How Bank of America Botched Some Basic Accounting

As Bank of America prepares to buy $4 billion of its own stock, a boneheaded accounting mistake is driving the price down. Shares slid by almost 6 percent this morning when the bank said it had miscalculated how much capital it had on hand. The slip-up also froze the bank’s strategy to reward loyal investors by raising its annual dividend from a penny to 5 cents a share–plans that are on hold until Bank of America susses out with the Federal Reserve just how much ballast is in the bottom of the boat.

The mistake was buried in a complicated jumble of financial machinery that the bank inherited when it bought Merrill Lynch in 2009. The glitch involved structured notes, hybrid products in which an underlying debt obligation fluctuates based on something entirely separate. Imagine a loan whose payout rests on whether Facebook shares fall by 20 percent.

What’s interesting is that Bank of America did not appear to have fouled up its accounting on esoteric bets that were in play—so-called “unrealized” notes—in an error that might have been somewhat understandable. It appears the bank just overlooked a batch of these products that had run their course and ended up as a loss.

The slip-up won’t affect earnings but it will require quite a bit of expensive paper-shuffling, as the bank tries to clear its books with the Fed and get regulators to approve its stock buyback and dividend plan. All told, the correction required the bank to lower its important ratios by fractions of a percent. (Here’s the full, very dense mea culpa.) That’s a fairly big deal for a corporation with almost $1 trillion in loans outstanding.

And since the Great Recession, the Fed has become rather touchy about these things. It much more aggressively checks up on the amount of liquid assets big banks have on hand and how risky they are. The goal is to make sure an institution doesn’t throw a bunch of its cash into something like crummy mortgage securities, assume everything is hunky-dory, and drag the global economy to the brink of destruction.

Apparently, it’s all too easy to forget about some of that toxic old stuff.

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