Lenders earning huge profits on fake revenue from can-kicking efforts

The housing bust should have wiped out America’s lenders. Instead, we deemed these institutions Too-Big-Too-Fail, and we pumped billions of dollars into keeping them afloat. Since the emergency cash was not enough, we suspended prudent accounting rules and allowed lenders to report the value of bad loans based on financial models rather than actual market prices. As long as lenders didn’t foreclose, they didn’t need to recognize the loss on their non-performing loans.

But it’s really worse than that.

Lenders quickly realized they could turn this accounting loophole to their advantage in several ways. First, they embarked on an aggressive program of modifying loans to keep borrowers making payments. Rather than accept smaller profits, they modified the terms of these loans to interest-only. This reduced the borrowers payments while keeping lender revenues and profits the same. Second, for those delinquent borrowers that didn’t agree to a loan modification, lenders simply booked the lost income as profit anyway. How could they do this? Since the could model whatever they wanted for accounting services, they assumed house prices would rebound, and they would at some point in the future get back their principal plus the accumulated interest payments they booked as profits. Although this scenario isn’t particularly realistic, it past muster with accounting regulators, so banks eagerly booked this phantom income as profit to boost their financial statements.

Banking regulators did require lenders to increase their loan loss reserves “just in case” they actually recorded a loss. Lenders weren’t happy about this because loan loss reserves are dead money they can’t loan out and make a profit on — or so it would seem. Now that home prices are rising, lenders found a third way to make money on their can-kicking. They are reducing their loan loss reserves and booking that as profit too.

I can’t claim we are a Banana Republic, but we appear to have a Banana Banking System.

Lenders are recording profits on non-performing loans!

They are making money by virtue of not recording losses!

Does this seem right to you? Perhaps it’s time to review the sanity of mark-to-model accounting. Without it, lenders wouldn’t be able to play these games. When losing becomes winning, something is very wrong with our financial system.

Big Banks Are Padding Profits With ‘Reserve’ Cash

As Revenue Slows, Some Banks Increasingly Use Loan-Loss Reserves to Boost Income

Michael Rapoport — Updated Oct. 25, 2013 7:23 p.m. ET

Federal regulators have warned banks to be careful about padding their profits with money set aside to cover bad loans. But some of the nation’s biggest banks did more of it in the third quarter than earlier this year.

J.P. Morgan Chase & Co., Wells Fargo & Co., Bank of America Corp. and Citigroup Inc., the nation’s largest banks by assets, tapped a total of $4.9 billion in loan-loss reserves in the third quarter, up by about a third from both the second quarter and the year-ago quarter after adjustments. All the banks except Citigroup showed significant increases compared with the second quarter.

Accounting rules allow the money to flow directly into profits. In all, it made up 18% of the banks’ third-quarter pretax income excluding special items, the highest percentage in a year, according to an analysis by The Wall Street Journal.

I give them credit for creativity. They are taking lemons and making lemonade — it’s nothing I want to drink though. If it weren’t for the implicit backing of our government and their too-big-to-fail status, these banks would be very poor investments.

The moves come at a time when banks are being slammed by revenue slowdowns. Big commercial banks have suffered from a double whammy of plunging mortgage lending and trading activity. Third-quarter revenue for the four banks dropped an average of 8% from the previous quarter. The KBW Bank Index has declined 2% in the past three months, while the S&P 500 stock index has gained 4% over the same period.

The accounting maneuvers show how banks can prop up earnings when business hits a rough patch.

“You’ve seen reserve releases improve the stated numbers,” said Justin Fuller, a Fitch Ratings analyst. “Going forward, I think there’s fewer levers to pull for the banks.” …

They could always go into vice. At least those are cash businesses where nobody lies about their accounting.

The banks justify the releases. They cite improvements in credit quality and economic conditions—which make it less necessary for them to hold large amounts of reserves as a cushion against loans that go sour—and they say they are following accounting rules that require them to release funds as losses ease.A Bank of America spokesman said “the significant impact in credit quality we’ve seen in the last 12 months” has driven the reserve releases. J.P. Morgan, Wells Fargo and Citigroup all pointed to previous comments their top executives recently made indicating that reserve releases were merited because of factors like improving credit quality and the recent increase in housing prices.

The sophistication and brazenness of the ways lenders rob and pillage the US economy are remarkable. They don’t need to justify anything since they’ve bought off all the politicians who might do something about it.

But the Office of the Comptroller of the Currency, which regulates nationally chartered banks and federal savings associations, is reiterating warnings to banks about overdoing it.

In a statement to the Journal, Comptroller Thomas Curry said the OCC is monitoring banks’ loan-loss allowances “very closely” and that “we continue to caution banks not to move too quickly to reduce reserves or become too dependent on these unsustainable releases.” He didn’t comment specifically on the banks’ third-quarter releases, but said OCC examiners “will continue to challenge allowances on a bank-by-bank basis if necessary.”

I imagine the banks are concerned about the big bad regulator, right? What’s the worst they could do?

If the regulator finds problems with a bank’s reserves, it can issue a “matter requiring attention,” a specific finding of a deficiency that a bank must address, an OCC spokesman said. The agency has thousands of such findings outstanding on a variety of subjects, but the OCC spokesman wouldn’t say how many, if any, were related to banks’ reserve releases.

In other words, the regulators will do absolutely nothing.

Mr. Curry has been vocal on the issue for more than a year. In September 2012, he called it a “matter of great concern,” warning banks that “too much of the increase in reported profits is being driven by loan-loss-reserve releases.”

Last month, Mr. Curry said in a speech that when economic growth is slow, as it is now, banks might take more risks to maximize their returns, and so it is “particularly important” they maintain appropriate reserves. While some level of reserve releases is “certainly warranted,” he said, the ease of boosting earnings through the practice “has proved habit-forming” at some banks, though he didn’t single out any specific institutions.

Ordinarily these banks would be singled out by the market, and their stock prices would plummet. But since they are all too-big-to-fail, nobody cares.

Mr. Curry said his previous concerns initially seemed to get banks’ attention, and reserve releases temporarily eased, but that was “an anomaly.” Since then, he said, the releases have increased again, despite “loosening credit underwriting standards” that suggest banks are facing higher risks.

Why should the banks care what this bureaucrat says or does?

Bankers say current accounting rules essentially compel them to release reserves when loan losses ease, because the rules use past and current loan losses as the criteria for determining the proper level of reserves. James Dimon, J.P. Morgan’s chairman and chief executive, has been particularly vocal on the issue—at one point in 2012, he said that, while the bank wants to be conservative on its reserves, “the accountants look at a whole bunch of numbers. They make you take it down. So we had to take it down.”

The accountants made them do it? Give me a break.

But critics said banks have more discretion than that, and rule makers at the Financial Accounting Standards Board have proposed changes that would require banks to recognize losses based on expectations of further losses. Such a move would lead banks to record loan losses sooner and set aside reserves more quickly, analysts say.

Those potential changes are still pending, and Mr. Curry said in his speech last month that he supports the “thrust” of the FASB proposal.

These changes will remain pending forever. There is little or no chance of mark-to-fantasy accounting going away any time soon. As long as banks are potentially exposed to hundreds of billions of dollars in losses due to their borrowers being hopelessly underwater, regulators will not pressure banks to change their ways.

There is a reason these accounting rules are important. The integrity of our banking system is no small matter. If you need a reminder, I suggest you watch the video below.

If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered…I believe that banking institutions are more dangerous to our liberties than standing armies… The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.

Thomas Jefferson

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5626 SPRAGUE Ave Cypress, CA 90630

$620,000 …….. Asking Price
$706,000 ………. Purchase Price
4/25/2007 ………. Purchase Date

($86,000) ………. Gross Gain (Loss)
($49,600) ………… Commissions and Costs at 8%
($135,600) ………. Net Gain (Loss)
-12.2% ………. Gross Percent Change
-19.2% ………. Net Percent Change
-1.9% ………… Annual Appreciation

Cost of Home Ownership
$620,000 …….. Asking Price
$124,000 ………… 20% Down Conventional
4.28% …………. Mortgage Interest Rate
30 ……………… Number of Years
$496,000 …….. Mortgage
$123,493 ………. Income Requirement

$2,449 ………… Monthly Mortgage Payment
$537 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$129 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$75 ………… Homeowners Association Fees
$3,190 ………. Monthly Cash Outlays

($477) ………. Tax Savings
($680) ………. Principal Amortization
$192 ………….. Opportunity Cost of Down Payment
$98 ………….. Maintenance and Replacement Reserves
$2,322 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$7,700 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,700 ………… Closing Costs at 1% + $1,500
$4,960 ………… Interest Points at 1%
$124,000 ………… Down Payment
$144,360 ………. Total Cash Costs
$35,500 ………. Emergency Cash Reserves
$179,860 ………. Total Savings Needed
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