BofA: Too big to fail a math test
Bank of America has joinedÂ CitiÂ in the dubious group of banks who have failed the Fedâs stress test twice. The Federal ReserveÂ announced yesterdayÂ that the bank would have to resubmit its capital plan due to incorrectly reported data.
While BofA made an accounting mistake, and a rather egregious one, the Fed also failed to spot the error the first time around.Â Ben WhiteÂ quotes an unnamed senior bank executive performing blame jujitsu: âEasy to blame BofA here but seems like some of the blame goes to the opaque design and implementation of stress testing by the Fedâ.
Last month, the Fed approvedÂ Bank of Americaâs planÂ for a $4 billion share buyback and a $1.5 billion dividend increase. Now, after BofA found problems in its capital calculations, it isÂ halting those plansÂ and will submit a new plan to the Fed. The bankâs error was in calculating the value of a set ofÂ structured notesÂ issued by Merrill Lynch in 2009.Â The WSJâs Michael RapoportÂ explains the rule that tripped up BofA, called the âfair value optionâ:
The issue goes back to the 2007 accounting rule that granted banks a âfair value optionâ â the opportunity to value some of their debt at market value, or the best approximation of it, instead of at their original cost.
When making the calculation to get from its capital under accounting rules to its regulatory capital, BofA stripped out âunrealizedâ changes on those structured notes â i.e., the paper gains and losses on notes it still held. But the bank also stripped out ârealizedâ losses on structured notes that had matured or been redeemed â and it wasnât supposed to do so.
Bank of America isnât likely to find solace in the fact that the mistake it made wonât even be a mistake much longer:Â Floyd Norris notesÂ that just last week the âFinancial Accounting Standards BoardÂ tentatively agreed, on a 5-to-2 vote, to end that practice at a date to be determinedâ.
Peter Eavis and Michael CorkeryÂ write that while the banks submit their own calculations in the stress test, the âFed is also meant to review the banksâ numbers, using its own examination to identify potential red flagsâ. Eavis and Corkery quote CLSA bank analyst Michael Mayo, who bluntly puts the onus on Bank of America: âItâs a bank. It needs to get the numbers rightâ.Â Actuarial sprezzaturaÂ may have been cool in Medici Florence, but itâs shocking, andÂ trust-depleting, at a modern global financial institution.
Matt LevineÂ echoes Mayoâs point. Bank of America overstated its capital, Levine estimates, by $2.7 billion under current rules, and $4 billion under the not yet implemented international Basel 3 regulation. While the rules that led to the mistake are complex and counterintuitive, Levine says, âthe people doing your regulatory capital calculations really ought to know how to do regulatory capital calculations! âThe rules are hardâ is not a good excuse for a $2 trillion bankâ. âÂ Ben Walsh
On to todayâs links: