Peeling away financial reporting issues one layer at a time

Hank Paulson Says Another Financial Crisis is Inevitable: The FASB is Working to Prove Him Right

Hank Paulson, former Treasury Secretary, recently gave an interview to Marketplace host Kai Ryssdal to mark the fifth anniversary of the Lehman Brothers bankruptcy.  More to the point, Mr. Paulson said that he decided to re-issue his book on the 2008 financial crisis, plus a new prologue, because: another financial crisis is inevitable; the vulnerabilities that gave rise to a barely-averted meltdown haven’t changed very much; and the public has lost its “sense of urgency” for financial reforms.

Mr. Paulson also acknowledged that one of the difficulties was convincing a skeptical public that “TARP was not for Wall Street and the bankers.”  Rightfully, the public wanted the government to hold individuals accountable, and it was unfair, to put it mildly, that helping bankers instead of punishing them was the only way to save their banks, and our economy.

That was the part of the interview that hit me right in my accounting solar plexus.  Five years after the 2008 Financial Crisis, loan accounting has still not changed one iota.

It has been my position throughout that the FASB has come to realize that their own individual interests, as opposed to the public interest, requires that any changes they make to GAAP must be acceptable to Wall Street and the bankers.   And, two recent columns from Jonathan Weil bear me out:

  • One Ebrahim Shabudin, a bank executive, has settled with the SEC, which found that he schemed to successfully delay the recognition of loan impairment charges.  The 2009 bankruptcy of his bank ultimately cost the federal government $1.5 billion: 20 percent in squandered TARP funds and the rest in costs incurred by the FDIC.
  • The Comptroller of the Currency has expressed his concerns that systemically important banks are improperly reducing their loan loss reserves — while loosening credit at the same time.  

Here’s a thought experiment that occurred to me after reading Jon’s columns:

First — Imagine that accounting standards require banks to report the current value of their loan portfolios on their balance sheets.  Ideally, the valuations would not be the responsibility of bank managers and would be performed by independent experts, but let’s not ask for the impossible.  Instead, let’s stipulate the status quo with regard to management’s responsibilities and that any number that is reported is subject to their manipulation; we can also (sadly) stipulate that the auditor’s responsibilities and competencies with respect to financial statement audits of banks is a situation that can’t be improved upon.

Next — Hold that thought and also imagine any loan loss reserve methodology that you think the FASB should adopt, if it were to adopt such a methodology. Feel free to pick from an incurred loss model or an expected loss model.  Pick from two buckets, or three buckets — I don’t care.  I only care that you choose the accrual rules that you believe would have the best chance of not being associated with the next financial crisis.  

Now, the good part — Imagine that you are a member of the FASB except: you are not getting paid $600,000/year (my estimate of actual salaries) for ten years of just sitting on the Board if you behave yourself; and that after you serve, because you  have demonstrated that you are an independent thinker, you won’t be invited to serve on more audit committees of Fortune 100 companies than you’ll be able to accept.  You have to imagine that your sole objective is to stand behind new accounting standards that will minimize the likelihood of a financial crisis. For if one should occur, you will at least be able to live with yourself for having promulgated neutral accounting standards that will have served the public interest.

At this point, the object of the exercise should be painfully obvious.  Compared to current values, even the best possible version of amortized cost accounting that bankers could use to save their hides (a la Mr. Shabudin), or feather their nests (a la the bankers who remain at large) is nothing more than a straw man.

But whether you choose current values for loans or your straw man, its impossible to deny that the FASB’s any “sense of urgency” for resolving the question is absent.  Yet, according to the Comptroller of the Currency, the earnings manipulation games being played by the too-big-to-fail banks are already back to mid-season form.


  1. Reply Steve Rabin September 28, 2013

    FASB board members, in general are former big-4 audit partners, and I imagine their pay is a step down from what they made in the firm. They are not allowed outside employment and agree to be independent. If their independence is a question mark to you now, then what about all the audits they signed as independent auditor when they were big-4 partner?

    • Reply Tom Selling September 28, 2013

      Hi, Steve:

      Good point, but let’s look at some data: the current roster of board members. You’ll see that very few came straight from Big Four partnership to join the Board:

      Linsmeier — never a Big Four partner
      Buck –never a Big Four partner
      Siegel — never a Big Four partner
      Schroeder — a big Four Partner more than 20 years ago, before leaving for financial services
      Kroeker — Yes, I guess, even though he was at the SEC for many years.
      Golden — Yes, but left the Big Four in 2004 to be an FASB staff member. (Maybe being a Big Four partner isn’t everything it’s supposed to be in terms of pay for effort, stress, etc.?)
      Smith — Yes, but similar to Golden

      In general, SEC Commissioners are law firm partners or hold prestigious chairs in law schools. If they don’t get paid more than POTUS, then I don’t see why FASB members get paid more.

  2. Reply Warren Miller, CFA, CPA September 29, 2013

    What’s it take to change the behavior of these bankers? Would the possibility of capital punishment bring them to heel?

  3. Reply Tony Frank September 29, 2013

    Has there ever been a bigger fraud than hank paulson? He should be prosecuted for what he did to preserve the goldman mafia.

  4. Reply Allan Hooper December 8, 2013

    The public are part of the problem also surely ? In the Western world, there seems to have been a fundamental shift in attitudes to risk and borrowing. Personal, corporate, countrywide risk do not seem to resonate unless and until they directly impact us as individuals and that attitude sets us up for an even bigger disaster in the not too distant future I believe.

    • Reply Stephanie Chen December 25, 2013

      You’re right Allan in your assumption about the public. The lack of awareness of what the laws and regulations to average individual is astonishing.

      My friends have all kinds of student loans and never once ponder where the money comes from and what the impact is not just on the economy at large but the supply and demand impact it has on the costs of their educations!

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