Why you cannot believe banks’ audited financial statements

From the Financial Times:

Rules regarding how banks account for off-balance sheet interests are “irretrievably broken”, a senior group of international rulemakers has warned.

The rules, which have allowed trillions [note the “t” — not “m” or “b” but “t”] in assets to escape close scrutiny, have come under attack in the wake of the credit crisis as banks have been forced to disclose huge losses on these holdings.

But a report by a high-level group of accountants has warned that completion of the current overhaul of the rules would not be possible in the near future.

“Completing a final standard by mid-2011 will be extremely difficult, perhaps impossible,” says the report seen by the Financial Times and prepared by board members of the US-based Financial Accounting Standards Board and the International Accounting Standards Board.

While the report does not yet represent the official view of the accounting bodies, it is a sign of the turmoil within the industry in grappling with the off-balance sheet issue. [By “grappling”, they mean, “Holy s—, are we in trouble now.”]

Accounting standard setters are already under pressure for their support of marking assets to current market prices – a practice that has resulted in billions in writedowns and affected banks’ profitability seriously. [That’s not the issue with mark-to-market — the issue with mark-to-market is that it leads to a death spiral by which new downward marks lead to loan calls and fund redemptions which lead to panic selling which leads to new downward marks which leads to… you guessed it, banks’ off-balance-sheet entities going kablooey and suddenly showing up at the door like your unwanted uncle.]

The Financial Stability [ha!] Forum, a global body of regulators and central bankers, has asked the IASB and its US counterpart to consider the issue as a matter of urgency. Accounting standard setters are in the throes of discussing how to respond.

However, the report by the high-level group of accountants says the project to overhaul current rules on off-balance sheet interests has lost momentum because of staff turnover and “relative inexperience”.

Remember Enron?

Imagine Enron times a hundred.

This just gives me an excuse, after hyperventilating, to roll out one of my favorite New Yorker cartoons…

[Cartoon omitted] – Link here