Two of my favorite columnists, Floyd Norris and Jonathan Weil have put in their two cents worth on the implications of the Greek bond accounting issues brought to the fore by the IASB's letter to the European Securities and Markets Authority (ESMA). I have already written two posts on the issue, and I certainly don't want to beat it to death, but Floyd and Jon have turned up the heat that cooks the IASB's goose to a crisp.
The biggest surprise came from Floyd's column, in which he revealed that the IASB letter was kept secret, until it was subsequently leaked to the Financial Times. Only after it was leaked, presumably, did the IASB post the letter to its website. Here are just a few reasons why this is so outrageous:
Tipping the scales at the SEC – The IASB simply could not bring itself to publicly acknowledge that consistent application of IFRS takes a backseat to politics in the EU. If the SEC were to adopt IFRS in the wake of this debacle, either it or its registrants will be the chumps. The best case scenario is that SEC registrants and their auditors would be forced to behave themselves, while varying degrees of equivocation would be the norm practically everywhere else.
The CYA imperative – My guess is that the IASB feared political reprisals if it were to publicly humiliate EU regulators for their tacit and/or explicit support of bogus accounting maneuvers. Yet, it couldn't completely ignore the accounting misstatements; for if Greek bonds investors actually do get left holding the bag, the IASB would be blamed for promulgating rules that allowed important information to be hidden until it was too late to do anything about it. At a very minimum, the IASB had to create some sort of paper trail that it could pull out of its archives in a doomsday scenario. Its story would be that it wasn't the accounting standards that were faulty; it was the fault of auditors and regulators for not compelling the banks to adhere to those standards.
Busting the myth of investor primacy – Floyd's article documented the fact that the accounting issues being raised are not merely a question of form, but that, in some cases, there is not enough disclosure to permit an accurate restatement. If the IASB were genuinely committed to investor primacy, secrecy would be entirely out of the question. On this side of the pond, for example, it has been my experience that the SEC will require restatements when they could have an immediate impact on investors' decisions.
When evaluating the propriety of a secret communication amongst regulators, it is simply not relevant that the SEC has enforcement power and the IASB does not. Hans Hoogervorst, as a former regulator, surely knew what the right thing to do was, yet he chose secrecy. Going public with the accounting misstatements – including the specifics of each one – might not have induced the needed restatements, but it was the only principled alternative. Shame.
The Tip of the Iceberg
It was obvious that the IASB's letter only addressed the tip of the iceberg – the Greek bonds classified by investors as "available for sale," but Jonathan Weil makes two important observations in that regard. First, a mere 10 percent of the Greek Bonds were not sheltered from fair value measurements through re-classification as "held-to-maturity." Second, the reason why this percentage is so low harkens back to the politics of 2008, when the IASB amended IAS 39, without justification, to permit reclassifications out of the trading and available-for-sale (i.e., fair value measurement) categories.
On that last point, I'll simply conclude with Lynn Turner's (former SEC Chief Accountant) reaction to Jon's column, which I received via email:
"[Jon's article] highlights what fools the European regulators and accounting standard setters now look like. The article rehashes how the Banks and Politicians ganged up together on both the FASB and IASB to immensely water down their rules three years ago, so that banks could prepare misleading financial statements that omitted losses on their investments. At the time, the SEC also failed to defend the FASB and in fact, when questioned, told a congressman they would see to it the FASB got the rule changes done in just 30 days.
Now, … this change has allowed: (1) banks to avoid reporting the losses they have suffered on Greek debt, (2) banks are slowing "dripping" their losses into their financials over a number of years including years to come, much like Chinese water torture, (3) resulting in banks failing to actively manage their problems, [my emphasis] and (4) extending the problem and probably the magnitude of losses incurred.
Back at the beginning of the 1990's, a report from the GAO noted the US government had engaged in similar financial shenanigans until Richard Breeden became chair of the SEC and forced the S&Ls and banks to report their true losses. Unfortunately, the politicians undid his work and the result is noted [in Jon's article], with a very negative outcome for investors."
Ask yourself this: if issuers of financial statements were required to mark all of their investments and loans to market through net income, would the too-big-to fail banks in the EU be in the mess that they are now in?
Repeat the question for the S&L crisis of the 1990s and the financial crisis of 2008.