Trading and finance blogger Thomas Tan has well summarized[1] many of the criticisms I have had of the unjust practices of the big banks and their bail-out sugar-daddy, big government. Tan compiles seven specific ways in which these cesspools of toxic financial waste have presented themselves as healthy and robust institutions. The question is, “How do all these big banks, tottering on the edge of bankruptcy just a few months ago, suddenly show billions in profits?” Despite all the positive news about recovery and passing of “stress tests” (double-speak for “buying time” while big government pretends it has the problem under control), banks have hidden a monster of details in the deep dark abyss of unreported news, all in the name of increased transparency. The details carry ominous portents.

Following Tan’s summary, here are the seven deadly sins of big accounting:

1) The One-Hit Wonder of Refinancing. Immediate (and genuine) profits have rolled in due to refinancing. Problem: these come at lower interest rates (less long-term income for banks), and the immediate increase in profit comes from the one-time fees charged for the process. Further, banks only refi for qualified people—a limited few. These “new” mortgages are not for people who have suffered foreclosure, face foreclosure, or have the slightest credit difficulties. In short, these refiswill end soon when the pool of eligible borrowers runs out. The bad part for banks here is these new profits are basically a one-quarter phenomenon.

2) State of Denial. Talk of a “bottom” for the housing market is a big lie. Some investors have begun to sweep up cheap foreclosed properties in some areas, and this gets reported in mainstream news with little qualification. This implies a turnaround in new home buying. These reports do not mention that commercial mortgages face even bigger problems than residential (which itself has not necessarily bottomed) and present even larger potential effects. Bernanke admitted this a few days ago, and the press ignored it, choosing rather to focus on his claim that we “may” be experiencing signs of recovery. Worse yet, credit card and consumer debts, as at least one analyst has measured, have only progressed about a third of the way downward to expected losses. All of these debts work together to say that expected losses are much higher than reported. Meanwhile, banks have written down less than half of these expected losses so far. Not a realistic reported outlook on their part.

3) Fox in Charge of the Hen House. Banks get away with these lower write-downs because their write-off process is governed totally in-house, at their own whim, according to their own arbitrary decision. At present, they have chosen to delay reports of losses as long as they can. They report as much income (including bailout money) as they can, while deferring reports of losses as long they can, resulting in the appearance of profits on the books. In reality, total losses would subsume even the generous amounts of bailout money, and neither the banks nor the government wants the public to see that.

4) Wishful Thinking as Fact. As I reported previously, the Federal Accounting Standards Board manipulated its “mark-to-market” rule that normally would require banks to list assets at current market instead of projected future values. As a result, banks assign whatever value they can get away with to their toxic assets, and thus create artificially high numbers. Bank of America did this when acquiring Merrill Lynch: they value poor assets on Merrill’s books higher than Merrill itself had, and magically created a $2.2 billion increase in alleged value. There is perhaps no more dishonest practice than these owner-imputed false values.

5) Down is Up, Loss is Gain! I’m not making this up! Banks are allowed to report the diminished value of their debts as earnings because they could theoretically purchase their own debts (from themselves?) at a now lower price. Citigroup used this to convert a $900 million loss into a $1.6 billion gain. In a related version of this, they set aside lower reserves for projected losses, sometimes missing the mark by billions. They show these misallocated billions as profits.

6) The Goldman-Sachs Time-Warp Leap-Frog. Goldman switched to calendar-year reporting instead of fiscal-year, and this allowed them to skip perhaps their worst month of losses without reporting. Nearly $800 million in losses will never grace an official report. Instead, GS beats expectations (yea!) and the Street buys in big-time.

7) Who Insures the Insurers? Credit Default Swaps are basically insurance policies written from one bank to another insuring against a borrower’s default on debt. These swaps quickly create a web of legal and accounting nightmares. They grew quickly prevalent since issuing banks charge a fee to write them (quick short-term income) and purchasing banks get “assurance” of the future profits from a particular loan. Thus, the banks can log the expected income as gains. The problems come when massive defaults hit across the board, and issuing banks (AIG) can’t make good on their promises. Bailout money to the rescue! The bailouts channeled through AIG to several of the banks who rested on these swaps—and then report the bailouts as earnings.

In each of these devious accounting maneuvers, banks hide the dark reality and the dim future while claiming sun-shiny profits. And all have passed the so-called “stress tests”; some will merely be required to come up with more capital. That’s all. Some writers have questioned how the banks will magically just generate the required billions they need, but the above measures should show that they have plenty of hats for pulling rabbits out of.

The question is, how long can they continue before reality sets in somewhere? Someone has to pay eventually. If, as we all suspect, the burden falls on “taxpayers,” then expect massive inflation. We should expect this anyway. But the fact that much of it will come because big government has allowed big banks to hide, lie, and manipulate their accounting means that our entire financial system is not only built on a lie (fiat money), but operates according to lies a matter of principal.

The only possible lynchpin of banking is God’s demand for private property and honesty (Ex. 20:15–16). In more specific form these demands say, You shall do no wrong in judgment, in measurement of weight, or capacity. You shall have just balances, just weights, a justephah, and a just hin (Lev. 19:35–36). Without this lynchpin there is no lynchpin. Without this hinge society is unhinged; the stronger will deceive and overpower the weaker; the rich will grow richer, not biblically through honesty, but through injustice. We have seen nothing but deception and financial injustice out of our big banks and our big government who plays along.

Any society that tolerates these financial sins is not free, not virtuous, and cannot and will not remain prosperous for long.