite of the fact that other than dropping the charter, Macquarie planned no new activities or staffing changes.

Four groups characterize the entire banking universe: Bloated unprofitable regulated banks, WalMart banks, profitable creative smaller institutions such a MacQuarie, and 500,000 small US banks. (Don’t ask me about the last class. I’ve never understood them. To me they are like the woods your grandpa told you, “You can go in there if you want, but nobody’s ever come out again.”)

Banking behavior and regulatory behavior are easy to explain once you understand the game. If you run out of ideas, as did Hugh McColl at North Carolina National Bank, just start acquiring other regional banks that have run out of ideas until you become an unprofitable large bank and you become large enough to be the government’s problem, not the stockholders’. Especially good if you can give yourself an emblematic name like Bank of America.

If you are already a large bank, keep adding new banks as competition to become large and unprofitable heats up, raising the hurdle to qualify for largeness status. It also helps to do many things the public doesn’t understand. That way you can blame mathematics on your lack of new ideas. You went to the cutting edge, and you got cut. How could anyone blame you for that? Thus the perfect regulated bank is large and complex enough that if anything untoward happens, it won’t be understood by the public. Politicians and regulators can act surprised.

That way, the public won’t realize that corrupt bank regulation is no longer accompanied by the soul-searching and internal agency bickering of the 1970’s. Today it’s just a daily grind. This leaves us with the question, what is the Fed going to do about FASB’s attempt to clean up the banks’ off-balance-sheet scam? First, they will wait. Maybe the economy will turn around and everyone will forget the whole thing. Second, as in 2002, they might think of some ridiculous compromise, using it to roll FASB as they did in 2002, which leaves the impression that they have done something. Third, they will think of an entirely new scam. What they will not do is leave the banks to their own devices.

The large banks are a little like the Middle East. Such a hash has been made of the situation that the only thing worse than the hellish result of the old policies is the still more hellish result of walking away.