Just like the real estate agent who is heroically solving Califorina's oversupply of housing by giving away one house when you buy another, Wall Street firms are courageously propping up their own balance sheets by booking gains as a result of declines in their own creditworthiness.
Here's how it works. The banks are taking advantage of rule that allows them to count the value of the debt they owe as decreasing then the market prices for their debts fall. The rule is the mirror image of the "mark-to-market" accounting that has forced them to write-down assets such as mortgage securities that trade at lower levels than they expected.
This story has been around for a few weeks now. But it's getting more attention today. Some people are wondering if those downgrades from S&P could actually boost bank's balance sheets by providing new room for these dreamy accounting fixes.
After the jump, Dick Bove explains the difference between the new Wall Street accounting and reality.
Here's how it works, according to Richard Bove, an analyst at New York-based Ladenburg Thalmann & Co. A company decides to designate $100 million of its subordinated bonds as subject to mark-to-market accounting. The price of the bonds drops to 80 cents on the dollar from 100 cents. So the firm books $20 million on the "presumed savings that you have on your liabilities,'' Bove said.
"In the real world you didn't save a dime,'' he said. "You still owe the $100 million. It's another one of these accounting rules that basically takes you further and further away from reality."
That's a fair point. Although, presumably, the banks marking down their own debt could go out and repurchase it on the open market at the discounted rate. So it's not quite as unreal as it might seem.
Wall Street Says -2 + -2 = 4 as Liabilities Get New Bond Math [Bloomberg]