Wednesday, February 11, 2009

Banks have a trillion dollars of worthless goodwill

What's the real book value of the banks? The WSJ has an idea. Another bogus trillion dollars of assets are sitting on the banks balance sheet called "goodwill." And this goodwill sits on top of the banks toxic assets.

However, there is another class of "assets" on the balance sheets that has so far been overlooked. During the boom years, many banks accumulated large amounts of intangible assets -- such as a company's reputation, know-how, employee morale or market position -- that are supposed to generate future profits. When banks took over other institutions at inflated prices, they booked the difference between the price paid and book value as "goodwill."

Asset-price bubbles clearly lead to goodwill inflation as can be seen from the fact that in the U.S., according to the latest available data, goodwill and other intangibles quadrupled to more than $300 billion from $80 billion over the last five years. During the same time, the proportion of equity backed up by tangible assets only doubled, to close to 40% from 19%

Bank of America, for example, has more than $90 billion in goodwill and other intangible assets on its balance sheet, more than twice the company's market value of less than $40 billion. Many other banks are in a similar situation. The largest eight U.S. banks have a total of more than $300 billion in goodwill and other intangible assets on their balance sheets. In Europe the situation is not much different. According to the latest data available, the dozen largest European banks reported €270 billion in intangible assets on their balance sheets. It's not surprising that the largest banks have proportionally the largest amounts of goodwill on their balance sheets since most of them grew via acquisitions during the boom years.

Now that the bust is with us, the question is whether all that "goodwill" still exists. Under today's market circumstances, the "fair value" of this hot air could be close to zero. The banking bailout thus could become much more expensive.

The U.S. banking system still has about $1 trillion in capital left, according to the latest estimates from the U.S. Federal Reserve, and could thus absorb at least part of the losses on its toxic assets. However, for the largest eight U.S. banks, intangibles amount to close to 50% of their equity. For the entire U.S. banking system this ratio is somewhat smaller, around 40%. In reality, then, the U.S. banking system has much less capital left to absorb losses on "toxic assets." After accounting for the fair value of its goodwill and other intangibles, it may need an additional $400 billion just to re-establish an adequate capital base. "Detoxification" would have to come on top of this.

Banks want to keep this hidden. Why else does Meredith Whitney use tangible book? How about Wells Fargo latest earnings report? They didn't disclose their Tangible Equity Capital (TCE) because it didn't disclose the "goodwill" from their Wachovia acquisition! When should you count goodwill? How about when the bankers pay out their bonuses in "goodwill!"

That's why the banks are in Dante's eighth circle of hell!

Until the taxpayer bails them out!

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