Bankers sweat over sub-prime accounting

Bank of England

Banks across the world were fretting over the accounting for complex
derivatives this week, as US banks sought to draw a line under the crisis of
confidence in the markets.

As UK regulators struggled to deal with a run on the bank at Northern Rock in
the UK, US banks were reporting third-quarter numbers including new estimates of
the value
of complex sub-prime mortgage related instruments.

The market for such instruments has collapsed, meaning banks can no longer
‘mark-to-market’ and will have to construct complicated models in order to
report under mark-to-model valuations. But such models are controversial, after
being abused by Enron.

A senior member of the profession warned banks: ‘The market is what it is,
and people who try and build their wishes and dreams into valuation models will
find that that is not consistent with the accounting rules.’

A Big Four partner told Accountancy Age that the crisis compared
with the dotcom crash and the Russian default of 1998. Paul Sater, financial
services partner at Ernst & Young, said: ‘We’ve experienced similar market
conditions before: the 1994 bond crash, Mexico in 1995, Asia in 1997, Russia and
Long Term Capital Management in 1998, the internet bubble – all these were huge
challenges too. In times like this the audit of valuations requires significant
application of auditors’ judgment. There is no silver bullet.’

Lehman Brothers took a $700m (£350m) writedown on its share of the complex
instruments on Tuesday, with Morgan Stanley due to report yesterday and Goldman
Sachs and Bear Stearns today.

Fears over possible losses from the complex derivatives instruments have
crippled banking systems across the world, as banks grow concerned about lending
to each other. The US third-quarter numbers are crucial in assessing how bad the
issues are.
Although the world stock markets began falling in July, Sater suggested that
banks had already been working on the accounting models for the previous two
quarters, after initial concerns over sub-prime problems crystallised in

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