Banks Lower Debt Levels Just Before Quarterly Reports
This morning, The Wall Street Journal* *breaks the unfortunate if unsurprising news that big Wall Street banks routinely lower their debt levels shortly before reporting their quarterly statements, making the banks seem less leveraged than they are.
A total of 18 banks, including Bank of America, Goldman Sachs and Citigroup, use the repurchase agreement, or repo, market to lower their debt temporarily. The repo market is, to simplify, a market banks and other big financial institutions use to exchange equity for cash for short periods of time and the market on which there was a kind of bank run during the crisis. (More on that later.)
The Wall Street Journal* *says the firms were reducing their debt levels more than 40 percent beyond their quarterly averages. What’s worse? “The practice of reducing quarter-end repo borrowings has occurred periodically for years, according to the data, which go back to 2001, but never as consistently as in 2009.”
The Securities and Exchange Commission — in the wake of the revelation last month that Lehman Brothers used such transactions to park billions of debt off its balance sheet shortly before its collapse — is investigating banks’ use of the tactic. In my mind, there is one dead simple way to preclude banks from skewing their debt and leverage levels using repo transactions (which are, I should note, common, important and perfectly legal): Require banks to report not just their debt levels at the time the reports come out, but their quarterly average debt levels, thus removing the incentive to alter them.