Monday, October 13, 2008

"Marking to Make-Believe" Accounting at Goldman Sachs

Goldman Sachs Group (GS-$111.00) filed its August 2008 quarter report with the SEC last week. The venerable investment bank is among the first of the major institutions to report earnings since the U.S. credit market began to seize up at the end of August 2008. At the time the earnings were made public in a Goldman Sachs press release on September 16, 2008, the market was surprised by stronger than expected earnings. Yet Goldman shares sold off to a three-year low as investors anticipated yet another shoe to drop from the "credit market centipede."

Earnings impress few these days as risks lurking on corporate balance sheets have come to light. Some have blamed accounting practices, specifically Financial Accounting Standards Board Rule 157, which went into effect in November 2007. Rule 157 changed the way public companies increase or decrease asset values on their balance sheet to reflect the prices that would be received if the asset were sold right then and there. The process, called "mark to market," is repeated each quarter.

In Goldman's quarter filing total current financial assets valued at fair market prices were $400.1 billion. This includes collateralized agreements and other financial instruments owned by Goldman. This asset category peaked in value at $498.9 billion at the end of the February 2008 quarter and has declined in each of the two quarters since.

That is only half of the story. Goldman has liabilities such as financial instruments sold to other parties with agreements to repurchase them later. At the end of the August 2008 quarter, total current liabilities composed of financial instruments that had to be marked to market prices were $378.9 billion. Fortunately, for Goldman such financial assets are still valued higher than similar financial liabilities.

Goldman began explaining the so-called FASB Rule 157 in its first-quarter 2008 10-Q, even going so far as to describe the hierarchy of information sources prescribed by Rule 157 to determine "fair market value." Back then only a few financial experts could see the trouble looming with the newly adopted standard. What happens, for example, when there is no market for a certain financial instrument or the market all but goes away such as for collateralized debt obligations? It becomes necessary to abandon market prices altogether and search for "recent trades." When even scattered values are not available, Rule 157 prescribes the use of "unobservable inputs" -- a euphemism for accountants own assumptions -- a practice which many financial analysts have dubbed "'marking to make believe."

As impressive as Goldman's detailed explanation of Rule 157 might be, what is missing from the quarterly filing is whether Goldman was able to "mark to market" or had to "mark to make believe."
Original new stories can also be found at BNET Energy & BNET Insight: 10-Q Detective

Reporting by contributor Debra Fiakas, who does not hold a financial interest in any stocks mentioned in this article. The 10-Q Detective has a Full Disclosure Policy.


FeirFactor said...

Is there ANYTHING in this post that suggests Goldman fudged the books on Level 3 assets? Anything at all?

Better detective said...

There is information available! "10Q Detective"? Yeah, right.

Look at p20 of the filing. Level 3 assets (ie mark to model) are less than 10% of total financial assets and the proportion has declined in the last quarter. That said, it's still $58bn, a whole lot more than their Tier 1 capital of $44bn.

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