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Discussion in 'Financial Cents' started by Jonas Parker, Nov 11, 2007.

  1. Jonas Parker

    Jonas Parker Hooligan




    November 8, 2007 -- IF you think banks have trouble now, just wait until they report financial results in January.
    That's when the balance sheet will really hit the fan.
    The problem involves a rule passed a couple of years ago that will put the banking industry's outside auditors in peril if they sign off on results that they really can't verify.
    And right now there is nothing verifiable - or even understandable - about the banking industry's exposure to derivatives.
    The auditors' dilemma was caused by a rule change that now prohibits banks from indemnifying auditors against mistakes.
    All other kinds of companies can hold their auditors blameless in the event of errors that might generate investor and government lawsuits.
    And sometimes that's the only way the accountants will give a nod to the company's books.
    But a rule enacted in February 2006 by the Treasury Department, Federal Reserve and the Federal Deposit Insurance Administration now prohibit banks from doing that.
    When the rule was proposed the government said it believed "that when financial institutions agree to limit their external auditors' liability. . . such provisions may weaken the external auditors' objectivity."
    This rule is in the spirit of the Sarbanes-Oxley era, when the government attempted to make all corporations' numbers more transparent and hold company executives responsible for any misstatements.
    Sarbanes-Oxley didn't work out quite as planned, with many smaller companies complaining about the cost of complying.
    And the 2006 changes in bank audits could create additional unforeseen problems.
    Chris Whalen, who runs The Institutional Risk Analyst, says the indemnification rule was changed "during a blissfully quiet time."
    He adds that the ramifications of the new rule "wasn't an issue because nobody saw any risk."
    Now there is risk.
    As I worried about in past columns, the value of the U.S. dollar has been falling rapidly.
    This is largely due to the fact that the Federal Reserve is attempting to reduce interest rates at a time when inflation isn't tame.
    But it's also because the Chinese, already feuding with the U.S. over trade issues, are mischievously threatening to sell dollar assets.
    And while the Fed won't say so, it's pretty clear that the rate cuts are intended to help out troubled banks.
    The issue of banks indemnifying their accountants can only make the situation worse.
    These days, the financial markets are seeing so much risk that it's difficult to keep up.
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