BankAmerica Disaster Arose From a
Lack of Standards
by Martin Mayer
The Wall Street Journal
Page A22
(Copyright (c) 1998, Dow Jones & Company, Inc.)
The revelation that BankAmerica lost $372 million in a complicated joint venture
with the
BankAmerica and David Shaw, a former
But the real results of such trading were not even predictable, let alone
inevitable, if market volatilities exceeded certain almost impossible
parameters. That, of course, is just what happened: The Asian tigers rolled over,
the Japanese banks ran out of let's-pretend room on their bad assets, the
Russian state imploded -- and so did the computer models. Bids for the
instruments the computers had modeled simply disappeared. In August, all the
funds following the principles that informed the Shaw-BankAmerica partnership
began to give their investors bad news. So far as the outside world knew,
however, the BankAmerica venture was the Chevy truck of trading: like a rock.
Stockholders in NationsBank and BankAmerica who voted in September to approve
the merger had no notion that one of the partners was bleeding hundreds of
millions of dollars.
Asked in October why the bank continued to carry its Shaw investment at cost
in August, when the losses in the deal became overwhelmingly apparent, a
spokesman said the bank had believed that the values would come back with the
passage of time -- and, anyway, the comptroller of the currency, the bank's
federal supervisor, had known all about it. If Shaw as an investment company
had tried to value its holdings in the joint venture at cost, somebody could
have gone to jail. But the bank could do so, because banking regulators have
long permitted banks to state their assets at "historic cost,"
without reference to market value.
Bonds held in a bank's trading portfolio, as distinguished from bonds in its
investment portfolio, must be carried at market price, but the bank itself
decides which portfolio is which. In an activity called cherry-picking, bonds
that show a profit can be moved into the trading account and sold to improve
reported earnings while bonds that show a loss are slotted into the investment
account and carried at cost. To keep bonds in the investment account, a bank
need merely declare an "intention" to hold the paper to maturity. The
chief accountant of the Securities and Exchange Commission in the late 1980s
expressed his distaste for this brand of "psychiatric accounting,"
but banks are supervised by banking regulators, not by the SEC.
The psychiatric element in bank accounting was then multiplied in the 1990s
with the surge in derivatives activity. Because a derivative is neither an
asset nor a liability, banks carried this portfolio off the balance sheet
altogether. And they claimed the right to postpone the recognition of losses
(or gains) in these instruments on the grounds that derivatives were often
hedges against changes in the value of the investment portfolio or -- taking
"intent" to the nth degree -- hedges against changes in the value of
mortgages or securities the bank planned to acquire in the future.
About a decade ago, the Financial Accounting Standards Board decided that
valuations of financial instruments should be standardized across industry
lines, and commercial banks -- like investment banks, brokers and mutual funds
-- should have to carry their securities at market price. Federal Reserve
Chairman Alan Greenspan objected strongly, warning that if they had to carry
government bonds at market price, banks might not buy such stuff, making it
more difficult for the government to fund its deficit; and in 1991 the banks
were in such trouble that Richard Breeden, the SEC chairman who had led the
charge for reform, was pushed aside.
In 1996, however, the FASB went ahead anyway, proposing a set of rules for
valuing all bank investments, including derivatives. Again, Mr. Greenspan and
Comptroller Eugene Ludwig objected; valuing the assets, after all, is what
their bank examiners do for a living. Mr. Greenspan went so far as to write
letters to the chairmen of the congressional committees that supervise the SEC
opposing such a plan.
But the Shaw-BankAmerica saga makes the FASB case. It demonstrates the need
for imposing market-value accounting on banks, especially larger banks, which
increasingly rely on the market rather than on deposits for their funding. And
it argues decisively that when banks are given expanded powers, which will
probably happen in the next session of Congress, they should exercise them only
through holding companies that have to meet SEC reporting standards and not --
as the comptroller and the Treasury Department want -- through "operating
subsidiaries" of banks that can cook their books and keep their
shareholders conveniently in the dark.
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Mr. Mayer is a guest scholar at the Brookings Institution and author of
"The Bankers: The Next Generation" (Dutton, 1997).