A Big Gulp for Big Banks?

In the latter part of last month, we got earnings reports from investment banks Lehman Brothers (NYSE: LEH), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), and Bear Stearns (NYSE: BSC). Investors were very focused on these reports as a signal of how deep the U.S. credit crunch and market turmoil had cut. With the exception of Goldman Sachs, which used its magical superpowers to deliver killer numbers in the face of major turmoil, the results confirmed that investors' worries weren't misplaced.

Fast-forward to this week, when we have the big banks preparing to report earnings. Well, we've hardly reached the pivotal day -- Citigroup (NYSE: C) starts off the group and doesn't report until the 15th -- and it already looks bad. Citi said it will have a $5.9 billion writedown, UBS (NYSE: UBS) will be lopping off $3.4 billion from its results, and Merrill Lynch (NYSE: MER) will take something in the neighborhood of $4 billion on the chin.

Credit Suisse even found it prudent to issue a press release saying that it expects to be profitable in the third quarter. This may seem like overkill, but investors had reason to worry after UBS said that the losses it is taking will push it into the red by as much as $680 million overall for the third quarter.

Taking extra pain?
In an article released today, The Wall Street Journal (subscription required) posed the question of whether some of these banks are writing off more than they need so that results in future periods could look better.

One might wonder why a major capitalist institution like, say, Merrill Lynch would do such a thing. Well, imagine you're in the hospital and the doctor diagnoses you with the ebola virus. Subsequently hearing that your house burned down, your wife cheated on you, and somebody kicked your dog might not have the same impact that it normally would.

The same is true for the banks. If they know they're going to have to book major writedowns during the quarter, throwing in some other losses here and there probably won't elicit the same reaction from investors that it normally would. Producing lower results makes results in future periods look better by comparison, and using overly conservative valuation estimates on some assets would give them a cushion in the future and may even lead to a marking up of the assets.

But would they be so bold ...?
So is this happening? It's hard to say for sure. Though Deutsche Bank's (NYSE: DB) CEO Josef Ackermann was quoted in the Journal as saying that its reported writedowns were "about transparency," the losses really don't do much to actually make the banks any more transparent. In fact, all the losses really do is show that the banks are willing to concede that they did take huge losses recently -- something investors were worried the banks would be unwilling to do. As Chris Rock might say, "You're supposed to recognize your losses! What do you want, a cookie?"

Given the amount of shuffling going on in the upper echelons of the banks involved, there's certainly nobody happy about the losses. However, as new people take the helm at the affected segments, it would be tough to argue that they aren't using the most conservative valuation methods and taking the biggest losses possible. For these newcomers, taking big losses up front will help make them look like saviors later on as results improve dramatically.

And on Wall Street, we all know that big performance equals big bonuses.

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