Philadelphia Reflections

Bank Accounting Off the Books

Banking

Banks have long operated in a dual system of regulation, state and federal, which permits some shifting back and forth between regulators. Mergers sometimes confuse matters further, and a system of one-bank holding companies adds to the stew. Local banks, waving the red shirt of domination by Wall Street at their state legislatures, have resisted interstate banking in a wide variety of ways. Sometimes a customer finds that funds transfer between two branches of the same bank must be treated as out-of-state action, and so on. Inevitably there is a certain amount of dealing by subsidiaries which are not recorded on the books of the home bank of a bank conglomerate in ways prescribed by the subsidiary's regulator, or not recorded at all. Equally inevitable is the accusation of off-the-books illegality by competitors, politicians, or the merely captious. Fine points of these legal and accounting arguments must be left to experts, peer review, and courts. Muttering Enron at every opportunity, accusers may be right that some of these arrangements have stepped over the line; partisans in Congress and the legislatures, on the other hand, may be correct that existing law is bad law. This is not a good place to debate either point.

Credit Crunch

It does seem appropriate to notice that banking has long been massively inefficient and that much of this inefficiency has been imposed by regulators. Regulators represent the public, more or less, and the public is rightly nervous about stewardship of its assets. Dual regulation offers refuge from the ancient fear of confiscation by the sovereign and is worth a certain amount of inefficiency if it works. But it does create loopholes, and it does impair transparency. In the case of the credit crunch of 2007, it sequestered bad debt in off-the-books ways, perhaps creating tax avoidance, but mainly creating distrust among counterparties. In those days of awful turmoil, no one knew what was going on, multi-billion dollar losses were being confessed by premier institutions, so transactions were delayed, avoided, or rejected. Transactions with anybody. When the time comes to reconsider regulations, it should be emphasized that by far the most damaging component of the whole mess was lack of transparency. Once more, a massive computer programming effort is entirely capable of restoring transparency to the existing regulatory structure, highly pigglety though it may be. After we achieve transparency we might consider achieving efficient transparency, and after that perhaps ponder fairness in transparency. When a trader calls another and asks to buy a zillion shares, the happy recipient of the call likes to glance up at his screen to see what the other fellow is worth, before he shouts, "You got it!"

What the Federal Reserve might well call the highest priority calls for respect, as well. Ever since we began the century-long transition from a gold standard for money, there has been a concern that the Fed might not be able to determine how much money, or credit, or liquidity -- is actually in existence. We have reached a point in this process where the Fed has largely stopped trying to measure monetary aggregates, and merely adjusts its tools to keep the money supply sailing between the rocks of inflation and recession; if neither rock is in sight, the amount of money is about right. That system has served us for eighteen years, long enough to spark hope that it can be permanent. But when a rocky shore does make an appearance, the Captain of the ship must know how much slack he has, and how reliable his sonar. For huge sums to be obscured within bank subsidiaries or delayed marking to market, is to increase the chance we will run up on the rocks when it might have been avoided. He too needs transparency, but he also needs prompt obedience to his orders. The rest of us passengers are rightly concerned when he appears before Congress and admits he is not sure what the situation is. As long as that is the case, fairness -- and dogma -- be damned.

Taking a step backward, the whole credit crunch has brought to the world's attention that real estate transactions are both immense, and immensely inefficient; a great deal of money is to be made if any step in the chain can be streamlined. Therefore, real estate agents, real estate lawyers, title insurance, surveyors, advertisers, inspectors and everyone else who makes a living from real estate sales -- can expect to be drawn into an annoying process of inspecting the premises, promises, kickbacks, referral fees and marketing costs of a whole expensive process, first blasted open to inspection by implementation defects while computerizing the mortgage step. It appears to be high time for it.

Originally published: Wednesday, February 13, 2008; most-recently modified: Sunday, July 21, 2019