John Hussman of Hussman Funds used to insist that much of the profit ‘recovery’ in the United States, post-crisis of 2008, was due to the suspension of mark-to-market accounting rules in 2009 (in April, I think). I was not sure if the suspension of rule FASB 157 has remained in force. But, this blog post confirms that FASB 157 suspension is alive and healthy. Banks are continuing to mark-to-model and we have no way of knowing how much of their profits is well earned and how much of it is not. In fact, it is worth studying – for a doctoral thesis – the impact of FASB157 suspension and QE on the US stock market’s meteoric rise (see the chart here on the rise of S&P 500 stock index).
Besides FASB157, there is also the absurd rule which allows banks to record as ‘income’, an erosion in the market value of their debt. So, a credit quality deterioration raises the bank’s reported income as the loss in the market value of the bond (par value of the bond – current market value) is allowed to be added to income. Unsurprisingly, this caused confusion and resulted in BofA to misreport its capital base. I am assuming no mala fide here.
Accounting rules, globally, are the biggest reminder of the complex world that we have created or the tangled web we weave when we first practice to deceive. Sir Walter Scott must have had accounting rules in mind, when he said that.