On Monday, Bank of America (NYSE: BAC ) announced the suspension of a dividend and share buyback plan when it came out that its capital calculations have been incorrect since 2009. The plan had been approved by the Fed following annual stress testing earlier this year.
The capital change was small, reducing Common Equity Tier 1 by just $4 billion to $130 billion. So why is it such a big deal?
"What else could be lurking?"
As CEO Sam Pappas of Mystic Asset Management, put it, "It's positive that Bank of America found the mistake and reported it to the Fed. But it also makes you wonder what else could be lurking."
The concern is that this relatively small but strangely persistent error could be just one of many. The fact that it took five years to discover is no small thing, especially when you consider that it's not just internal accounting staff who look at such numbers -- auditors and regulators are also responsible for making sense of the books.
It also doesn't help that the mistake affects Common Equity Tier 1, which presumably should be the simplest and most reliable measure of bank capital. Where else might we find such errors, and how big might they be?
Too big to manage?
The second glaring issue in all of this is manageability. Not only could there be other mistakes floating around unnoticed, but the fact that this oversight persisted for so long could be a sign that large banks like Bank of America are simply too big to manage. Maybe the operational complexity is making it impossible to properly catch all the potential problems.
Jim Cramer, who is admittedly not known for understatement, has expressed his own frustrations on the matter, which, despite a degree of hyperbole, reveal a lot about the difficulty investors are facing:
This is a disgrace. Is the bank too big to run? Do they have any idea what's going on? ...I'm looking at it and I'm saying, 'How could I have been so stupid?' They're just hard to understand, these banks. It's too hard.
Too big to regulate?
Finally, the Fed will not come away unscathed in all of this. It's of course a bit much to expect the regulator to look at every single financial line item in its reviews. On the other hand, computations of Tier 1 capital have obviously been under-scrutinized.
The implication is that the Fed's blessings regarding capital adequacy and shareholder plans might not be as reliable as they should be. Could stress tests be giving investors a false sense of security? The thought is especially troubling because Common Equity Tier 1 is the foundation of capital adequacy requirements by the Fed; it isn't an insignificant variable.
It's worth noting that this news is uncomfortably close on the heels of the Fed restating the stress test results. It was also Bank of America, and not the Fed, which discovered the mistake.
Perhaps the Fed is too dependent on banks to understand their own operations and provide reliable data. But if the bank's can't understand themselves either, we have a serious problem. Either way, this new headache does not instill a great deal of confidence in either the banks or their overseers.
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