Accountants Misled Us Into Crisis

This headline is the headline of an article I would recommend everyone read about the financial crisis. This article, by Floyd Norris, can be found in the Friday morning New York Times (see http://www.nytimes.com/2009/09/11/business/economy/11norris.html?ref=business). As readers of this blog know, I have been a strong advocate of more transparent and open reporting from all organizations, but especially from financial institutions. Mark-to-market and the determination of fair values of financial assets, I believe, is a must going forward!

The bankers cry only after-the-fact, that is, once their bets on mismatched maturities on their balance sheets or on the assumption of riskier assets has gone sour. They can’t have it both ways, which is how little children want it. If you are going to take risks, Mr. Banker, then accept the responsibility for the risks that you take. Don’t cry about unfair accounting standards once the milk is spilt.

To me there are two major reasons why shareholders and regulators should be alerted to the bets that bankers have placed. The first has to do with achieving a more appropriate valuation of the stock of the bank or financial institution. Owners should know what bets have been placed so that they can incorporate risk into the valuations they are placing on the stock of the company they are interested in investing in. Regulators need to know as truly as possible the potential danger a bank faces and the treat the bank poses to the bank insurance fund.

The second reason has to do with management, itself. I have led the successful turnaround of three financial institutions. In each case, a major reason the banks got themselves in trouble was that managements repeatedly postponed, and then postponed again, dealing with problems because they could hide the problems from both the investment community and the regulatory bodies. This is also the case in the vast majority of troubled or failed institutions.

Successful managements must own up to the problems that they have created and act to correct those problems as soon as they can. The openness and transparency created by good accounting standards are important tools to create an environment in which managements do identify problems early and then act on them.

In a real sense, however, accounting standards are a crutch. Good executives require full disclosure of asset values and report this information to shareholders and regulators. They also act to resolve problems in a timely manner, as the problems are identified. Good executives create a culture in which they learn about problems as soon as possible because they don’t want surprises. I was taught that this is what good management is all about.

Perhaps we should post a list of all banks and bankers that are in favor of easing these reporting rules and discount the price of their common stock by 30% to 40% from current levels.

The reason?

To me, any banker that wants to ease up the rules on reporting the fair value of assets is, by definition, a poor manager and a poor leader. And, I do not want to invest in any organization that has poor management or poor leadership.