Auditing is important, but what causes a disaster, is more important than how it is being accounted.

Sir, “FT Big Read. Auditing in crisis: Setting flawed standards” of August 2, discusses, among other, the huge divergence of figures in the auditing of the value of derivative exposures of AIG and of Goldman Sachs, even though their auditor was the same, in this case PricewaterhouseCoopers. 

That it was “striking how little was verifiable, that there were few credible market prices, let alone transactions, to support the key valuations”, explains much of the divergence.

Sharon Bowles, former chair of the European Parliament’s economic and monetary affairs committee explains it with: “Accounts have always contained estimates; think of the provisions companies make against foreseeable future losses, but the un-anchoring of auditing from verifiable fact has become endemic.”

That “un-anchoring from verifiable facts” is not limited to auditing. 

Sir, for the umpteenth time, without absolutely no verifiable facts, regulators concocted their risk weighted capital requirements for banks, based on the quite infantile feeling that what was perceived risky must be more risky to the bank system than what was perceived safe. In fact what could have been verified, if only they had looked for it, was the opposite, namely that what’s perceived safe is more dangerous to our bank systems than what’s perceived risky.

With that the regulators assigned to AAA rated AIG, by only attaching its name to guarantee an asset, the power to reduce the capital requirements for investment banks in the US, and for all banks in Europe, to a meager 1.6%. That translated into an allowed 62.5 times leverage. Let me assure you Sir that without this the whole AIG and Goldman Sachs incident described would never have happened. 

As always, what causes the problems is much more important than how the problems are accounted for. Though of course I agree, sometimes bad-accounting could in itself be the direct cause of the problems. 

The article also refers to “the so-called efficient markets hypothesis… that now somewhat discredited theory”. Sir, no markets have any chance to be credited with performing efficiently with such kind of distortions. For instance how verifiable is it now that sovereign debt is as risk-free as markets would currently indicate, when statist regulators have assigned it a 0% risk free weight, and are thereby subsidizing it?

@PerKurowski

Why do financial regulatory authorities, while preaching the value of diversification, act in favor of concentration?

Sir I refer to Harriet Agnew’s “FT BIG READ. Professional Services: Accounting for change” August 28.

In November 1999, in an Op-Ed in Caracas Venezuela, this is what I had to say on what is discussed there:

“I recently heard that SEC was establishing higher capital requirements for stockbroker firms, arguing that . . . ‘the weak have to merge to remain. We have to get rid of the rotten apples so that we can renew the trust in the system.’ As I read it, it establishes a very dangerous relationship between weak and rotten. In fact, the financially weakest stockbroker in the system could be providing the most honest services while the big ones, just because of their size, can also bring down the whole world. It has always surprised me how the financial regulatory authorities, while preaching the value of diversification, act in favor of concentration.

The SEC should not substitute the need for capital in place of the need for ethics, nor should it allow that fraudulent behavior hides amid the anonymity of huge firms. In this respect, let us not forget that the risk of social sanctions should be one of the most fundamental tools in controlling financial activities.

Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

@PerKurowski

One little raffle would do it

Sir, Barney Jopson in “Unknown auditor? Not in my back yard, thank you” describes how though everyone knows it is not good for the markets to be so much in the hand of just four big auditing firms no one really gets around to do something about it, and so it seems that your regulator could be lacking some testosterones. Honestly, how difficult can it be to pick, through a raffle, 150 of the 300 largest companies that should be able to use a mid-tier auditor, and just ordering them to do so within a year if the want to avoid a huge fine. It is high time for the world to start thinking about taxing the largest before they become the-only-one and so from auditor firms we might then have to move to the banks.