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Banks' accounting creativity may prop up earnings

NEW YORK - Wall Street's banking titans have a history of being slow to acknowledge bad news. Don't count on them to come completely clean in their quarterly earnings reports this week about how the credit crisis is rocking their businesses.

That's because bank leaders have a crafty tool on their side: accounting rules. They give Goldman Sachs, Merrill Lynch, Morgan Stanley, Bear Stearns and Lehman Brothers wiggle room in sizing up - and potentially downplaying - the losses they are facing on illiquid assets they hold that have been battered by imploding credit markets.

That may make it hard for investors to judge the impact of the credit crisis on markets and the economy.

The market turmoil, which intensified in August, has inhibited bond underwriting and the unloading of loans used to finance leveraged buyouts. Distressed subprime mortgage debt also remains a significant worry.

Wall Street research analysts have been cutting the investment banks' profit projections in recent weeks in anticipation of weak earnings reports.

Goldman Sachs Group Inc. may take as much as a $3.1-billion haircut as it writes down the value of assets tied to subprime mortgages and leveraged loans, cutting earnings by 24 percent, according to credit research firm CreditSights. Lehman Brothers Holdings Inc. could see its earnings sliced in half due to an estimated $2.8-billion write-down, while Bear Stearns Cos. could see a $696-million write-down, which could knock down earnings by 23 percent.

Although those estimates are eye-popping, no one really knows for sure what will happen when the quarterly reports start coming in today.

"These are not people who will just say 'We blew it,' " said Lynn Turner, former chief accountant of the Securities and Exchange Commission and now an independent consultant. "They don't like putting out bad news unless they have a good reason or an excuse."

Turner says accounting rules could enable the banks to report better results than anyone is expecting. That's because they have the discretion to determine the market value of certain parts of their credit portfolios.

Put simply, the banks can adjust the value of their assets each quarter by assigning a price to them based on what the marketplace commands for similar assets. The process is known as mark-to-market.

The banks have plenty of incentive to delay the bad news for as long as they can - and try to ride out the current financial storm with as little damage disclosed to investors as possible.

It's probably too late for any industrywide fix this time.

Be warned: What you see may be a sugarcoated version of earnings.

[Last modified September 18, 2007, 01:10:07]