(MoneyWatch) Every business these days trumpets its commitment to transparency. Nowhere is this more true than in the banking sector. Stung by the grotesque misrepresentation of their assets before 2008, every CEO on Wall Street is eager for platforms from which to show their wounds and testify to their conversion to transparency.
If only. In a magnificent forensic analysis of the Wells Fargo balance sheet, Frank Partnoy and Jesse Eisenberg demonstrate the degree to which this most conservative of banks is anything but transparent. Going line by line through the annual report, they identify all kinds of land mines which a thoughtful but less obsessive reader might easily miss.
For example, Wells Fargo says that it made $1 billion from 'customer accommodation,' loosely defined as trading of securities or derivatives conducted to help customers manage market price risks. Given the bank's $148 billion reserves, $1 billion in trading doesn't seem like a big deal. In fact, that $1 billion masks derivatives trades of about $2.8 trillion in 'notional amounts' as of the end of 2011. It may be that many of these trades are set against one another; moreover, even the greatest pessimist would not regard the full notional amount as being at risk. But, as we all learned in 2008, it is not unheard of to lose a very large proportion of the notional amount of a derivatives trade. Nowhere does Wells Fargo tell investors how much it stands to lose in a worst-case scenario. It isn't required to.
So how much risk is the bank taking on? We don't know. What we do know is that this is not the bread-and-butter bank that its marketing, folksy stagecoach and all, might wish to convey.
Moreover, Wells Fargo is heavily involved with what we used to call 'special purpose vehicles' but (since they invariably remind everyone of Enron) have been renamed VIEs: variable-interest-entities. The point of these satellites is to show that there is an obligation somewhere -- but to keep it off the balance sheet. At the end of 2011, Wells Fargo reported involvement in entities that had a total asset value of $1.46 trillion, maximum exposure to loss in which is estimated at over $60 billion. But with not all of the bank's VIEs consolidated, all we have is a signal that there is a $1.46 trillion exposure to "complete unknowns."
"These disclosures make even an ostensibly simple bank like Wells Fargo impossible to understand," Partnoy and Eisinger wrote. "Every major bank's financial statements have some or all of these problems; many banks are much worse....Banks today are bigger and more opaque than ever."
They are not alone in their conclusions. Paul Singer, who runs Elliott Associates, wrote "There is no major financial institution today whose financial statements provide a meaningful clue." And Arthur Levitt, the former chairman of the SEC (and a big fan of my book, Willful Blindness) confided in the authors that none of the post-2008 remedies had diminished the likelihood of financial crises.
This could go a long way towards explaining why the market isn't interested in investing in banks these days: too much opacity, too much risk and far too little confidence than even the management knows what is going on. Equally corrosive, to maintain transparency and then not deliver it is a fully effective means of destroying trust. Say one thing, do another and you should not expect anyone to believe you.