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Accounting Magic Saves the Day

A recent spate of positive financial reports from some of the nation’s largest banks has led some commentators to declare an end to banking crisis. In the past week, Goldman Sachs, Wells Fargo, Citigroup and, as of this morning, Bank of America have reported better-than-expected results for the most recent quarter.

Too bad most of the good news is based on accounting tricks. Consider the following:

* At Goldman Sachs, a $1.8 billion net profit came from redefining the company’s fiscal year to exclude December 2008, a month in which the company recorded $1 billion in losses.

* At Citigroup, the company’s $1.6 billion net profit came in large part from a $2.7 billion  credit value adjustment. This accounting move allowed the company to record a gain for an amount equivalent to the decline in the value of its outstanding corporate debt on the grounds that, if it wished, it could repurchase the devalued debt at a cheaper price.

* At Bank of America, the company’s $4.2 billion net profit came mostly from a Citi-style  credit value adjustment of $2.2 billion coupled with a $1.9 billion, one-time gain from the sale of of a stake in an Asian bank.

Nothing in the recent reports suggests that the fundamental solvency problems facing the banks have gone away or that the banks will no longer be looking to the federal government for assistance. Moreover, the problems likely will worsen, given the increasing amounts of money the banks are setting aside to cover anticipated bad debts from lines of business like consumer credit cards. And given the anticipated losses and the banks’ weak positions, it is unlikely that they will be extending much credit anytime soon.

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