June 2 (Bloomberg) -- Leave it to Wall Street to profit from its own distress.
Merrill Lynch & Co., Citigroup Inc. and four other U.S. financial companies have used an accounting rule adopted last year to book almost $12 billion of revenue after a decline in prices of their own bonds. The rule, intended to expand the ``mark-to- market'' accounting that banks use to record profits or losses on trading assets, allows them to report gains when market prices for their liabilities fall.
The new math, while legal, defies common sense. Merrill, the third-biggest U.S. securities firm, added $4 billion of revenue during the past three quarters as the market value of its debt fell. That was the result of higher yields demanded by investors spooked by the New York-based company's $37 billion of writedowns from assets hurt by the collapse of the subprime mortgage market.
The article isn't quite as clear as it could be, but I think I can explain. Basically, the regulators said that these institutions should actually report what their assets are worth - market value - rather than some fantasy made up "model" number. So they said fine, but we want to do the same for our liabilities! So if Merill owes $100 million, but that debt is currently trading at $80 million because of fears that Merill will default on the debt, Merill gets to say "yay! We only owe $80 million." Of course that isn't true. They owe $100 million, and they have to either pay or default, but the fact that people are worried they'll default means they get to pretend they owe less than they do.
Does this make any sense? Of course not.
More than that, they get to pick and choose which liabilities they get to account for this way.