52 Banks in America failed in last one year

According to the data by FDIC(Federal Deposit Insurance Corporation) 52 banks have failed in the last one year, one failure per week on an average. This, once again, highlights the gravity of the crisis, and its impact on the financial institutions across the United States.

Month	No. of banks failure
Apr-09	8
Mar-09	5
Feb-09	10
Jan-09	6
Dec-08	3
Nov-08	5
Oct-08	4
Sep-08	3
Aug-08	3
Jul-08	3
May-08	2
Total since May 2008	52

These banks combined had an asset size of 388 billion USD. The failure had cost about 2 billion dollars to the FDIC Deposit Insurance Fund.

Washington Mutual was the biggest of them all with 307 billion dollar assets in its balance sheet. Before the failure it was the sixth largest bank in US. The panic started in Washington Mutual when about 16 billion dollars were withdrawn from the bank during 10 day bank-run. This was about 9% of the size of the total deposits in the bank. However, the pain was avoided by the sale of the bank to JP Morgan Chase (JPMC). This failure was the largest in the history of America.

The second biggest bank to fail during the year was IndyMac Bank with 32 billion dollars of assets. This was the fourth largest bank failure in American history. The failure cost FDIC about 9 billion USD.

About FDIC
"The Federal Deposit Insurance Corporation (FDIC) preserves and promotes public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions for at least $250,000; by identifying, monitoring and addressing risks to the deposit insurance funds; and by limiting the effect on the economy and the financial system when a bank or thrift institution fails."

Off Balance Sheet accounting

As an investor we would be looking for information that is from various sources like annual report, news, analysis etc. But truly there are times when we are not sure about how the company is making money. Though one may think of spending more time in knowing exactly what the company is doing. But that may not be true, as managers may choose not to disclose those to the public. Hence there is always a cap on the information available to the public when there is no ceiling set by any governing body.

This is the major reason why stock market are inefficient!. Let us look more closely at specific accounting malfeasance. This will help us see what is the information that we should be looking more closely when evaluating a company? The biggest corporate scandal in U.S happened in the starting of this decade including Enron, WorldCom.

Although Enron was involved in more than one accounting scandals, the important one was the off balance sheet accounting. It is just pure number jugglery. Towards the end of a financial year if Enron notices that there is $3, 00,000 bad debts, it will simply create a Special Purpose Entity to get this huge debt off the record and create revenue! Now you might wonder what this SPE – Special Purpose Entity is? It is another entity set up by the Enron. Now how would this SPE raise money? They would finance it through banks. Isn’t surprising to know which bank would lend money for such bad debts. But much to our surprise it is all the globally reputed banks. Now the real motivation for the banks to lend money is the coveted stocks of Enron which was consistently increasing in value. That is surprising to see, how the market will evaluate a company with such an accounting practice.

The story doesn’t end here as the equivalent stock which was pledged for this bad debt should also have an accounting entry. This is where the Enron were smart in using the loop holes in accounting standards. They booked them under the issue of stock against promise to pay- notes receivable. Although there is a long standing accounting rule that says Notes Receivable created for the issue of stock should not be treated as an asset but as a contra equity- deductions from owners’ equity. But Enron actually treated as an asset. This is the multibillion dollar “mistake” that Enron did. Without any genuine earnings they were able to bloat their balance sheet!
WorldCom story was a little different. It overstated cash flows by booking $3.8 billion in operating expenses as capital expenses. For an exhaustive list of accounting scandals refer to the link below
http://www.forbes.com/2002/07/25/accountingtracker.html

There is a separate area called the forensic accounting which provides report on the insights into this number jugglery. Now as an investor what are the word of caution?
1. Income from unspecified source, that are not revealed or from special purpose entities
2. Loading of inventories to a sister company
3. Income from asset sales or financial transactions
4. Frequent accounting restatements
5. Accrual earnings that run ahead of cash earnings consistently
Although the list is not exhaustive these are the learning from the past. But the most essential thing for any successful investment as Warren Buffet says is to invest in something where you really know and like the business! It is strange though to see the herd mentality.

What is Balance Sheet?

Company's financial position at any point of time.
Shows the balances of all the accounts at one place.
Shows Assets, Liabilities and Shareholder's Equity
Summarizes the resources and the claims of owners and creditors

Structure:
Account Form
Indian : Liabilities & Shareholder's Equity - Left Column; Assets - Right Column
American : Assets - Left Column; Liabilities & Shareholder's Equity - Right Column
Report Form
Indian : Liabilities & Shareholder's Equity followed by Assets
American : Assets followed by Liabilities & Shareholder's Equity

Order:
American; In descending order of liquidity
On Left Side:Cash comes first; fixed assets last.
On Right Side:Accounts payable first; Shareholder's Equity Last.

Items in Balance Sheet (B/S)
Assets
Cash & Cash Equivalents
Accounts Receivable/Debtors
Inventories
Property/plant/equipment
-Accumulated Depreciation
Intangible Assets like patents, rights etc.
Liability & Equity
Accounts payable (spontaneous liability)
Accrued Expenses (spontaneous liability)
Deferred taxes
Long-term debt
Stockholder's equity (prference and common)
Retained earnings
-Treasury stock(common shares in reserve)