The financial sector, along with exchange traded funds (ETFs), are being boosted by what may seem to be a financial legerdemain.

There are many complicated rules in the banking and finance industry, and one such rule, the purchase accounting rule, is able to make bank earnings look better than they otherwise would, says Jeremy Hobson for Marketplace. This is going make discussions about how these financial institutions should be regulated tough.

For example, federal regulators seized Washington Mutual when it failed and sold it to JP Morgan (JPM) for around $2 billion. JP Morgan used an accounting rule to mark down the loans on WaMu’s balance sheets upon purchasing the institution, and JP Morgan would eventually mark up those loans when the market is doing better. Wells Fargo (WFC) also did the same thing with Wachovia’s assets and PNC Financial Services (PNC) did it with National City.

But we should scrutinize these business models carefully because we as outside investors don’t have access to the detailed information that auditors would. So we should look to auditors to keep the shareholders informed about whether financial institutions are reporting good earnings or a trick in accounting.

  • Financial Select Sector SPDR (XLF): down 2.9% year-to-date; JPM is 13.2%; WFC is 8%


Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.