TOP TRICKS OF THE ACCOUNTING TRADE
Corporate Watch’s friendly accountant takes us through some of the latest shenanigans.
Accounting may seem like a dull and unworthy topic for anyone with a thirst for social and economic justice, however the humble balance sheet can pave the way for a myriad of unscrupulous activities to be carried out by companies and government alike, all under the guise of respectability or the anonymous cloak of dullness.
Accountancy these days doesn’t just reflect what companies do after they’ve done it; it dictates what and how they do it in the first place.
Collateralised Debt Obligations’ (CDOs) – making the bad money disappear
It was accounting alchemy that made possible the boom in sub prime lending and the boom in mortgage lenders’ profits. Banks are required by state regulators to hold a certain amount of capital (money) as a buffer for the loans that they make. The level of capital that is required is in proportion to both the amount of loans and the risk level of loans – the loans that are recorded on the bank’s balance sheet, that is. In theory, the more loans and the more risky loans, banks make the more capital they need to support this lending. The requirement to hold this buffer of ‘dead money’ was originally intended to prevent banks over stretching themselves and engaging in reckless lending activity. As ever with capitalism, however, limits to expansion have to be smashed through and accountancy played a big part in doing so. The establishment of Collateralised Debt Obligations (CDOs) allowed banks to shift huge amounts of high risk loans off their balance sheet, thus reducing the level of capital they had to hold in relation to them. This freed up that capital to be used to support the offering of even more loans and so the spiral continued. On the flip side the massive borrowings that were run up in funding this irresponsible lending by the banks were also hidden off the books. Banks and their executives and shareholders benefited enormously at the time through the enhanced profitability that these dodgy deals provided. The freeing up of ‘dead money’ previously held as a capital buffer enabled expansion. Banks could also then charge fees to other investors (which included local government funds, charities, hospital funds, churches, employee pension funds, etc.) for setting the whole thing up in the first place. The impact once this charade came tumbling down hit home in a viciously unequal manner. In 2007, in the US alone, 1.3 million homes were served with some form of foreclosure order with that figure estimated to double in 2008. Meanwhile some of the principal architects of these schemes suffered the ‘humiliation’ of having to accept fat pay deals and step down from their positions. Chuck Prince of Citigroup picked up a severance package of $100m (on top of the $53m salary he received in the four years he was in the job) yet still works for the same company - ironically as a ‘consultant’ on regulatory matters. His counterpart Stan O’Neal at Merrill Lynch although not contractually entitled to any severance pay, picked up a cool $159m pay off on top of the $160m he ‘earned’ in his five years as Merrill’s chief executive. PFI – let’s put the future behind us
Most PFI contracts that central or local government enter into have the concept of ‘off balance sheet’ financing at their heart. This accounting trickery allows future obligations (i.e. liabilities) taken on by public bodies to be hidden and not disclosed as liabilities on the government’s balance sheet. This makes the government’s official borrowing figures far lower and gives the pretence that this method of providing public services is in the interest of the public and the taxpayers, rather than a transfer of resources to corporations and consultants. Under PFI, instead of the government issuing bonds or borrowing in the markets to fund projects, the private providers do this instead. Due to the difference in credit worthiness between the UK state and those private suppliers, the cost of borrowing is much higher when done in this way. This higher cost (along with the profit demanded by the suppliers) is passed back to the public through regular payments to the PFI supplier over periods of up to 30 years. So, in addition to being locked into inflexible and costly contracts for public services, the very cost of them is far higher than an exact same scheme would be, but for the PFI/off balance sheet element. We are peddled the lie that this allows risk to be transferred from the public to the private and is therefore a price worth paying. It is clear, however, where the risk really lies when you look at examples of failed PFI’s, like Metronet, where the debts of the failed provider land back in the hands of the taxpayer. The real value of pensions
Changes to accounting rules in the last decade or so required companies to properly value the level of liabilities they held, in relation to final salary pension schemes, in a different manner. This change did not alter anything basic in the obligations held by companies in relation to these pension liabilities. However, the change in the rules led the way, and was used to justify, the closure of most of those pension schemes and therefore put an end to what had been a valuable benefit for many workers. A simple change in accounting treatment prompted the closure of these schemes. This now means that most pension schemes transfer all the risks onto the worker. It could be argued that the change in rules has just made companies more aware of the huge cost of providing final salary pensions. However, it shows the importance, and unreal nature, of accounting; only when the companies were forced to formally recognise those liabilities on their books did the closure of those schemes speed up.
It was accounting alchemy that made possible the boom in sub prime lending and the boom in mortgage lenders’ profits. Banks are required by state regulators to hold a certain amount of capital (money) as a buffer for the loans that they make. The level of capital that is required is in proportion to both the amount of loans and the risk level of loans – the loans that are recorded on the bank’s balance sheet, that is. In theory, the more loans and the more risky loans, banks make the more capital they need to support this lending. The requirement to hold this buffer of ‘dead money’ was originally intended to prevent banks over stretching themselves and engaging in reckless lending activity. As ever with capitalism, however, limits to expansion have to be smashed through and accountancy played a big part in doing so. The establishment of Collateralised Debt Obligations (CDOs) allowed banks to shift huge amounts of high risk loans off their balance sheet, thus reducing the level of capital they had to hold in relation to them. This freed up that capital to be used to support the offering of even more loans and so the spiral continued. On the flip side the massive borrowings that were run up in funding this irresponsible lending by the banks were also hidden off the books. Banks and their executives and shareholders benefited enormously at the time through the enhanced profitability that these dodgy deals provided. The freeing up of ‘dead money’ previously held as a capital buffer enabled expansion. Banks could also then charge fees to other investors (which included local government funds, charities, hospital funds, churches, employee pension funds, etc.) for setting the whole thing up in the first place. The impact once this charade came tumbling down hit home in a viciously unequal manner. In 2007, in the US alone, 1.3 million homes were served with some form of foreclosure order with that figure estimated to double in 2008. Meanwhile some of the principal architects of these schemes suffered the ‘humiliation’ of having to accept fat pay deals and step down from their positions. Chuck Prince of Citigroup picked up a severance package of $100m (on top of the $53m salary he received in the four years he was in the job) yet still works for the same company - ironically as a ‘consultant’ on regulatory matters. His counterpart Stan O’Neal at Merrill Lynch although not contractually entitled to any severance pay, picked up a cool $159m pay off on top of the $160m he ‘earned’ in his five years as Merrill’s chief executive. PFI – let’s put the future behind us
Most PFI contracts that central or local government enter into have the concept of ‘off balance sheet’ financing at their heart. This accounting trickery allows future obligations (i.e. liabilities) taken on by public bodies to be hidden and not disclosed as liabilities on the government’s balance sheet. This makes the government’s official borrowing figures far lower and gives the pretence that this method of providing public services is in the interest of the public and the taxpayers, rather than a transfer of resources to corporations and consultants. Under PFI, instead of the government issuing bonds or borrowing in the markets to fund projects, the private providers do this instead. Due to the difference in credit worthiness between the UK state and those private suppliers, the cost of borrowing is much higher when done in this way. This higher cost (along with the profit demanded by the suppliers) is passed back to the public through regular payments to the PFI supplier over periods of up to 30 years. So, in addition to being locked into inflexible and costly contracts for public services, the very cost of them is far higher than an exact same scheme would be, but for the PFI/off balance sheet element. We are peddled the lie that this allows risk to be transferred from the public to the private and is therefore a price worth paying. It is clear, however, where the risk really lies when you look at examples of failed PFI’s, like Metronet, where the debts of the failed provider land back in the hands of the taxpayer. The real value of pensions
Changes to accounting rules in the last decade or so required companies to properly value the level of liabilities they held, in relation to final salary pension schemes, in a different manner. This change did not alter anything basic in the obligations held by companies in relation to these pension liabilities. However, the change in the rules led the way, and was used to justify, the closure of most of those pension schemes and therefore put an end to what had been a valuable benefit for many workers. A simple change in accounting treatment prompted the closure of these schemes. This now means that most pension schemes transfer all the risks onto the worker. It could be argued that the change in rules has just made companies more aware of the huge cost of providing final salary pensions. However, it shows the importance, and unreal nature, of accounting; only when the companies were forced to formally recognise those liabilities on their books did the closure of those schemes speed up.
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