Fact vs. Fiction

Within the past twenty-four hours, we have been treated to two remarkable fairy tales. Unfortunately, I don’t foresee a happy ending to either situation.

First, the bank stress tests. In order to determine how they would fair, nineteen banks tested under the new (old) mark-to-model rules by factoring in continued unemployment and housing problems. In essence, the banks were asked if they have enough capital to ride out the storm. Absolutely, the banks replied. Maybe you need a little bit more capital, the government said. So, to meet the need, stock will be sold to the public. Everyone breathed a sigh of relief, CNBC started cheerleading, and the stock market was off to the races.

I could dispute, and be challenged, on many of the assumptions and the results and opinions. Fair enough. However, indisputable, is that every bank has made no adjustments for the impairment of good-will on their balance sheets. For example, Bank of America ($13.51 - 5/7/09) is still carrying good-will as though Merrill Lynch, Countrywide, and Bank of America had a value at the peak of the stock market in 2006-2007. Since good-will makes up the lions share of assets, what happens when the crunch comes again? Cash, stocks, bonds, etc., are real. Good-will, however, is an accounting creation with no tangible value. It is supposed to be tested annually, to see if good-will (carrying value), is less than fair value. If it is, then impairments are required to be taken (charged off.) Done correctly, we would get a true picture of a company’s value. But since accounting rules allow a great deal of discretion and judgment, we can expect a great deal of liberty to be taken by the banks.

Does anyone really believe the valuations of good-will? Well, some people must. These banks will more than likely write-off a series of impairment charges which will create a slow bleeding death, thereby manipulating reality. This doesn’t even take into consideration the dilution of capital raises, sales of some of their most profitable enterprises, the impending tsunami of commercial real estate foreclosures, and credit card write-offs.

The second fairy tale is unemployment. Hooray, hooray. Only 539,000 people lost their jobs in April, a slowing in downsizing. Jubilation. We’ve turned the corner. Not so fast. First, the seasonal adjustments somehow created 65,000 new jobs. Where? Next, the announced 60,000 people hired by the census bureau, which by definition, is part-time work. No problem, we need the employment numbers, just create it by calling the part-timers full-timers! So, 539,000 + 65,000 + 60,000 = 664,000 of potential unemployed people. Also, keep in mind, previous months figures have been adjusted. 30,000 more unemployed in February and 30,000 in March, bringing their totals to 681,000 and 699,000, respectively. Somehow, they came in just under that 700,000 magic number that spells crisis. Oh, to have a pencil with an eraser!

One other point, the Birth/Death Model. This model is making an assumption that businesses too new, or too small, to participate in the employment measure have created a certain number of new jobs. It is not researched, it is not fact, it is only a guess. Where are these jobs? By the way, in the numbers reported today, 226,000 jobs were supposedly created under the Birth/Death Model. Give me a break!

Wishing and hoping doesn’t change the truth. When it comes to banks and jobs, it’s just pure fiction.

Till next time,

Bill



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