◼ FINANCE Bloomberg Businessweek December 23, 2019tank, just a few days after it had been calculated to
meet a regulatory requirement. In their report they
called the moves “optimization” strategies.
The measure in question is the liquidity
coverage ratio—basically a bank’s ability to get
its hands on cash in a hurry. A ratio of 1-to-1 is
the goal. The first part of that calculation is high-
quality liquid assets—holdings the bank can sell
quickly without taking a hit on price. The more
of those a bank has, the better it can weather a
storm. The second part is the expected size of the
storm, measured as the cash that will likely flow
out of the bank in the next 30 days.
Optimization is how banks pump up the amount
of bulletproof holdings they can report. Post-crisis
rulessaya bankcan’tcountasa liquidassetany
bondsit’sissueditselfandstillholds.Competitors
areinthesamefix,owningself-issued bonds they
can’t count as liquid. Swapping them temporarily
solves everyone’s problems. And that’s what they
were doing, using short-term repurchase agree-
ments that give each bank the right to borrow
against the other bank’s bonds. This maneuver
allows both sides to count the other bank’s bonds
as liquid assets. The ECB declined to comment on its
discussions of this issue with the individual banks.● LOSING LEVERAGEThefinancial crisis isoften remembered as
amortgage meltdown.Butitbeganwiththe
implosion of Lehman Brothers Holdings, and that
involved fake finance.
Banks are measured by the value of their
assets—the securities they own and the loans
they’ve issued. They acquire most of those assets
and fund most of the loans by borrowing money,
while using their own money, or capital, as well.
If a bank has a huge amount of assets relative to its
capital, that means it’s borrowed a lot—and that
it could get in trouble during a financial squeeze.
Lehman was able to make its assets look smaller
than they were. A few days before the end of a
quarter, it borrowed money for a short time,30
putting up securities as collateral. It used that
money to pay down other debts. It treated this deal
as a sale of securities—as if it had sold an asset,
settleda debt,andthusgottensmallerandless
risky.Butit wouldsoonbeobligatedtobuyback
thesecurityandtakeoutanotherloantodoit,
returning to the same size it was before the trick.
Inthesecondquarterof2008,a fewmonthsbefore
itscollapse,Lehmanlooked$50billionsmaller
thanit actuallywasthankstosuchdeals,according
to the findings of a bankruptcy court examiner.
ThetrickLehmanusedis nolongerpossiblein
theU.S.,whereaveragingofassetsis requiredfor
mostcapitalcalculations,nota singlesnapshot.
But that’s only one tactic. Thelesson from
Lehman?“Well,justthecontinuedavailability
ofaccountingtrickstodressupyourregulatory
ratios,” says Sheila Bair, chairman of the U.S.
Federal Deposit Insurance Corp. during the cri-
sis, who spoke in an interview for the web series
Bloomberg Storylines, in an episode on financial
fakery. “It’s still going on.”● RISK HIDING
Capital is a bank’s bedrock. The money the bank gets
from investors when it issues stock? That becomes
capital. The bank makes a profit and doesn’t pay
all of it out as a dividend? What’s left is capital. The
point of capital is that if some of the bank’s invest-
ments go bad, the bank can stay alive—it’s essentially
the money it doesn’t have to repay to anybody.
Like the homeowner who needs to come up with
a down payment on a house to qualify for a mort-
gage, banks must have a certain amount of capital in
relation to the risk they’re taking. Where 20% equity
is good for a house, regulators widely consider capi-
tal above 10% of assets as safe for banks. But bankers
don’t like having so much capital—they’d rather use
more borrowed money to make loans or buy invest-
ments to juice their returns on capital. One way to
reduce the amount of capital they must have is to
make “risk adjustments” to their assets.
Look at any big banks’ accounts, and you’ll find
more than one capital ratio. There’s the one the
banks highlight in their reports, which looks really
good, averaging 13% among Europe’s top 10 banks
and 12% among the U.S.’s top eight as of the end of
the third quarter. And then there’s the one further
down that comes in at about half those levels—4.7%
in Europe and 6.6% for the U.S. The difference? In
that first number (called Common Equity Tier 1), the
rawassetsare“risk-adjusted”beforethey’reputinto
theequation.Lessriskyassetsessentiallybecome
smallersothattherelative amount of capital looks
bigger. That’s right: The banks get to decide that“You have to
assume you’re
only seeing
a fraction of
what’s going
on in fake
finance”