You may have seen an interesting article in today’s FT by Tony Jackson. As we all know, major banks in the US posted attractive earings in the first quarter of 2009, leading to a rise in the price of their shares. What now emerges is that they did so by writing down the value of their debts — ‘marking to the market’.
There is some justification for this. Let us suppose that Bank A issued bonds to an amount of $100 million five years ago, and that these instrucments are on paper repayable at that figure in another five year. However, let us also suppose that they are simultaneously standing at 10% of face value in the market place. If Bank A buys its own bonds in at 10% of their face value, it will wipe out $90 million of its debt, leading to a genuine, $90 million increase in the value of its net assets. From a strict accounting point of view, this approach is apparently correct. On the other hand, it misleads because it creates the impression that Bank A’s underlying business is returning to profitability whereas the reverse is the truth — the bonds stand at a huge discount because it is close to bankruptcy. Are they large banks not once again misleading the public? O tempora, o mores!
Best — Will Hopper
