Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [93]
The SEC appeared to override the accounting board. Since when does the SEC interpret accounting rules that contradict public pronouncements by FASB? Yet the SEC seemed to encourage investment banks to classify more assets as “Level 3.” Classify they did. For example, in early May 2008, Goldman Sachs Group Inc. announced that for its fiscal quarter ending in February, it increased its Level 3 assets by 39 percent or by more than $27 billion. It had $96.4 billion in assets sitting in its Level 3 accounting bucket. Morgan Stanley had $78.2 billion in assets sitting in its Level 3 accounting bucket. Merrill Lynch announced that its mark-to-myth assets increased from $48.6 billion at the end of 2007 to $82.4 billion for the first quarter ending March 31, 2008 (Merrill is on a different fiscal calendar), an increase of 70 percent.33 The list goes on. Merrill Lynch’s new CEO, John Thain, brought in 51-year-old Tom Montag from his old Goldman Sachs stomping grounds to head up global trading for around $40 million.34 Wouldn’t you think that for that kind of money, Merrill could disclose their assumptions?
How could one value Merrill Lynch, Lehman, or any of the other investment banks? How could anyone trust their numbers?
Lehman announced a probable loss for second quarter 2008 of $2.8 billion, the first loss since going public in 1994. It came as no surprise when Lehman said it might boost its Level 3 assets. It raised $12 billion in new capital between February and the end of May, and said it would raise $6 billion in new equity diluting shareholder equity by 30 percent. Through sales, it reduced leverage from 31.7 times to 25 times. It sold $130 billion in assets (but it did not specify how it sold all of those assets so quickly or to whom).35
Richard “Dick” Fuld, the 62-year-old then CEO, was a Lehman lifer. In December 1983, when Fuld was chief of trading operations, he made a presentation to Lehman’s board as it met over lunch to assess capital needs. Richard Bingham asked Fuld how he had made money in his trading operations the previous five years and how he would make it the next five. Fund responded: “I don’t know how I made it over the last five years.”36 Fuld added he had hired people “to study how we’re going to do it over the next several years.”37 An appalled Bingham asked how long that would take. Fuld responded: “Two years.”38 I wonder if Fuld completed the study.
The SEC quickly moved to give the appearance it was on top of things. After all, we wouldn’t want another debacle like Bear Stearns, would we? The SEC said it would require Wall Street to report its liquidity levels and its capital starting later in 2008.The SEC wants disclosures “in terms that the market can readily understand . . .”39 Oh, really? About that letter the SEC sent in March. . . . That ship has sailed. After financial institutions stuff tens of billions of dollars worth of assets into a black box (Level 3 accounting buckets), how is the market supposed to readily understand? The Federal Reserve Bank, the new liquidity provider for Wall Street, seemed to have no idea of what was going on, either.The American taxpayer should ask for a refund for the money allocated to keep the SEC in operation. It makes one wonder just what it would take to get Christopher Cox booted out and have a thorough housecleaning at the SEC.
I do not as a rule weigh in on quarterly earnings statements, but I will occasionally volunteer my views just to keep making the point. I had publicly challenged AIG’s writedowns in August 2007, Merrill’s in early October 2007, and challenged Citigroup’s reported numbers in January 2008. I told the Wall Street Journal that Citigroup might need $3.3 billion more in write-downs on its “super safe super senior” positions to reflect market prices. That would have increased Citigroup’s overall write-down due to subprime from $18 billion to $24