Why I Love Accountants: the Subprime Mortgage Debacle
If you were the head of some large organization and faced some really serious crisis with which you had little experience—who would you want at your side?
1. your lawyer
2. your CFO
3. your management consultant
4. your PR and marketing guru
5. your COO
Me, I’d pick the CFO. Why? Because (s)he’s most likely trained in accounting. And I have come to believe that accountants have—overall—the clearest and most practical view of the world of all the professions.
I suppose it has something to do with a closed system view of the world. Everything’s either a debit or a credit; it must have an account, and an offsetting account. And everything must cross-foot; it must all add up.
But unlike other closed systems (scientology? creationism?) there are very few gaping holes of the “here a miracle happens” sort.
When I was a management consultant, I built a case study out of a client experience, and frequently used it as an interview case. I also tested it on many of my own colleagues. Most cracked the code after about three minutes; some in two minutes; a very few in one minute.
Our CFO —Ross Currie—got it in 15 seconds, and he wasn’t a consultant. He was a trained accountant.
For a example of what I’m talking about, try a delightful column by Jim Peterson, who writes for the Business Section in the International Herald Tribune. In Accounting for Subprime—Scoring the Scorekeepers, he writes:
As soon as commerce moved beyond one-to-one barter, conventions were required to quantify such inherently judgmental issues as the hazard of re-payment in future periods, the time value of money to change hands at a later time, or the transfer of performance to a third-party.
So viewed, subprime and the credit market turmoil are all about the accounting, and nothing else. Fundamentally flawed assessments were made – whether out of venality or ignorance – about the quantification, of timing and transferability of the risks associated with uniquely complex financial derivatives, and the collapse in their values as knowledge and experience eventually caught up.
So the accounting for mortgage-based assets and their off-spring should be seen as a proxy for the reckoning of financial reality in all aspects:
He then goes on to describe the accounting view of each player in the debacle—people who overpaid on houses with over-leveraged credit; the investment banks who dreamed up the toxic waste; and the merry-go-round investors who bought it.
Read the rest his article to find out its implications for Sarbanes Oxley.
Like I said—in a crisis, I’d pick the CFO.
Who would you go for?
To claim that the mortgage meltdown is fundamentally about accounting is a very facile argument. Just about any economic story can be reduced to numbers. Numbers only tell part of the story.
Part of the story is also “irrational exuberance” Far too many people thought that houses were immune to the vagaries of the business cycle. That too is a “story about numbers” look at the history and surprise, surprise, there are numerous examples of housing bubbles popping with devastating effects. All those people who bought houses in the confidence that that would be able to “flip” them were arrogantly assuming that the economic conditions would never alter. There was a herd mentality and fundamental lack of reason that permeated the rank speculation in the housing market. Real estate is not for the faint of heart and using a house as an investment opportunity is at base an ignorant thing to do without tons of research. For most people a house is best used as a home, not as a 401k.
But the big story was the rank corruption and dishonesty of the present housing bubble. Agents were encouraged to sell the worst loans to prospective buyers, thus “liars loans and interest only loans and hideous ARM s paid huge commissions while straight-up fixed interest loans were left in lurch. The special loans were so dense and confusing that even your CFO could not make heads or tails of them. All he could have told you was “walk away from this loan; there is now way to tell what the real bottom line is.”
Having read your blog; I come to the realization that the whole mortgage debacle was a fundamental violation of trust. The trust that your lender is looking out for your best interest was violated by the compensation schemes. The trust you had in government to prevent bad apples from gaming the system was undermined by deregulation allowing predators to run rampant. The trust that people had in buying the bundled loans was disabused by the fact that the supposed assets were mostly hot air. Up and down the line people were scamming and being scammed. From the appraisers to the real estate agents to the loan companies to the big investment institutions—every one was abusing trust.
This meme could be developed further but not by me – someone out there in the ink-stained community does a much better job about explaining the necessity of trust in our lives.
Your story about who you’d want at your side in a crisis is telling. And it reminds me of some focus group research we did in the 1990’s when I was editor of the (then newborn) Accounting Today magazine.
We were asking a roundtable of small-business people about their perceptions and relationships with various professionals — lawyers, CPAs, etc.
One member of the panel said something I’ll never forget about the difference between lawyers and accountants and how clients work with them.
I think it went something like this: "I love my lawyer — he’ll fight for me. And I love my accountant — very smart guy."
"So who do you trust more?" we wanted to know.
The small-business owner (I think he was in the furniture business) thinks hard, and finally says, "Well, I listen to my lawyer. He can always make a good case for his reasoning. But I obey my accountant. If I do what my accountant tells me to, I won’t need my lawyer."
Rick that may be self-serving for accountants–but it’s a helluva good quote. I happen to believe it myself.