Nearly 18 months ago I ragged on Washington Mutual, which has since been "absorbed", and their silly projections, loss reserves, and payment of dividends out of capitalized interest (which is not real money by the way.)

Today, the poster child for "silly" is Wells Fargo.  From the NY Post's article:

Wells "decided" in their latest quarterly report to cut loan loss reserves.  That would make sense if their losses were decreasing.

They're not - they're increasing.  Year over year, they are up 238% for Wells, and the trend has not changed.  In 3Q they reported $4.995 billion in defaults, against 4.073 billion for the second quarter, an increase of about 23%.

So why cut loss reserves by $500 million, or 20%?

Good question. 

This sort of balance sheet game is perfectly legal, but it raises more questions than it answers.  The machinations make the balance sheet look better than perhaps it should be, thus boosting the stock price, and thus making it easier raise capital.

Isn't the whole reason we're in this bit of a pickle because people haven't been quite "straight" with the street and the public about their exposures and risk?

I think so.

Never mind that this is the second time in two quarters that Wells has done something "sneaky" with its balance sheet to "goose" their reported results.  Last quarter they changed their treatment of "delinquent" loans, extending to 180 days from 120 days the amount of time that must elapse before they considered a home equity loan as "not paying".

Where I am from, and in my experience in business, when an account goes 30 days past due it is "delinquent."  When it goes 60 days past due it is "seriously delinquent", and by the time it goes 120 days past due I've written it off or sold the account to a collection agency.

Simply put, once you're four months out, say much less, six, you're not going to get paid.  The late fees, charges, and interest are gone, not to mention the principal.

How many rabbits do you have in that hat Rich?  And pray tell, what happens when you reach into the hat once more, find no rabbits, and are forced to reconcile all of the "deferred" losses that come back against your balance sheet and results?

This is the precise sort of "massaging" that has gotten us into this mess in the first place.  We are well past the point where regulators and Congress should be in the middle of this mess, issuing directives and laws, not fiddling while we further destroy trust in our banking system and capital markets.

Washington Mutual's Killinger, in my opinion, should have been under investigation (along with its board, audit committee, and auditors) as soon as they reported first quarter two thousand seven results, in which they reported less in cash earnings than they paid in dividends.  It was at that point that, from my perspective, their fate was sealed, as once you start spending cash you don't really have, paying dividends from a bookkeeping entry instead of real money, you are on borrowed time.

This bit of shuffling isn't as severe but it raises the same sort of questions and if we intend to get out of this crisis and rebuild confidence we the people, investors, and other banks deserve answers. 

Balance sheets should be transparent and easily understood.  Loss reserves should be reasonably related to the trend in defaults, and further, when economic times get bad you tighten, not loosen terms and definitions of when a payment is late.

Under a reasonable accounting program you would declare a loan that is sixty days late as "in default", not 120. 

Why?

Because when the economy deteriorates so does on-time payment performance and further, those who are late are more likely to never pay you at all.

This places your accounting and reporting in the most pessimistic light that is reasonable under the circumstances, which means that if you are successful in managing your losses and recovering them, you will outperform expectations - the definition of a sound and secure firm.

Good luck finding just one financial institution on Wall Street that believes in these principles, or one regulator willing to force prudence on them.