Geekesque arguesthat the commercial banks are solvent, but, even if they are not, they can be made to be solvent by deals with bank holding companies or, vice versa, that commercial banks can make deals with holding company parents that will not affect their solvency.
This central argument of his argument, as far as I understand General Accepted Accounting Principles (GAAP) and Financial Accounting Standards Board (FASB), is invalid. The central issue is whether the commercial banks are solvent. This issue is one of accounting. The only reason holding companies are relevant is the role they play in accounting.
Or, in other words, the only reason the holding companies are relevant is due to the issue of which entity, the commercial banks or their holding companies, are insolvent.
You may wonder why this matters? Because we are seeking to bailout or save banks that lend to us rather since they are at the core of a stalled economy.
Black’s comments were centrally focused on accounting fraud. I understand his argument to be that banks cannot use the finance of one entity to give the appearance of solvency to another.
You have to apply the accounting rules to look at all deals and follow the trail of those deals to answer this question about real solvency. The concept is not as complicated as it seems, but it is fact intense.
On the issue of stress test, it does make me long for transparency because that would solve many of the questions that remain over Geithner's plan.
If you want a practical example, think of owning two businesses that you incorporate separately with their own accounting system that most be used to report to creditors. You have a total of 10,000, but each of the businesses needs 10,000 according to your creditors to secure their services and products.
They will use that credit as a deposit that they will return to you in 3 days, but will require that you sign a contract that says you will maintain a 10,000 balance at all times.
You sign contracts with the creditors for both businesses saying you have 10,000 in each account that you will maintain throughout your dealings with them or 20,000 because each deal requires 10,000.
You open a bank account for each business. Now, let’s say you want to make it appear that you have enough money to cover the liability from the creditors of each business when they come due. So, you place the 10,000 into one account when the creditors need to see the account has sufficient funds.
Suppose you stagger the date for the creditors of the other business so that they will check a week later after the first business creditors checked your other business account. Immediately after the first creditors check your first business account, you move the money to the second business account. The second set of creditors now believes you have 10,000. You keep moving the money around according to scheduled periodic checks.
Remember, you really needed 20,000. In effect, you are committing a type of fraud. The solvency of each business can only be determined by understanding the fraud you committed.
You are moving money from one account to the other pretending you have more money than you have. This very simplified example is the core issue of which Black was trying to discuss. The law over which company is subject to receivership is a smoke screen.
The relevant issue is to follow the deal trail to determine whether the commercial banks are insolvent. Many companies have engaged such practices in the past. They have gotten into trouble for it for a reason.
The question is not which company is subject to receivership. As I explained to Geekesque, the issue is to determine if the banks are merely inflating the balloon.
In other words, as with my example, the issue is whether or not the creditors will all check at once to see whether you really have the 20,000 that you needed to do both deals or is this all just an illusion credited by accounting fraud. The holding companies are irrelevant to the commercial banks except for anwering this basic question.