Just Gimme Some Truth
A Message from Our CEO
"All I want is the truth now. Just gimme some truth now." - John Lennon
“Gimme Some Truth” was Lennon’s rant (listen to the song). This is the Dave Misch, banker version about one of the causes of the Great Recession of 2008 – the demise of truth in financials.
First, the audit went away. No longer did the Big Eight accounting firms pull data, determine statistical sample size, decide on a 96% or 99% confidence level, etc. No, that would have disrupted the consulting side of the business (read “Enron”). The accounting profession - with the aid of the regulators - separated the fee-based firms/functions from the audit-based firms/functions, but the damage was done. No more would auditors be truly looking at statistically significant samples. The profession had morphed into: What procedures do you have? Let’s look at 4-5 transactions? All good? Let’s move on. The rating agencies looked at models. I was there…I saw it happen.
The government’s answer has been Sarbanes-Oxley and Dodd-Frank. Ask Jamie Dimon how that helped, and he was widely acknowledged as one of the best CEO’s in the business. (As a side note, I would bet that if we took the implementation costs of these two bills and spent them on good old-fashioned auditing, we’d be in a better place.)
Do you think if someone had done true auditing on the loans underlying the sub-prime based mortgage bonds that they might have found out what was going on? Maybe. Maybe not. But I bet they would have had a better chance of identifying the problems. Now, of course, the complexity of the financial services business is such that you may not find individuals with the ability to audit the transactions.
Consider JP Morgan Chase again. How is it, then, that JPM loses $2-$5 billion in this manner? Where were the internal auditors? The external ones? How should Dimon have known what was going on? While I am sure Dimon made some mistakes, it is unreasonable to expect him to be able to “get into the weeds” enough to have culled this out without some help.
I am currently reading “The Crash of the Titans” about the fall of Merrill-Lynch. It is amazing how often Merrill-Lynch management was surprised by the reset in the expected losses. Once. Twice. Three times. Look at what is happening in Greece, Spain and the rest of Europe. How many times have we heard about a bailout only to have it followed by subsequent bailouts? When do we get to the bottom of this and how do we do it if we don’t look at the details at least on a sampled basis?
In many of these cases, I don’t know how you can expect top management (who are hopefully not turning a blind eye) to know what is going on in an objective manner if there isn’t an independent third party checking things out. And shouldn’t Boards of Directors want a strong audit just in case senior management IS turning a blind eye? Shouldn’t shareholders? Shouldn’t regulators?
The second big change was the trend away from historical cost to fair value. What a “feel good” term. Fair. Value. Who doesn’t like both of those? Put together and it’s Nirvana, right? Value, schm-alue. There is nothing fair or valuable about fair value accounting. It took a concrete number—what somebody actually paid for an asset at a point in time—and made it a squishy, arbitrary, difficult to decipher mess. The world functioned quite well when investors and other users of financial statements got “the truth” and not some distorted, assumed version of “the truth”. While well-intentioned and a derivative (we should have known it would be an issue) of the lowering of costs or market principle, FVA has given new meaning to the term “creative accounting” and has made comparisons - between asset classes, periods, and companies - difficult and inconsistent at best.
I recently read somewhere (“Titans”?) that fear and greed are a key part of balancing risk/reward and, in the absence of fear, greed runs amuck. You can’t have fear without truth and I don’t know how you get to the truth when you have someone with an eight-figure bonus standing between you and the truth.
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