The Perils of "Don't Ask, Don't Tell" Banking

There is a moral hazard with “don’t ask, don’t tell” mark-to-fiction accounting principles.

When banks are allowed to hide their losses, presumably because the truth is too painful for the economy to accept, then banks overstate profits. Based on overstated profits, banks provide excessive bonuses and compensation packages. Thus capital that should be reserved to cover anticipated future losses is instead distributed annually as compensation.

But these losses eventually must be disclosed and when they are the question arises, will the banks have sufficient capital to cover actual losses? And if they do not, what happens next? Can the financial industry absorb them or will the U.S. Treasury be required to cover them? If it is the latter what will be the implications on sovereign credit worthiness, interest rates, future taxation requirements?

Perhaps the accounting rules had to be altered last year to prevent a complete market meltdown and because assets could not be fairly valued due to market disruption. However, now that the crisis is over, isn’t it time to restore mark to market accounting and allow market forces to reshape the industry?

Are we not making matters worse by hiding the true financial position of these institutions thus allowing needed capital to shift into compensation?

If we must continue to “protect the industry from full disclosure”, should we not at a minimum impose substantial fees upon the industry to prepare for the ultimate judgment day? Will the $90 billion assessment proposed by the Obama Administration be sufficient?