The Delusion May Be Greater than First Thought

Yesterday, I mentioned the curiously detached-from-reality perspective of investors in regard to the poor results from Citigroup, among others. People somehow got the impression -- no doubt encouraged by management -- that the news was some sort of one-off, throw-everything-in-the-kitchen-sink type of event, and that everything would be hunky-dorey next time around.

Leaving aside the question of what causes people to experience such levels of cognitive dissonance in the face of overwhelming facts to the contrary, it's possible the delusion may be even greater than first thought. In "First Brokers, Now Banks: More Fictitious Gains," Barry Ritholtz, my friend and must-read publisher of The Big Picture blog, elaborates further on the latest in a long series of scams that may give some stock investors what they crave most: fundamentals that are always positive or that can always be spun in a bullish fashion.

Yesterday's surprisingly bad news out of Citibank and then UBS sent us back to the  research archives looking for information about the quality of Banks earnings.

As we noted last week, much of the Brokers' gains were fictitious.

It turned out that a decrease in the value of the B/D's  own debt was offset with a phantom accounting entry. These are presented in the earnings as if they are actual gains, not accounting phantasms.

But don't think its just the big Brokers. The Banks are now getting in on the scam act:

"Now some banks may be set to similarly benefit from their own misfortune. Financial titans such as Citigroup Inc., Bank of America Corp., and J.P. Morgan Chase & Co., which will report third-quarter results next month, all opted earlier this year to start applying market values to some of their own liabilities, according to the research service the Analyst's Accounting Observer.

This means they, too, might see a boost to profit from declines in the value of their debts during the summer credit crunch. "It might not be unusual at all to be seeing gains on debt issued hitting earnings in the third quarter," the Analyst's Accounting Observer said.

Officials at Citigroup, J.P. Morgan and Bank of America declined to comment.

The brokers and banks are doing nothing wrong or improper in booking such gains. The accounting rules as they stand allow the practice. But some investors are crying foul, saying the rules shouldn't have been changed to allow for such gains . . ."

So much for gains in earnings quality . . .

Comments

[J. Bridges]

Mr. Panzner,

Watching the tape painted higher with every new recessionary data point is getting very old; and alarming. Your comments about deluded market participants are salient. But, having read your book, don't you think there are far less innocent reasons for the market's Fed inspired 12% jolt in six weeks?

Despite the red-ink welling up in my account, I would say the odds of a major market event are rising along with the indices. Any thoughts?

Many thanks for trying to help small investors protect their wealth,

[The CAT]

Right on!! NY'ers are especially lost still feeling the 5 boroughs are bubble-proof. It's evident sellers are still thinking a little too optimistic about the market. While I see NY dropping less than some areas due to labor, their will be a correction no doubt as salary vs. wage is at outlandish proportions in the city. I personally am 90/10 split on my 401k with the 90% conservative investments and hedged to the gills. I also have no credit debt or mortgages, entirely debt free thankfully...

My initial suspicions started back when the bubble began. Houses prices in my area in Queens increased by 40-45%, salaries however increased at normal levels leaving most people out of the picture. My first instinct was "this can't be, why has the prices increased without everything else following in trend? Next thing I hear friends of mine in 100$ financing deals raving over the market watching their houses skyrocket. I began to feel like a loser as my fear over this situation held me back from getting in the mix. I remember waiting for the bus one day. At the traffic light was this kid who looked about 18-24 Years old in a brand new Mercedes and I said to myself "Wow, what a fool I must be that at 35 I'm taking the bus and this kid's got a Benz, WTF!!!!"

As we see this total credit market scam unfold, I predict credit card and other loan types will also suffer defaults on payment furthur weakening the market and our dollar. Thanks to blogs like these we now understand that my lack of a Benz was actually my display of the real current financial condition of today's thirtysomethings!! Without big crditlines and no money down deals, most of us our ridin' the bus, the kid in that Benz better enjoy that lease because when it's up, his credit will reflect what he's really worth and he too will discover the joys of waiting on the streetcorner waitin' for a bus like me, watching the next sap pull up at the light and say "WTF"!!!