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.