Posts Tagged ‘Finance’
Wednesday, August 31st, 2011
“In an age of lightning-fast stock trades and instant communications, yearly and quarterly financial reports seem stuck on an industrial-era pace that some say was obsolete decades ago,” Reuters reports. “Accounting experts have long called for a move to real-time, online reports in lieu of quarterly earnings statements that investors now use to decide whether to buy stocks.”
Well, not all accounting experts. Smeal’s own J. Edward Ketz and his colleague Anthony Catanach of Villanova University have serious doubts that society would be better off with this constant barrage of financials. They covered the topic recently on their blog, Grumpy Old Accountants:
Even if one could produce daily financial statements, there remains the problem of comparability. It is hard enough now to compare quarterly statements of different firms whose seasonal effects vary, but now let’s try to compare daily financial statements of CBS with Ford. This is nonsense. Even restricting such analysis to firms in the same industry will not guarantee comparability as there is too much daily variability.
Let’s now consider auditing this “moment-by-moment” report generating machine. It isn’t clear to us that the reports are auditable, except for the cash flows. Worse, how does a business concern construct viable internal controls to handle the transactions and events in such an environment? Given the pitiful state of some firms’ internal control systems, the extra strain would make a mockery of the audit process.
Having the technical skills and the technical machinery to allow daily or hourly financial reports is not sufficient for enabling continuous financial statements. No, either the accounting reports become dumbed-down or we toss accrual accounting out of the window. And audit firms have too much trouble auditing corporations now—witness the scores of restatements and accounting scandals—that they would have no chance of ever doing it right in a continuous reporting environment.
We pity the SEC if this day ever comes.
There’s more on their blog.
Thursday, July 21st, 2011
Smeal’s John Liechty testified before the U.S. House Committee on Financial Services, Subcommittee on Oversight and Investigations, last week regarding the newly formed federal Office of Financial Research (OFR). The OFR, which was formed last year with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, is charged with collecting data on the financial system to allow another government entity, the Financial Services Oversight Council, to effectively monitor its stability and ward off potential threats. The agency is the brainchild of Liechty, who spent 18 months gathering industry support and meeting with members of Congress to push its establishment.
According to The Hill‘s On the Money blog, the banking subcommittee wanted to learn “how the new Office of Financial Research plans to keep mounds of financial data safe from hackers. … With hackers always looming over the horizon, Republicans want to know what the office—which they charge lacks proper congressional oversight—is doing to keep that information in the right hands.”
In his prepared testimony, Liechty explained the origins of the OFR and why he believes its a necessary component to the country’s financial security. He opened with an outline of his three main points:
Financial stability requires transparency – The ability for regulators to both see through the counterparty network and the ability to see through asset backed, financial products to the underlying assets is an important fundamental component that is needed in order to be able to monitor the stability of the financial system. Transparency will require universally accepted identifiers and reporting standards—in essence it will require banks to get their back-offices in order. The investments required to improve transparency will not only result in improved macro-prudential regulation; they will result in improved risk management and substantial operational savings for the industry.
We face a significant scientific task – Not only do we not have the data in place, we have not done the science needed to understand system-wide risks to the financial system. In many ways, financial regulators are like the weather services, before the National Oceanic and Atmospheric Administration (NOAA) was established. NOAA was given the mandate to i) collect new data, ii) develop new models for identifying extreme events and improving weather forecasts, and iii) conduct the science necessary to understand the weather systems and build these next generation models. The Financial Services Oversight Council (FSOC) and the Office of Financial Research face similar challenges and have been given a similar mandate.
We cannot afford to fail – We live in a leveraged economy where the resilience and growth potential of the economy depends on having both an innovative and stable financial system. Innovation often leads to instability, unless the appropriate infrastructure is in place to provide stability. The FSOC and OFR offer a way forward to build this infrastructure. The risk that we live with, if we fail to have the proper oversight to provide a stable system, is not just the devastating economic impact that would come from another financial crisis of the magnitude of the 2008 crisis, but more importantly the political reality that will follow. If we can’t get this right and there is another crisis, then there is a very real risk that the political response may result in a response that adversly affects the finanical market’s ability to innovate.
You can view the entire hearing on the House banking committee’s website. For more on the Office of Financial Research and Liechty’s role in its creation, check out this Smeal Report feature from late last year.
Friday, May 20th, 2011
Public radio’s Marketplace last night reported on the federal Office of Financial Research, a new financial watchdog dreamed up by Smeal’s own John Liechty and put into place with that passage of the Dodd-Frank financial reform law. The Marketplace report, which tells the story of how Liechty came up with the idea for the oversight agency, is online here.
For more on the Office of Financial Research and Liechty’s role in its creation, check out this Smeal Report feature from late last year.
Thursday, April 28th, 2011
What a week for couch potatoes—thrilling NBA and NHL playoff games; the fairy-tale royal wedding; and yes, the grand-daddy of them all, Federal Reserve Chairman Ben Bernanke’s Wednesday press conference. The first ever in the history of the Federal Reserve, I might add.
While I have no illusions that Bernanke will win the Nielson ratings wars this week, there is no doubt that the press conference was a seminal event in the Federal Reserve’s evolution toward greater transparency and accountability in its policymaking. Did the Chairman make any breaking news? Absolutely not, but there was important market reaction to what Bernanke said and the way that he said it.
Here is what I heard, and my perception of how the markets continue to view Fed policy:
1) The Federal Reserve Mandate – It was very clear that the chairman attempted to draw boundaries around what the Fed can do and what the Fed can’t do with respect to economic recovery. For the past three years various pundits have criticized the Fed for doing either too much or too little during the recent crisis, perhaps even overstepping its powers. Bernanke must have stated at least 15 times that the Federal Reserve’s mandate is to maintain/promote a growth level consistent with full employment and low inflation. His latest projections for the end of 2011 are range-bound estimates of GDP growth of 2.1 percent, inflation of 2 percent and unemployment at 8.3 percent.
These numbers are not going to make anyone jump for joy. But what is important here is that Bernanke emphasized (given his mandate of balancing growth, employment and inflation) that, in weighing the costs and benefits of various policy tools, he is more concerned with anemic growth and employment than he is with the specter of runaway inflation—at least for the next year. Notice there is nothing in the mandate statement concerning the appropriate level of the dollar.
2) Inflation – Bernanke was very clear to emphasize that if the Fed begins to see stronger signs of prices heating up, then the Fed will take swift action on the inflation front. This is definitely not what inflation hawks wanted to hear. Bernanke clearly feels that the main concern of Fed policy is unemployment and sluggish growth (yet, there are signs in the public speeches that other Fed Board members are beginning to challenge the Chairman’s position). Critics point to skyrocketing oil and commodity prices, the rise in food prices and some evidence of rising input costs leaking into other consumer good prices (Procter & Gamble and Coca-Cola announced price increases on products yesterday). Critics point out that latest CPI data shows all-level prices rising at a 2.7 percent rate, while Bernanke’s emphasis on the “core” CPI of 1.2 percent is unrealistic (the core rate strips out price increases from food and energy, which tend to be more volatile).
So how did the markets react? Silver moved up nearly 7 percent, approaching an all-time high of $50 an ounce, gold was more muted, rising about half a percent (Gold Bugs are now Silver Bugs), and oil was basically flat.
Clearly, Bernanke attempted to speak to “Main Street” in emphasizing that he understands the pain caused by food and energy price increases making up a significant portion of American budgets. However, inflation is defined as the general rise in the level of ALL prices, which is the reason for his focus on Core CPI. My feeling about the Fed’s position is that prices in two large sectors of the U.S. economy continue to be stagnant—housing and even more importantly wages. Until Bernanke sees inflationary pressure in the form of a wage and price spiral, I think he will continue to emphasize accommodative monetary policy. Bernanke was very clear on this point stating that the Fed could target a 0 percent CPI through monetary tightening, but in weighing the costs and benefits, the effect on economic growth and employment would be recessionary.
Monday, October 4th, 2010
The Economist recently reported on a proposal introduced by the Financial Accounting Standards Board, which requires firms to publish information on reasons they might be sued and how much it would cost them. The Economist argues “this would provide a how-to guide for lawyers looking for targets.”
“Firms would have to disclose any money set aside for potential settlements,” they write. “This would reveal to tort lawyers the general area where the richest pickings might be.”
These new rules, which are scheduled to go into effect on Dec. 15, force firms to highlight their own vulnerabilities by regularly updating this disclosed information.
Smeal’s Ed Ketz believes this proposal goes too far and won’t help the investment community.
While I generally support more disclosure over less disclosure so that investors and creditors have more information about a business enterprise, the FASB proposal for greater disclosures on litigation goes too far. It likely won’t help the investment community because the estimates of payouts are not reliable; worse, the plaintiffs’ bar might use the estimated damages as a floor for lawsuits against corporate America. This would have the unintended effect of magnifying losses beyond reasonable amounts.
Tuesday, September 28th, 2010
Smeal’s John Liechty appeared on Bloomberg Television yesterday to talk about the Office of Financial Research, a new federal agency he helped create that is charged with identifying systemic risk in the financial sector.
You can view his appearance on YouTube.
Wednesday, September 15th, 2010
The Wall Street Journal reports today on the role Smeal’s John Liechty had in the creation of the new federal Office of Financial Research, which is part of the recently enacted financial reform bill. Here’s an excerpt:
Pennsylvania State University Prof. John Liechty last week gave an exam to his marketing class. Far from campus, another of his projects faces a much bigger test—and all of Wall Street is watching.
Mr. Liechty, 44 years old, has helped design an electronic safety net to assess systemic financial risk in a bid to prevent another banking calamity. The project—formalized as a new federal office in the financial-regulation act—is called the Office of Financial Research.
… Messrs. Liechty, Reesor and Flood got the idea for the OFR while attending a February 2009 financial-system workshop. Mr. Liechty realized regulators had no ability, or legal framework, to collect and share data on the global financial system and therefore no way to measure system-wide risk.
“Not only is it crazy, it’s dangerous,”‘ Mr. Liechty recalls thinking.
They wrote a seven-page paper proposing a national institute of finance that would operate a data center and then facilitate research and analysis. The proposal said regulators then could assess a financial contagion and perform independent stress tests for banks.
The article goes on to explain how Liechty and his colleagues worked with Congress to draft the legislation, which was signed into law by President Obama on July 21.
Friday, September 10th, 2010
When FASB chair Robert Herz announced that he’s stepping down at the end of this month, the Financial Times reported that his retirement decision was “greeted with dismay by the accounting profession.” Perhaps so, but Smeal’s Ed Ketz is not among the dismayed.
In April 2009, when FASB eased mark-to-market accounting rules under pressure from banks and Congress, Ketz wrote a column entitled “Herz Should Resign.” An excerpt:
I have found Mr. Herz quite intelligent, filled with much knowledge about accounting and finance, well-mannered, articulate, and an avid defender of the accounting profession. Unfortunately, I also find Herz lacking in courage and moral fortitude. Whenever some bully comes on the scene and challenges him and the FASB to a fight, he runs away. When accounting truth is at stake, he compromises and enables corporate managers to use methods and vehicles by which they can cook the books. Shame!
In his latest column, Ketz offers some suggestions to replace Herz:
To begin, I think the appointment of Leslie Seidman as interim chair is a mistake, and I certainly would not make this interim appointment permanent. Even if she is highly credentialed and capable, she is a banker, having worked for JP Morgan. The guilt-by-association eliminates her from consideration.
The [Financial Accounting Foundation] needs to appoint someone who has the necessary accounting and political skills to be chairman. He or she also needs the courage to confront the primary enemies of good financial reporting.
I would also like to see the FAF appoint somebody from the user community, somebody who deeply understands the needs and the recent frustrations of investors and creditors. Names like Jim Chanos and David Einhorn come to mind. They understand accounting thoroughly, having penetrated the deceits foisted upon them. And they won’t take any crap from Wall Street or from Congress.
Considering the composition of the FAF, I expect them to give us the same old same old. But I can dream, can’t I?
Thursday, July 22nd, 2010
Smeal’s Brian Davis weighs in on the financial reform bill signed into law by President Obama yesterday:
An old Army buddy once gave me his words of wisdom as we were dreaming of ways to change the world: “Proceed until apprehended.” Which, I did. Well, I eventually screwed up (but not before gallantly saving my client more than $1 million). When I asked my Army guru to opine about my next course of action, he smiled, wished me luck, and told me to “lay back and enjoy it.”
Obviously to anyone who has ran afoul of conventional thinking, if your risks turn out to be mistakes, then the consequences of your behavior will be less than rewarding. At least, going forward the best you can hope for is to lay back and enjoy it.
Welcome to FinReg.
A recent New York Times article says it all: Banks Seek to Keep Profits as New Oversight Rules Loom.
As everyone with an interest in the future wants to know—“Is this the regulatory panacea to cure all ills?” Of course not. But, FinReg is the next step in what democracy promises—change, by incremental change. Notice how vague the definitions are, and how vague the timing of compliance is as outlined by the legislation. The main provisions of the bill—the establishment of a derivative clearinghouse, limits on banks’ ability to trade on their own accounts, a consumer protection agency to oversee credit card practices, and some form of bankruptcy rules to unwind failing institutions—attack the main causes of the recent financial crisis.
I hate to use an overused phrase, but the devil is in the details. How well the new regulations and regulators perform will depend upon how the bureaucracy writes the specific rules to meet the new mandates. FinReg only lays out the architecture and goals of the new regulatory environment. The hard work will be done piecemeal as regulators write the rules and the banking lobby attempts to shift the effects of these rules in favor of their interests. Compliance is not required on most provisions for five years. As a result, we will not be able to sum up the performance of the bill for at least ten years or until the next crisis erupts. Stay tuned.
Friday, May 14th, 2010
“The Senate approved a provision that would thrust the government into the process of determining who rates complex bond deals, in a move to end alleged conflicts of interest blamed by some for worsening the financial crisis,” The Wall Street Journal reports. “The amendment aims to resolve what’s considered one of the thorniest problems in financial markets: Bond issuers choose ratings agencies and pay for ratings, meaning raters’ revenues depend on the very firms whose bonds they are asked to judge. Under the new provision, the Securities and Exchange Commission would instead establish and oversee a powerful credit-rating board that would act as a middleman between issuers seeking ratings and the rating agencies.”
Years ago, Smeal’s J. Edward Ketz proposed a much simpler way to remedy this conflict of interest in a manner that doesn’t establish an entirely new regulatory scheme. From a 2008 Ketz column on SmartPros.com:
The fundamental problem with credit ratings is the conflict of interest caused by the issuer’s paying the rating agency. Because such a conflict of interest exists, various potential problems surface since employees—in particular managers and analysts—know how they are compensated. Even if the credit rating agency is smart enough to avoid direct linkages between compensation and ratings, there nevertheless is an association. All employees know that their continued employment, their salaries, and their promotions depend upon their contributions to the real business of the organization.
… The real solution is simple and existed prior to 1970. Require the credit rating agencies to charge the users of its information instead of charging those they investigate. The conflict of interest is completely removed. Not only that, but you reinstate a market mechanism: If the users really want the information, they will pay for it. And if the market has sufficient competition, the price will be the value of the information.