How Should We Interpret the String of Positive Earnings Reports from U.S. Banks?

BY busadmin  April 20, 2009 at 3:05 PM EDT

Bank of America; via Flickr

Question: After three major banks – Citigroup, JP Morgan, and Goldman Sachs – announced better-than-expected earnings last week, Bank of America announced more than $4 billion in first-quarter profits today. How should we interpret this string of good earnings reports?

Paul Solman: Often on this page I’ve written about the uncertainty inherent in the social so-called sciences, and in economics in particular. I’ve also quoted, I think, the punchline of my first accounting class in business school, fall of ’76: “Give me the accountant I want, and I’ll give you the earnings you want.”

That’s my reaction to the supposed earnings surge in U.S. banking — and apparently the reaction of investors. Bank stocks had plunged by this afternoon, when I sat down to write this post. I suggest you read this paragraph from today’s Washington Post about Bank of America’s “results”:

The bank booked a profit of $2.2 billion on the decline in value of its own debt, on the theory that the bank could now repurchase that debt at the lower price. Other banks, including Citigroup, have booked billions of dollars under the same rule. Some financial analysts regard the technique as obfuscating the true picture of a company’s health, because the companies have not actually repurchased the debt, so the gains could be reversed if the values rebound.

Now Bank of America reported just over $4 billion in “profits.” What the above paragraph means is that more than half the “earnings” came from the fact that investors so distrust BofA’s ability to repay its debts that those debts have plummeted in value on the debt market. Thus BofA could THEORETICALLY buy back its debts and make money on the deal.

I do not know how the banks will fare in the future. No one does. No ones does — ever. But as to the significance of the current earnings reports, I sure wouldn’t — how to put this? — take them to the bank.