Gonzo Accounting

So, I was speaking to the builder who has bought the wreck of a house next door—formerly owned by one of the true pigs in our county. It required four dumpsters to simply empty the house of literal garbage, before he could even begin the job of restoring the house.

At any rate, I was talking to him about the work—he has slowed down to a bare crawl over the past several months. Turns out, the local bank is partly at fault. They turned off the spigot. He has a loan with them to finance his cash flow until he can finish and sell the house.  Basically, they are not releasing any more money, presumably because of the Second Great Depression. They were bragging to him that they got 4.5 Billion dollars—the government forced them to take the money.  Yet, they won’t release the $40,000 he needs to continue and hopefully finish the construction work that will allow him to sell the house. So, he has had to turn to a different bank for the money. So, what is his bank doing with the 4.5 billion dollars? Who knows? Decorating the CEO’s office? Maybe. Apparently banks don’t practice the concept of “transparency.”

And that brings us to our lesson for today: transparency.

In reading an article in today’s NY Times, they were discussing the failure of rating agencies to reveal the truth about the gonzo investment schemes foisted on the public by banks and their “investment” partners. The problem? Well, it turns out there’s a (are you ready?) conflict of interest. Wow! Really? Wonder why that might be? Well, you see, the companies being rated by these “rating agencies” are also the ones who pay the rating agencies.  Sort of like “pay to play.” Not quite outright bribery, but very close.

So, our genius economic system overseers have decided that the system by which rating agencies get paid must change. Amazing, gents.

But hold on, is that the only problem?

I would submit, Not. I have this nagging suspicion that the rating agencies are partly either incompetent and/or they are dealing with an opaque system, in which truth is revealed only like peeling an onion, and the rating agencies can only peel back a few layers.

It seems to me that a second group is even more culpable in this racket. That second group is . . . drum roll please . . . the entire accounting profession. When the government whines that they don’t know where the banks are spending all that bailout money, they imply that they don’t have the information (ahhh . . . images of the CIA and weapons of mass destruction come to mind). Now, where might such information be available? Well, turns out that public bodies like banks and other financial institutions are supposed to have things called accounting systems. Those accounting systems are designed to record all transactions—to the penny. We even have systems called audits, by which outside financial accounting firms examine the financial records of public bodies and determine whether those companies books accurately reflect the true financial situation of the companies being audited, again, to the penny.

Now, guess who pays these financial accounting firms that are doing the audits? Well, the companies being audited pay them.  And, companies “shop” for audit firms, much like you shop for automobiles—only in this case the companies are more interested in simpatico, than mere price. If audit firms get too “objective” or too “independent” the companies can simply go elsewhere for their audits. Think there’s a relationship between the degree of opaqueness and the accounting partners’ behavior toward the company CEO’s?

So, much like the rating agencies, it would seem that we need to scrap the entire system by which accounting firms audit the books of public companies—that is, the system needs to be blown up entirely, and we need to start over with some brand new system.

So, President Obama, you need to put your best brains to work on devising a new accounting system for the United States. To point you in that direction, I suggest you consider designing a system in which all public companies (private companies doing business in the public marketplace, e.g., selling stocks, trading investments, etc.) pay into a shared fund to be overseen by the federal government, maybe the Treasury Department, or some new quasi-governmental agency). That shared fund would represent the proceeds by which this new entity would contract for accounting services to audit these companies. The accountants so hired would change every 2-3 years. The companies being audited would have no say—none, nada—in who gets hired to audit their books. The audits would have to follow a standard set of accounting principles.

With such a system, perhaps rating agencies, also now hired and paid by an independent agency, would have the necessary data by which to assess the degree of risk attached to companies in their financial transactions.

Now that’s Change I Can Believe In!