Thursday, October 13, 2011

Legalized Fraud

And if all others accepted the lie which the Party imposed – if all records told the same tale – then the lie passed into history and became truth  ("1984," George Orwell)
JPM reported $1.02 of earnings per share, ahead of the Wall Street Einstein consensus expectation of 92 cents.  HOWEVER, 29 cents - or 28% - of the reported number included a non-cash accounting gain which resulted from JPM exploiting a very controversial accounting rule that lets a bank essentially create income when the market value of its outstanding debt goes down in value.  Without this fictitious income, JPM would have reported 79 cents, well short of expectations.  Please read that again if you don't believe that you really read what I just wrote.  The truth is that if pour through JPM's earnings results with a critical eye, you'll see that underneath this accounting fiction that JPM's underlying business fundamentals are deteriorating.

How can serious investors trust ANY kind of earnings report that is put out by ANY financial institution?  What's appalling is the way the financial media looks at the headline numbers reported by JPM and lauds it for "beating" earnings and revenue expectations and remarks at what a great job JPM is doing.  And then casual investors turn on Bloomberg TV and see the accolades being tossed out or open the newspaper tomorrow and read how JPM's earnings report exceeded expectations, leaving said investor/observer with the impression that things are improving in our system.

The fact of the matter is that JPM's accounting presentation is legalized fraud.  The reporting of it by the financial media - which is financially supported by the advertising and promotional revenues paid by banks like JPM - is outright Orwellian.  Our entire economic and political system is on the very frightening slippery-slope toward the dystopic vision presented by writers like Orwell, Rand and Huxley.

Let's review how this legally fraudulent accounting gimmick works.  To be honest, I'm not even sure how the Financial Accounting Standards Board (FASB) OR the SEC ever allowed this idea to be made into a rule. It's literally legalized fraud. Although it's available to use for any company/entity, it was designed to apply specifically to Wall Street banks - any entity "with available-for-sale and trading securities" (the quote is from "Summary of Statement 159," FASB). In other words, this rule was designed to permit banks to further manipulate their accounting income (i.e. non-economic, cash-based earnings).

Here's how it works:  if the market value of a company's debt obligations (bank debt, bonds, etc) goes down in value, the company is permitted to recognize "accounting" income measured by the amount that the holding value (book value) of the debt obligation declines.  In other words, the company can create income based on the amount the book value of their debt declines, even though this decline typically reflects a higher degree of risk and financial instability.  The "income" is created by assuming that the company could go out into the market place to purchase and retire this debt at a big discount to what would be owed on the debt (the par or principal amount) at maturity.  You may need to think about this for a minute to really understand how the rule works, so that you can understand how pathetically flawed the logic is behind the rule.

Here's the coup de grace of this rule's absurdity, straight from FASB: "The fair value option is applied only to entire instruments and not to portions of instruments." In other words, in order for a company to book this accounting gain, it must take the full amount of market value decline on the entire debt issue - for each debt issue being used for this purpose -  under the completely mythical assumption that it could theoretically go out to the market buyback the entire amout of each debt issue at market value, thereby creating savings by retiring this debt at a discount rather than paying it off as it matures. Sound like anything that is anywhere even remotely close to being realistic, especially for companies with 100's of billions in debt outstanding?  The fact is, that when the market value of a company's debt obligations declines like this, it becomes even less likely that the company has the ability to go out and spend any cash to repurchase its debt.  This happens in reality very rarely.

I really can't believe that anyone, especially JPM CEO Jamie Dimon, can take JPM's earings with this accounting bullshit layered in and present them with a straight face. Seriously. The fact that reporters in the financial media are doing celebratory back-flips over this earnings report is a testament to the degree of absurdity and lack of accountability that has enveloped our system.  That Dimon can present this garbage is an egregious insult to anyone who understands accounting and finance.  It truly is Orwellian.

The golden truth is that most Wall Street analysts, if they even understand anything beyond simple GAAP accounting, will gloss over this earnings abortion and move on by explaining that JPM's balance sheet is stronger than is required by the regulators.  Dimon refers to this as JPM's "fortress" balance sheet.  Without having the time to delve into the research and calculations required, I would bet my entire net worth that if I went line by line through JPM's asset base and applied true market value standards to its assets, that its book capital would fall well below regulatory requirements.  In fact, that's the reality for every Too Big To Fail bank.

Given that we've witnessed the big banks create massive paper earnings first using "mark to market" fair value accounting on their assets, creating gains for income reporting purposes and fictitiously marking up crap assets for regulatory purposes, and then use the "reserve release" gimmick to generate fictitious earnings last quarter, and now this "debt valuation adjustment" fraud to generate paper earnings this quarter, I can't wait to see what accounting fiction they roll out for the 4th quarter. 

Rest assured that this is entirely fiction and fraud made possible by a system entirely based on paper currency and phony "accrual" accounting rules that have value based on what the Government decides to tell us its worth.  So yes, JPM is only playing by the "rules."  But it's also fair to say the big banks like JPM paid the politicians handsomely to have those rules put in place.  We'll know we've truly transformed into Orwell's vision when the banks announce that the losses they are reporting are really gains.  Oh wait, that's what DVA accounting gold?


  1. I think Congress threatened to regulate to get this if FASB did not implement

  2. Can I use this trick with my mortgage debt? net worth will go up:)

  3. Dave, Tutto bene? Sto bene.
    In an earlier thread you warned about keeping brokerage assets with a bank affliated broker. I assume that applies to Merrill Lynch since they are owned by Bank Of America.

    What are your thoughts on Scottrade? BTW, Charles Schwab, Scottrade as well as Merrill are all insured by Lloyds in an aggregate amount far less than the value of their total accounts. For example, Merrill has a Lloyd's of London policy in the aggregate (total) amount of $600 million. They've got assets well in excess of that. But, the same holds true for CS. They have a policy that insures for a total of $100 million which I'm sure is far less than the total of their assets. Is that standard in the industry? Bene grazie. Gallo (I can't seem to access my google account)

  4. (Dave)

    Ciao Gallo. Si si tutto bene, grazie.

    I don't really know a lot about Scottrade. You would have to look at their financials and the footnotes to their financials to see how much borrowing they do against the securities they keep in custody. But as long as they aren't part of a larger financial organization that does investment banking and runs principal market portfolios, they're probably fine. I'm sure they all have their warts, but it's all relative. There will come a time when you don't want ANY financial institution to have custody of ANY of your assets.

    Sono felice che tu sia ben - ci parliamo presto

  5. John Hathaway - We’re Definitely in the End Game for US Dollar

    John Hathaway continues:

    “Basically what’s happening is there is huge demand at grassroots levels for owning gold because nobody trusts banks and nobody trusts government policies. Some may be searching for a headline to get the gold market moving, but the people who are buying it for their own safety and protection don’t need that to buy.

    In my opinion we are definitely in the end game for the dollar as we know it. I’ve said it any number of times, we are past the point of no return for the dollar as a reserve currency. I don’t exactly how this will unfold, but any of the outcomes involve a higher gold price.

    Sentiment (on gold & silver) recently was down to unbelievably low levels along with the COT. So everything was indicative that we had a significant bottom....

  6. Dave,

    What is your opinion of numismatic or semi-numismatic coins over bullion? I know in the total collapse scenario the bullion is where you want to be as the premiums will vanish on numismatics but in an orderly fall for the dollar such as we have experienced with the last 10 years (*if you can even call it that) numismatic silver coins especially have really appreciated. The Australian 1 oz silver lunar coins for example have a mintage of only 300k and they sell at larger premiums today then ever. The 2012 dragon is selling for $99 from mint dealers and it is 1 oz of silver yet they are flying off the shelves. When I read your blog though I always get the total collapse scenario playing out in my head and think that maybe I should unload my numismatics while I still can for insane premiums and move it all into bullion. Just trying to get other opinions from like minded minds.


  7. (Dave)

    My personal view is that nuimismatic coins are for "art" collectors. I don't have to time to study what's what and what might go up in "collector" value for whatever reason.

    I look at buying gold and silver now as the cheapest way to buy the next global reserve currency - on that basis ALL gold and silver is very undervalued.

    Nuimismatics is for people who like to handicap race horses. I don't have time for that - I like to "handicap" mining stocks...

  8. JPM ends -4.42% today and shortly after Cramer screams that he's buying banks on mad money.

    Thanks for your in depth post and great due diligence.

    FASB = financial accounting suck board. Its clear they are a suck as in a succle up. They will suffer the fate of paul rudd in Year 1. See I know some artsy literature stuff too.

  9. Gold and silver are the very definition of honest money, and a nation's money speaks volumes conerning a nation

    Honest money-honest government (not always, but more often than not)

    Dishonest money-dishonest government

    Corrupted money-corrupted government

    Untrustworthy money-untrustworthy government

    worthless money-

  10. off topic but deals with fraud(the fed)

    here is a video of the republican debate last night on a question to herman cain as his favorite fed reserve chairman and then ron paul. cain=clueless; paul=pricless

    Paul, Cain Discusses Former Fed Chairman Greenspan

  11. (Dave)

    LOL JR - I heard you have Cramer-autographed posters hanging in yer bedroom and office

  12. DVA accounting? More like DVDA accounting HEY-O!

  13. After Goldman, Italian Protestors Besiege, Storm Headquarters Of Berlusconi's Fininvest

  14. All you need to know and it will happen in a flash second...

    Occupiers on Bank Law: Fix It

    Banks make, sell and rent money. Our fiat currency (decoupled from gold by Republican President Richard Nixon), consists of IOUs from banks, which in turn depend entirely on the faith of people and businesses in those IOUs, and on the willingness of the United States taxpayers to back them up. In other words, banks trade on government backing; it is their essential product. The days are long gone when any sensible person would accept a purely private bank note as money.

    Brodsky: Apropos of Everything @ TBP Conference
    Administered Dollar Devalua\on

    To remediate all past monetary infla]on and reset the global monetary regime, theFed would tender for privately‐held gold at or near the Shadow Gold Price (currentlyabout $10,000 / ounce).2.

    As the Fed purchases gold, the gold would flow to the asset side of its balance sheet.The Fed would fund those purchases through newly‐digi]zed Federal Reserve Notes,which would flow to banks in the form of net new deposits. This would be a discretemonetary infla]on event (devalua]on) and a simultaneous deleveraging.3.

    Once the Fed acquires enough gold from the markets, a gold price peg for the USdollar would be established.

  15. This is give good discussing of financial matter like bank resource and another debt crises.I like to visit him for getting a good information.