Banks Now Permitted to Count Goodwill as Capital

A sound case can be made for pro-cyclical capital requirements, that is, lowering the amount of capital that banks must hold relative to assets in bad times and increasing it in good ones. Indeed, well designed pro-cyclical rules lean against the banks’ propensity to overdo on lending to the point where they blow themselves up. And the fact is that regulators relax capital requirements (aka regulatory forebearance) when the banking system looks wobbly, so make a virtue out of necessity by making equity requirements more stringent in upturns.

So this regulators cutting banks some slack at times like this is predictable, and the measure described in the New York Times is no surprise:

With little notice, regulators at four agencies that oversee the nation’s banks and savings associations on Monday and Tuesday proposed a significant change in accounting rules to bolster banks and encourage widespread industry consolidation by making them more attractive to prospective purchasers. The regulators and the Bush administration have decided to resort to further loosening of the accounting rules to try to get the industry through problems that some experts have attributed in large part to years of deregulation…….

The action by the four banking agencies provides more favorable accounting treatment of so-called goodwill, an intangible asset that reflects the difference between the market value and selling price of a bank. The move is similar to a step taken in the midst of the savings-and-loan crisis that helped many institutions in the short run. Over the longer term, that decision increased the overall costs of the bailout after the government took away the goodwill benefits. Under the proposal issued this week, the regulators would permit buyers of banks and thrifts to count some of the goodwill toward meeting their regulatory capital requirements.

But is this way of going about it wise? Adam Levitin at Credit Slips thinks not:

Goodwill is a very problematic asset–it doesn’t have much (if any) liquidation value and can’t be sold by itself. No one will lend against goodwill. If capital requirements are really about ensuring that there is a solid fundamental core of assets backing lending operations, counting goodwill is quite questionable. The most troubling part of this is that we’ve been here before–in the S&L crisis, when the Federal Home Loan Bank Board (now OTS) permitted thrifts to count goodwill toward regulatory capital. The results weren’t pretty, as counting goodwill toward capital masked institutional insolvency and permitted thrifts to get even more leveraged relative to real assets. (See U.S. v. Winstar, 518 U.S. 839 (1996) for a concise discussion of the goodwill problem with thrift accounting).

One of the justifications of the government’s nationalization of Fannie/Freddie (for that is what it is, effectively) and functional purchase of AIG was that federal regulators wanted to be in control of these institutions to prevent them from doubling down on their bets and taking even bigger risks in an effort to regain profitability. The Fed/Treasury feared that the managers of these firms had little to lose so they would engage in overly risky gambles, which would only exacerbate the crisis. While the relaxing of the regulatory capital rules is meant to enable healthier institutions to take on troubled ones, but it runs the danger of setting up exactly the situation that the Fed/Treasury were worried about with Fannie, Freddie, and AIG.

These are not days for consistent policy making, and banking regulation is meant to avoid crises, not solve them, but if Treasury and the Fed can’t contain the crisis now, they’ve removed some of the safeguards that could prevent it from getting even bigger later.

Print Friendly, PDF & Email


  1. glacierpeaks

    I would invite someone to comment on this column in the Financial Times; the author says that the current nationalization of the lynchpins of the financial system should be made permanent. That way, we avoid the incentives for high risk that created the situation we are in now, and in times of duress, there is no uncertainty, neither on the part of goverment about which company to save and which to let fail, nor on the part of investors about which institutions are truly failsafe.

    Makes a lot of sense to me.

  2. Anonymous

    “The Fed/Treasury feared that the managers of these firms had little to lose so they would engage in overly risky gambles, which would only exacerbate the crisis.”

    Were Hank and Ben regarding themselves in the mirror when they voiced those fears?

    Because that’s what the Fed is doing as it turns its balance sheet to junk — doubling down its bets in a risky gamble, since it has nothing to lose but its equity and its institutional independence.

    Where are the constraints on government behavior? Congress is supposed to be that constraint. But they are just mushrooms like the rest of us — kept in the dark and fed a diet of manure.

    Perverse incentives, moral hazard, unintended consequences. Democracy, rent seeking and paper money mix like teenagers, fast cars and whisky. Somebody’s gonna get hurt before they’re through.

  3. Matthew Dubuque

    Matthew Dubuque


    I must point out that the information you provided for us to review leads me to conclude that you may want to revise your headline.

    I quote the following from your summary:

    “PROPOSED a significant change in accounting rules”.

    Administrative rulemaking is a rather lengthy process and can easily take more than 3 months to complete. It requires publishing the proposed rule in the Federal Register for a statutory minimum public comment, etc.

    I’m not master of administrative law; it is its own beast, but my knowledge of it from law school is that generally a statutory notice and public comment period is required.

    And indeed the language I cited in the text of the article is completely consistent with what I know.
    It is PROPOSED, not enacted, as near as I can tell.

    Yet your headline states “NOW” as if it were a “fact” in the present indicative tense. Proposed rules often change dramatically (or are never enacted) after agency review of the public comment.

    Am I missing something here?

    I know that King George has vested himself with unlimited powers and there may be exceptions to this statutory comment period, but again, the text of the article you provided to us to read indicates we still have a comment period for this that will take months before revisons and possible final enactment.

    Matthew Dubuque

  4. Alan von Altendorf

    This is like a butcher putting his thumb on the scale. Coca Cola’s secret formula was balance sheet valued at zero for 75 years. What was the “going enterprise” value of TWA, PanAm, Enron, WorldCom?

    Goodwill hits the balance sheet when someone pays a premium to acquire book value assets. It’s an accounting fiction destined to blow out. A penny in the fusebox.

    Mark to market. Count the cash in the till. WaMu is toast.

  5. doc holiday

    Comrade Smith,

    This is indeed great news! Warren Buffett had about $33 Billion in Goodwill about six months ago, so this will help sustain the synthetic growth rate which he and his fellow comrades have become dependent on! We can breath a collective sigh of relief that our system will be safer and now more transparent! Prost!

    Snark option, on full blast

  6. Dave Raithel

    “Good will” is one of those economic concepts that stymied my comprehension of bourgeois economic theory, in general. I just could not get past a real world ordinary language range of the meaning, e.g. “I know you and man, I owe you one” to “I know of you and and I know people you’ve done business with, and they like you” to ” “Hey, you’re white, and I’m white, so that gets you points…” Really, different people are going to find different things as the most salient indicia of impending collapse, but for me, this one pretty much confirms that I need to stock up on the propane tanks and shotgun shells. Gold I cannot eat, hunt, or cook with …

  7. Anonymous

    Bank regulations are not like accounting rule changes. Even if there may be a time lag before this is officially papered up, the regulators will act as if the rule is effective now.

    This is all about Wachova and WaMu, after all.

  8. Hu Flung Pu

    Can someone shed a little more light on this one?

    Is the new ruling that banks CURRENTLY with goodwill on their balance sheets can count that as regulatory capital? Or is that goodwill created in FUTURE ACQUISITIONS will count as regulatory capital?

    If banks with goodwill can now count that as regulatory capital, then literally hundreds of billions of dollars in capital was just created with a stroke of the pen. If only goodwill created in future acquisitions will be counted as regulatory capital, then this is no big deal. After all, only struggling banks that will get acquired for almost no premium to tangible equity will be selling for the foreseeable future. Consequently, I don’t see much acquisition-related goodwill being created over the next couple of years. Thus, no biggie.

    Anyone know which is the case?

  9. Hu Flung Pu

    Ok, I did a little research and the NY Times mis-reported this horribly. It’s no big deal. Looks like the new regulation allows the GAAP deferred tax liability that arises from amortizing the goodwill for tax purposes (goodwill isn’t amortized for GAAP reporting purposes) to count toward Tier 1 Capital. This actually makes sense. Modestly helpful to banks with goodwill, but not THAT helpful. The absolute maximum amount of goodwill that could be counted towards Tier 1 Capital would be 1/3 of goodwill, and that would only occur if the goodwill had been on the books for 15 years. My guesstimate is that at best (or worst, depending on how you look at it) maybe 10% of the goodwill out there will be able to count toward Tier 1 Capital. The Federal Reserve has a link that won’t fit here. Back to your regularly scheduled financial fiasco…

  10. alan von altendorf

    I still don’t like it. Unsaleable hot air cannot be capital, much less Tier 1 on a par with AAA bonds.

    BTW “hu flung poo” is the all time knock ’em out champ web moniker. Had me in stitches first time I saw that handle!

  11. Anonymous

    How much Goodwill do the securities holders of these banks feel toward them now? How is the Goodwill holding up among foreign purchasers of Wall St bonds? Goodwill must be earned, just as AAA ratings must be earned, and it can be lost by disasters like the one now in progress.

    Of course, I think of Goodwill from the point of view of a business man. Goodwill = customer satisfaction…very old timey notion.


  12. Richard Kline

    Yes, and by Friday the banks will be allowed to count lint picked out of their navels as capital. —And it will be worth more then their remaining ‘goodwill,’ because it will stink less.

  13. Blissex

    «But is this way of going about it wise?»

    Well, it depends on whether the current Republican administration wants to solve the problem or wants a japan-style solution.

    The current problem is that there are a lot of pending losses waiting to be realized and made material and counted. At the very least there are 3 million houses overstock whose mortgages are to be written down. Something around like a trillion.

    There are only a few possible paths:

    * Taxpayers put up about 1 trillion to cover those papers losses.

    * Financial intermediaries lose 1 trillion in capital and the financial system disappears.

    * Paper capital is created to balance those losses, and “goodwill” is part of that story

    Or combinations thereof.

    Since the issue is “paper” losses, that means accounting losses, and the SEC and company have been trying to find changes to the accounting rules that allow those “paper” losses to go unrecognized for a long time.

    One of those is the famous facilities by which the “paper” losses are exchanged for cash/treasuries by a generous Fed, another is the suspension for a year of the mark-to-market rule, and now this “proposal” about good will.

    Which is essential for another time tested accounting trick: to bury paper losses in a merger, as in ML/BoA. Well, goodwill (and taxation, and that has been taken care of) is a very important aspect of a merger, to trick up the accounts of the final entity.c

  14. Anonymous

    Won’t that goodwill evaporate as the dropping value of the assets is realized? Couple of write-downs and it is gone?

  15. Carlomagno

    @Blissex: that was me, forgot to sign in. I find it absolutely amazing that with such a precedent, any US regulator would even dare to suggest to again include goodwill in regulatory capital. Quite astonishing.

Comments are closed.