Great Forbes Article
Banks don’t tell investors how much of the “notional amount” that they could lose in a worst-case scenario, nor are they required to. Even a savvy investor who reads the footnotes can only guess at what a bank’s potential risk exposure from the complicated interactions of derivatives might be. And when experts can’t assess risk, and large bets go wrong simultaneously, the whole financial system can freeze and lead to a global financial meltdown.
Ever heard of “variable interest entities” aka VIEs? If not, you are not alone. They are phenomena that reside in what The Atlantic calls “an even lower circle of financial hell” than proprietary trading. They are basically a new label for “special-purpose entities” i.e. the infamous accounting devices that Enron employed to hide its debts. These deals were called ‘off-balance-sheet’ transactions, because they did not appear on Enron’s balance sheet.
As of the end of 2011, Wells Fargo, the “extremely safe bank”, reported “significant continuing involvement” with variable-interest entities that had total assets of about $1.5 trillion. The ‘maximum exposure to loss’ that it reports is much smaller, but still substantial: just over $60 billion, more than 40 percent of its capital reserves. The bank says the likelihood of such a loss is ‘extremely remote.’ As The Atlantic comments: “We can hope.”
Banks don’t tell investors how much of the “notional amount” that they could lose in a worst-case scenario, nor are they required to. Even a savvy investor who reads the footnotes can only guess at what a bank’s potential risk exposure from the complicated interactions of derivatives might be. And when experts can’t assess risk, and large bets go wrong simultaneously, the whole financial system can freeze and lead to a global financial meltdown.
Ever heard of “variable interest entities” aka VIEs? If not, you are not alone. They are phenomena that reside in what The Atlantic calls “an even lower circle of financial hell” than proprietary trading. They are basically a new label for “special-purpose entities” i.e. the infamous accounting devices that Enron employed to hide its debts. These deals were called ‘off-balance-sheet’ transactions, because they did not appear on Enron’s balance sheet.
As of the end of 2011, Wells Fargo, the “extremely safe bank”, reported “significant continuing involvement” with variable-interest entities that had total assets of about $1.5 trillion. The ‘maximum exposure to loss’ that it reports is much smaller, but still substantial: just over $60 billion, more than 40 percent of its capital reserves. The bank says the likelihood of such a loss is ‘extremely remote.’ As The Atlantic comments: “We can hope.”
We asked Wells Fargo to explain its VIE disclosures, but its representatives once again simply pointed us back to the annual report. We specifically asked about the bank’s own reported corrections of these numbers (in one footnote, Wells Fargo cryptically says, “ ‘VIEs that we consolidate’ has been revised to correct previously reported amounts”). But the bank would not tell us anything about those corrections. From the annual report, one cannot determine which VIEs were involved, or how big the corrections were.
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