When financial results are signifying nothing

By: Wolfgang Münchau

The truth is that nobody knows for sure how this credit crunch is going to end. We all have hunches. My own hunch is that it will come in different waves. The first wave will soon be over, but there will a second, possibly bigger wave. This may well turn out to be the most dangerous financial crisis of all time. But, to be fair, this is only a hunch, not based on data, but what I have heard, and appears plausible to me.

 

Lack of any hard evidence, the financial markets are clutching to every bulb that might might shed some light on this question. This week, everybody has been staring at the financial results of the US investment banks. Lehman Brothers, which reported on Tuesday, came in with a surprisingly good set of results, - meaning slightly better than expected by analysists. The markets took this as an incontrovertible sign that the worst of the credit crunch is over. Even Lehman’s CFO said so. “The worst is behind us”, he confidently predicted.

 

While Lehman Brothers exceeded expectations, Morgan Stanley, which reported on Wednesday, disappointed them by about the same margin. So you could say it is a draw. Time to wait for Bear Stearns, or Goldman Sachs. I will not be updating this blog on Thursday to take account of those results as well, for a simple reason: These results may tell us a lot about the quality of the management of these banks. Or they may tell us who was lucky, and who was unlucky, or who has got the better accountants. But they are certainly not going to tell us about liquidity conditions in global financial markets. The latter will depend much more on very much on whether a Spanish savings bank goes than it does not Goldman Sachs et al.

 

The Lehman result was good, for sure, but the FT story contained a curious sentence. “Its earnings were boosted by a lower tax rate and the use of a new accounting rule allowing it to book as profits the reduction in market value of some of its debt.” So, while the overall results are better, this is at least to some extent due to factors that have nothing to do with the health of the financial system.

 

In addition, corporate accounts are generally a bad proxy for national accounts. As Andrew Smithers once pointed out, if you add up all the debt, as stated in corporate accounts, (I think the geographical reference is the UK, but I am not quite sure), the total is significantly lower than what the national accounts show corporate debt to be. This decrepancy is due to accounting treatment. This is particularly relevant in our case, since the uncertain valuation of CDO tranches is behind this crisis. This means a bank may look healthy right until the very moment when the fat lady sings. While the people who believe that these results have a deeper meaning are generally no idiots, they still signify nothing.

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