Should US banks be allowed to lie?

Americans live in a culture of truth. Spaniards are less inspired by truth itself. This doesn’t mean that no one tells lies in the American business world, clearly not the case, or that the business culture of Spain is based on lies, clearly not the case either. But it means that in relative terms truth for truth sake is above all an American obsession. Lying is seen as a more serious failing in American culture than it is in Spanish culture. The abortion debate is an interesting one. Spain never legalized abortion, “lo descriminalizó” which means it made it illegal but without a penalty, this type of legal structure would not really make it in the States. But as a result in Spain the abortion debate is mostly over and in USA it is an endless, useless debate. But let´s move on to banking.

Why is it that now Banco Santander is still worth 42 billion dollars, and Citigroup, which is much bigger, is only worth 5 billion? Because Banco Santander operates in a culture of lax auditing and Citigroup operates in a culture of mark to market – and the same goes for all American and Spanish banks. Because the Bank of Spain has not asked Botín and his local competitors to price all their financial assets in the marketplace. Because Spain is a club in which it is better to have friends than to tell the truth at all cost, and the truth is that Spanish bank portfolios are not much better off than American bank portfolios but at least so far Spanish banks are the most profitable in the world. And this is happening while the economic crisis is much worse in Spain than it is in the USA with unemployment at over twice the rate of the 8% recorded in the States. Lies create inflated values on the bank assets and so far the value of Spanish banks dwarfs the value of USA banks.

But having said this, I am going to make my American readers nervous and, with the help of Steve Forbes, I am going to argue that perhaps in this case the Spanish system of accounting is actually better. I recommend that you read this article by Steve Forbes in the Wall Street Journal. No, don’t read it for its anti-Obama tone, which is pretty lame, but instead read it for a very specific issue that Forbes points out and that deserves to be discussed: living in a culture of truth can be extremely harmful and mark to market maybe a case of truth destroying an institution, in this case the American financial system.

But honesty is ingrained in Americans from early childhood. When you were growing up, how many times did your parents and teachers insist that you “tell the truth”? Indeed, none other than George Washington himself is revered for having supposedly uttered “I cannot tell a lie” as a young boy, his way of claiming responsibility for cutting down his father’s favorite cherry tree. As we all know, there are times when lying can keep valuable institutions from falling apart. Who knows how many marriages in Spain have been saved with a lie. Some people even say that the sincerity of American culture is a cause of the elevated divorce rate in the country. “Honey, there’s something I have to tell you” mark the beginning of the end for many couples? These bouts of sincerity – suicide when it comes to marriage – are less common in Spain. For society as a whole, the result is not bad. Steve Forbes’ article, can be interpreted as arguing that what is causing the American banking system to go under is a culture of sincerity. Steve Forbes’ main argument is that forcing banks to determine how much their loan portfolios are worth each month is asking for them to be too truthful, and that it is counterproductive to be so truthful.

According to Steve Forbes:

Regulators and auditors kept pressing banks and other financial firms to knock down the book value of this paper, even in cases where these obligations were being fully serviced in the payment of principal and interest. Thus, under mark-to-market, even non-suspect assets are being artificially knocked down in value for regulatory capital.

What Forbes is really asking for, without coming right out and saying it, is for the USA to adopt a more Spanish like system, to not judge everything by its market value, to lie a bit. He is saying that it is possible to do what is done in Spain in order to create the sensation that the banking system is much better than it actually is: not demand that loans be assessed in a secondary market, but instead with more abstract criteria regarding payment possibilities.

Which system is better in this case? The mark to market truth or the book value lie?

If growth restarts in Spain and loan portfolios regain their value, it will be clear that the Spanish system was the better one. But if portfolios fall to a certain level and the day of reckoning arrives, the culture of not marking to market, of unrealistic accounting will be seen as being much worse. I think it’s still too early to say which system is better. It is also worth mentioning that the reserve requirements of Spanish banks are more stringent than those of US banks and that a lot of lying went on in the process of getting people in the States to get poor credit mortgages to begin with. So maybe if less lying had gone on before, true accounting would not be so damaging to American banks now. Bottom line is that so far Spanish banks are way ahead. But the story is only unfolding and in the end it may turn out that the American system of extreme sincerity, was better.

• botin
• citi
• santander