How Will Financial ETFs Fair With BofA’s Accounting Tricks? (KBE, XLF, FAZ, FAS, IYF, VFH, SKF, UYG, BAC)

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July 18, 2010 9:11pm NYSE:FAS NYSE:FAZ

“The implications from the WSJ article are that ‘banks are carrying more risk most of the time than their investors or customers can easily see.’ When it comes time to reporting quarterly earnings


, Bank Of America (NYSE:BAC) found it appropriate to apply a little accounting trick, unintentionally of course. WSJ reports that ‘though much smaller in scope, Bank of America’s accounting of the six trades is similar to what a bankruptcy-court examiner said Lehman Brothers Inc. did to make its balance sheet look better before it filed for bankruptcy in 2008.’ Bank of America (NYSE:BAC) disclosed six transactions, also known as ‘dollar roll’ trades that were erroneously misclassified. Dollar rolls are deals in which mortgage-backed securities (MBAs) are transferred to a trading partner with a simultaneous agreement to repurchase similar – not the same – securities from the same trading partner (which was unidentified in this case).”

“To be allowed to categorize the transaction as a sale – thereby removing them from the balance sheet – BofA considered the trades to be similar. As it turns out, however, the securities that BofA repurchased had the same grantor and same coupon. They were not just similar, they were substantially the same. As such, the trade should have been accounted as borrowing not selling. Unfortunately for BofA, the process of borrowing does not remove the obviously toxic assets from their balance sheets. Those so called unintended mishaps occurred for six quarters from from 2007 to 2009. The classification error involved more than $10 billion in repos. Of course BofA did not volunteer that information. It was a required response to a courteous letter the SEC sent to 19 large financial institutions inquiring about their repo practices. Can you imagine what kind of information they’d get if the SEC dug even deeper,” Simon Maierhofer Reports From ETF Guide.

Maierhofer goes on to say, “From a $10 Billion to a $2 Trillion Problem: Before we discuss more than just the tip of the iceberg, let’s take a look at a few ETFs affected by accounting errors or financial engineering in the financial sector. Of course there are the usual suspects such as the SPDR KBW Bank ETF (NYSE:KBE), the Financial Select Sector SPDRs (NYSE:XLF), the iShares Dow Jones US Financial Sector ETF (NYSE:IYF), and the Vanguard Financial ETF (NYSE:VFH). There are short and leveraged ETFs like the UltraShort Financial ProShares (NYSE:SKF), Direxion Daily Financial Bear 3x Shares (NYSE:FAZ), Ultra Financial ProShares (NYSE:UYG), and the Direxion Daily Financial Bull 3x Shares (NYSE:FAS).”

Maierhofer writes, “The above-mentioned dollar roll tactic is fairly insignificant compared to the ramifications of the changed accounting rule 157. This rule allows banks to legally overvalue underperforming assets. In other words, a house with a $500,000 mortgage, currently worth $300,000, could be valued at what the banks estimate it could sell the house for in a healthy market, ten years from today. The balance sheets of hundreds of banks in the U.S. could be filled with $300,000 properties valued at close to $500,000. If you think that can’t happen, you may find the following numbers and statements taken from the FDIC’s website of interest:”

“Frontier Bank was closed by the Washington Department of Financial Institutions on April 30, 2010. According to the FDIC’s website, Frontier Bank had approximately $3.5 billion in totals assets and $3.13 billion in total deposits. Subtracting the liabilities from the assets, the bank’s book of business should be worth around $370 million. The FDIC’s website states the following: ‘The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $1.37 billion.’ Where does the $1.74 billion difference come from? Apparently the bank’s actual assets were less than reported, 50.3% less. This is just one of dozens of examples. Keep in mind that the combined assets of the four biggest banks are roughly about $7.5 trillion. Assuming those banks overvalue their assets by just 25%, a $1.8 trillion problem is yet waiting to the hit the fan,” Maierhofer Reports.

Vist the category for each ETF below for more insight on each fund:

SPDR KBW Bank ETF (NYSE:KBE) Visit Our (KBE) Category: HERE

Financial Select Sector SPDRs (NYSE:XLF)  Visit Our (XLF) Category: HERE

iShares Dow Jones US Financial Sector ETF (NYSE:IYF)  Visit Our (IYF) Category: HERE

Vanguard Financial ETF (NYSE:VFH)  Visit Our (VFH) Category: HERE

UltraShort Financial ProShares (NYSE:SKF)  Visit Our (SKF) Category: HERE

Direxion Daily Financial Bear 3x Shares (NYSE:FAZ)  Visit Our (FAZ) Category: HERE

Ultra Financial ProShares (NYSE:UYG)  Visit Our (UYG) Category: HERE

Direxion Daily Financial Bull 3x Shares (NYSE:FAS)  Visit Our (FAS) Category: HERE


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