1
The International Financial
Crisis
The Fall – 2008
The slides – into recession!
[How long will it last?]
2
Accountability
A well regulated community or business
entity, being necessary to the security of a
free society, the right of the people to keep
informed and to be armed with bare facts,
shall not be infringed.
US Constitution, Second Amendment [Amended]
3
The Life of a Turkey
SUSTAINING
ACTIVITY
Thanksgiving Day
TIME
4
The Life of a Financial Market Place
CORPORATIONS
HOUSES
MORTGAGES
BONDS
STOCKS
INVESTMENTS
DERIVATIVES
(CDOs, CDSs &
CMOs)
BANKERS’ FEES
COMMISSIONS
PROFITS
A
BLACK
SWAN!
SUSTAINING
ACTIVITY
TIME
T
If things cannot go on for ever, they will eventually and inevitably STOP!
[Herbert Stein – Chairman, President Reagan’s Council of Economic Advisors and
Professor of Economics at the University of Virginia]
5
The Life of the Financial
Market Place – A Black Swan!
An event or occurrence that deviates beyond what is
normally expected of a situation and that would be
extremely difficult to predict.
This term was popularized by Nassim Nicholas Taleb, a
finance professor and former Wall Street trader.
The Corporate Crisis
[A Massive Shift of Financial Power]
• In [John Kenneth Galbraith’s] New Industrial State, published in an age of low interest
rates and easy credit for large corporations (1967), the bank was considered secondary to
the large corporation. In my father’s judgment, the bank was too remote from the details
of corporate operations to control them effectively
• The high interest rates of the 1980s changed all that. Suddenly, after being secondary for
decades, the cost of funds became a predominant consideration for enterprise survival
• Monetarism thus made the industrial firm dependent, once again, on its source of
finance.. In this way, it reestablished the preeminent power of financial institutions…Wall
Street was back in charge.
• The result…was the rise of “short-termism”. Financial targets were set and had to be
met, whatever the implications for the long-term viability of the enterprise. A company
that failed to do so could be punished by a declining stock price and, ultimately, the
discipline of a hostile takeover, followed by aggressive disruption of the technostructure.
• Who could survive?
[The Predator State: James K. Galbraith]
6
Crown Water Company
[High Interest Rates & Increasing Debt/Equity Ratio]
• Decision-making power over the management of the assets of
the Crown Water Company (Community Assets) will gradually
shift from the Community's Managers (its Municipal
Government, other Ownership Board or Private Shareholders)
to Financial Investors.
[Credit-rating Entities may also be Involved]
• To protect their investments, the Financial Investors will
likely insist on loan conditionality or on increasing control
over the Enterprise.
• Such conditionality or management
control will almost certainly be designed to engender more
adequate internal generation of funds, especially by higher
consumer charges and/or improved operational productivity.
[The Crown Water Company: David C. Jones]
7
The computer room at King's College Cambridge, is named
after Alan Turing, a student there in 1931 and a Fellow in 1935
Computers – fathered by Turing - are now ubiquitous,
notably in accounting, finance and investment.
8
Mapping the Future
[County of Cambridgeshire UK.]
Alan Turing, father
of computers, went
to King’s College,
Cambridge, England
[What has This to do With Anything?]
9
10
The International Financial Crisis
The Fall - 2008
Newmarket
Cambridge
Six Mile Bottom
11
The Crash @ Six Mile Bottom - 1954!!
Type:
English Electric Canberra B.2
Operator:
RAF 231 OCU
Registration:
WD981
C/n / msn:
71051
Fatalities:
Fatalities: 3 / Occupants: 3
Airplane damage:
Written off (damaged beyond
repair)
Location:
.5 mile W of Six Mile Bottom,
Newmarket, Cambridgeshire,
England
12
After The Crash:
We shall need a New Market!
• There are reasons to believe that credit from taxpayers
can’t and won’t be repaid for many years, in that this credit is
financing the correction of huge financial and trading
imbalances between the western and eastern economies.
• We’ve witnessed a semi-permanent nationalization of the
banking system and will soon see significant taxpayer support
for real companies in the real economy.
• Thus, our banks and private-sector companies will have to
work much harder to sustain the goodwill of those who are
keeping them alive: millions and millions of taxpayers.
Robert Peston, 8 December 2008 [BBC NEWS]
After The Crash:
We shall need a New Market!
• The biggest lesson of all is that we are a million miles from
having created the political and regulatory institutions to
help us contain the risks of globalization. We and most of the
world may well have been beneficiaries of the open global
economy. But as millions lose their jobs in Europe and the US in
the coming year, the benefits will be forgotten.
• That means that those running our biggest commercial
businesses will have to be more visible. They’ll have to
manifest a genuine understanding not only of the anxieties of
their employees but of all taxpayers. Those chief executives who
succeed will be those who imbue in their businesses very
simple, commonsense standards of decency.
Robert Peston, 8 December 2008 [BBC NEWS]
13
14
After The Crash:
We shall need a New Market!
• They’ll almost certainly be paid less for doing more,
because the pricking of the debt bubble has undermined the
institutions – the private-equity firms, hedge funds and
investment banks – that were ratcheting up the pay of all
business leaders.
• If the unfettered movement of capital, goods and services
is going to survive, if there’s not going to be a retreat into
national fortresses that could impoverish all of us over the
longer term, we’ll have to find a far better way of
monitoring global risks and of bringing governments
together to deal with these risks.
Robert Peston, 8 December 2008 [BBC NEWS]
15
After The Crash:
We shall need a New Market!
• Some may see this as a threat to national sovereignty, as
the thin end of an anti-democratic wedge that’ll see the world
ruled by unaccountable bureaucrats. Reconciling our
political traditions with the imperative of making safe the
globalised world will be a challenge, to put it mildly. But it’s
not a challenge we can shirk.
Robert Peston, 8 December 2008 [BBC NEWS]
16
The International Financial
Crisis
Three Telling “Slides!” – 2008
From
The Washington Post
[Next 3 slides are © The Washington Post]
17
17
18
19
Marketplace Myths (1)
Government is, always and everywhere:
wasteful, spendthrift, incompetent,
inefficient, uneconomical and ineffective
Business is, always and everywhere:
ethical, frugal, thrifty, competent,
efficient, economical and effective
Private enterprise can, always and
everywhere, operate more efficiently and
effectively than a public enterprise.
Excuse Me?
20
21
Marketplace Myths (2)
The commercial market-place can, always and
everywhere:
allocate resources more efficiently than
governments.
There is no market failure. Always and
everywhere, there is only governmental
interference, together with policy and regulatory
failure.
[Even Federal Reserve ex-Chairman, Alan
Greenspan does not believe this any more!]
22
"Adam Smith" Economics or
"Adam's Myth" Economics?
• US President George W. Bush has admitted (2008)
that the financial system needs reforming, but
insists that the credit crunch was not a failure of
the free-market system.
• Question: What the hell WAS it the failure of,
then?
Excuse me?
23
"Adam Smith" Economics or Neo-comics?
Enron, WorldCom, etc.
Madoff
The US Economy
The Global Economy
Never Under-estimate:
• Stupidity;
• Obtuseness;
• Unwillingness to Rock the Boat.
[Paul Krugman (Nobel Economics Laureate):
Address to the National Press Club – 19, December 2008]
24
Efficiency & Ethics
The pseudo-science of
economics and the
myth of unconstrained
economic efficiency.
Economics – like tanks
and banks – does not
care whom it helps and
whom it hurts!
25
Efficiency & Ethics
The military tank is a marvel of science and
technology. Like the “science” of economics, it
very efficiently (but indiscriminately) controls,
supports, kills, wounds, destroys & damages.
26
Hungary:
Soviet Military Intervention - 1956
• To suppress a demonstration that was
reaching an ever greater and unprecedented
scale, by 2 a.m. on 24 October, under orders
of the Soviet defense minister, Soviet tanks
entered Budapest.
• “The Soviet tanks have gone. Western
banks have now replaced them! Is market
capitalism any better, for we ordinary
people, than communism?”
[A Hungarian worker: PBS News, 16 December, 2008]
Hungary:
IMF Financial Intervention - 2008
• Hungarian stocks and the currency soared on Wednesday, after the
country secured more than $25 billion in backing from global institutions
led by the International Monetary Fund.
• The financial sector hit the skids when credit began drying up over the
summer. Roughly 30 percent of Hungary's public debt and 60 percent of
loans to businesses and individuals are in foreign currencies, making
the country extremely vulnerable to a sinking domestic currency.
• Many home mortgages, for example, were denominated in Swiss
francs, as borrowers sought lower rates than they could get at home.
• That raised a danger that house payments would soar if the currency
tanked, a danger that was realized as the local currency plummeted,
losing 22 percent against the euro from mid-July to mid-October.
27
28
Weapons of Violence: Tanks or Banks?
“Violence is not just about bombing or shooting
or hitting people. Violence is any way we
have of violating the integrity of the other.
Racism and sexism are violence. Derogatory
labeling of any sort constitutes violence.
Rendering other people invisible or irrelevant is
an act of violence. So is manipulating people
towards our ends as if they were objects
that existed only to serve our purposes.”
© Parker Palmer: Repossessing Virtue – Economic Crisis, Morality and Virtue
Economic Efficiency: Tanks or Banks?
“[The man of system] seems to imagine that he
can arrange the different numbers of a great
society with as much ease as the hand
arranges the different pieces of a chess-board;
he does not consider that the pieces of a
chess-board have no other principle of motion
besides that which the hand impresses on
them; but that, in the great chess-board of
human society, every single piece has a
principle of motion of its own, different from
that which the legislature might seem to
impress on it.”
[Adam Smith: The Theory of Moral Sentiments]
29
Alan Greenspan and Adam Smith
US Senate Banking Committee*
"I made a mistake," Greenspan said, "in presuming that the selfinterests of organizations, specifically banks and others, were
such as that they were best capable of protecting their own
shareholders and their equity in the firms.”
[a.k.a. “I refute Adam Smith!”]
[* Lying to Congress is a felony]
“It is not from the benevolence of the butcher, the brewer, or the
baker that we expect our dinner, but from their regard to their
own interest....
“....He intends only his own gain, and he is in this as in many
other cases, led by an invisible hand* to promote an end which
was no part of his intention. Nor is it always the worse for
society that it was no part of it. By pursuing his own interest he
frequently promotes that of the society more effectually than
when he really intends to promote it.”
[Adam Smith “Wealth of Nations”]
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31
“Marxist" Economics or
“Capitalist" Economics?
• “From each according to his ability, to each
according to his need.”
or
• “From each according to his vulnerability, to each
according to his greed.”
32
Actually, Alan Greenspan Missed the Point!
Adam Smith Knew Better!
Read it again, this time with different emphasis:
“It is not from the benevolence of the butcher, the brewer, or the
baker that we expect our dinner, but from their regard to their own
interest....
“....He intends only his own gain, and he is in this as in many
other cases, led by an invisible hand* to promote an end which
was no part of his intention. Nor is it always the worse for
society that it was no part of it. By pursuing his own interest he
frequently promotes that of the society more effectually than
when he really intends to promote it.”
[Adam Smith “Wealth of Nations”]
33
Actually, Adam Smith Knew Better!
“…as in many other cases…”:
BUT – NOT in ALL of them!.
“…Nor is it always the worse for society…”:
BUT – sometimes – it IS!
“…he frequently promotes…”:
BUT – sometimes – he does NOT!
“…than when he really intends to promote it…”
BUT – not, always, when he really does NOT so intend!
[Adam Smith “Wealth of Nations”]
34
The Standard Neoclassical
Economic Model
“I argue that the first fundamental theorem of welfare
economics - asserting the efficiency of competitive
markets - is fundamentally flawed. Quite contrary to that
theorem, competitive economies are almost never
efficient...”
Joseph E. Stiglitz - Whither Socialism
(2001 Nobel Laureate in Economics)
Extracted from:
“Adam’s Myth Economics”
A Slide Show, by David C. Jones
35
THE CRASH:
What Went Wrong - Frenzy
When the housing market began
to tank in 2005, Wall Street ran
through the yellow light of
caution and created even riskier
investments – and Washington
had no mechanism for finding
out what was going on.
[© Washington Post: 16 December, 2008]
Regulation of Derivatives (1a)
The President's Working Group on Financial Markets brought
together, in 1998:
• Federal Reserve Chairman Alan Greenspan;
• Treasury Secretary Robert E. Rubin; and,
• Securities and Exchange Commission Chairman Arthur
Levitt Jr.
All were Wall Street legends, all opponents to varying degrees of
tighter regulation of the financial system that had earned them
wealth and power.
Their adversary, was Brooksley E. Born, head of the “Commodities
Futures Trading Commission” (CFTC).
Greenspan, Rubin and Levitt had reacted with alarm at Born's
persistent interest in derivatives, so called because they derive
their value from something else, such as bonds or currency rates.
36
37
Regulation of Derivatives (1b)
Many newer derivatives weren't traded on an exchange, constituting
what some traders call the "dark markets." There were now millions
of such private contracts, involving many of Wall Street's top firms.
But there was no clearinghouse holding collateral, to settle a deal
gone bad, no transparent records of who was trading what.
Born wanted to shine a light into the dark.…she now wanted to open
a formal discussion about whether to regulate them -- and if so, how.
Greenspan, Rubin and Levitt were determined to derail her effort.
At a meeting, in April, 1998, the trio's message was clear:
“Back off, Born!”
38
Regulation of Derivatives (1c)
The stalemate persisted. Then, in September 1998, a crisis arose
that gave credence to Born's concerns.
Long Term Capital Management, a huge hedge fund heavily
weighted in derivatives, told the Fed that it could not cover $4
billion in losses, threatening the fortunes of everyone, from
tycoons to pension funds. The Federal Reserve was TERRIFIED!
Two days later, Born warned the House Banking committee:
"This episode should serve as a wake-up call about the
unknown risks that the derivatives market may pose to
the U.S. economy and to financial stability around the
world." She spoke of an "immediate and pressing need to
address whether there are unacceptable regulatory gaps."
Regulation of Derivatives (1d)
• The near collapse of Long Term Capital Management didn't
change anything! The battle left Born politically isolated.
• In April 1999, the President's Working Group issued a report that
raised some alarm over excess leverage and the unknown risks
of the derivative market, but called for only one legislative change
• A recommendation was that brokerages' unregulated affiliates be
required to assess and report their financial risk to the government.
• Greenspan dissented on that recommendation.
By May, Born had had enough.
• In 2000, Greenspan and Rubin's successor at the Treasury, Larry
Summers, still held sway on keeping the CFTC out of the swaps
market.
39
40
The near collapse of Long Term
Capital Management
The Federal Reserve was TERRIFIED!
Question: As a result, how much was
done, by regulation or investigation, to
prevent a recurrence?
Answer: On a scale of 1 to 10 - Nothing!
41
Regulation of Derivatives (2)
• The crisis has prompted second thoughts.
• Goldschmid, the former SEC commissioner and the agency's
general counsel under Levitt, looks back at the long history of
missed opportunities and sighs: "In hindsight, there's no question
that we would have been better off if we had been regulating
derivatives -- and had a clearinghouse for it.“
• Levitt, too, thinks about might-have-beens. "In fairness, while
Summers and Rubin and I certainly gave in to this, we were not in
the same camp as the Fed," he said.
• "The Fed was really adamantly opposed to any form of
regulation whatsoever. I guess if I had to do it over again, I
certainly would have pushed for some way to give greater
transparency to products which turned out to be injurious to
our markets."
42
Accountability
Investors in and Sellers of Mortgage-backed
Securities (Derivatives):
“We were intending to use Arthur Andersen to
help us to prepare our financial statements.
“But, after “Waste Management Incorporated”
and “Enron,” Andersen went out of business!”
43
Accountability
Investors in and Sellers of Mortgage-backed
Securities (Derivatives):
“We used three “reputable” (??) credit-rating
agencies, to value our investments”:
“Sub-Standard and Very-Poor”;
“Very Moody” and “Filch Ratings”
44
Accountability – Credit Rating Agencies
• The G-20 Financial Crisis meeting last
weekend committed to exercising strong
oversight of credit rating agencies.
• Many of the financial instruments that
are at the heart of the financial crisis
had been given AAA ratings, meaning
they were supposed to be of the highest
quality. That turned out to be wrong.
[National Public Radio 21 November, 2008]
Accountability – Credit Rating Agencies
[Perverse Incentives - A Metaphor from School]
• I need good grades, to:
• Please my parents; and
• Get into a “good” university
SO
• I pay my school-teachers – money – to
give me good grades.
• He/she makes a good profit out of grading
for money.
QUESTION?
What’s the essential difference?
45
46
Accountability – Credit Rating Agencies
ANSWER?
Not very much, apparently!
Raters become the first industry to be handed new regulations
as a result of the credit crisis.
[CFO Magazine – CFO.com – 4 Dec. 2008]
As part of a new set of rules adopted today,
the Securities and Exchange Commission
will prohibit credit rating agencies from
helping to structure the same financial
products they rate.
47
Accountability – Credit Rating Agencies
ANSWER?
Not very much, apparently
• The regulator — which was given formal oversight of the
rating agencies two years ago — will also require the raters
to keep better records of their rating processes and thirdparty complaints, as well as make them decline gifts of
more than $25 from securities issuers.
• The changes are designed to mend a credibility-tainted
industry by reducing the firms' conflicts of interests and
making them more accountable for their evaluations.
48
Emergency Economic Stabilization Act (2008)
[Bailout of the U.S. financial system]
QUESTION?
• Why not give some of the (October 2008) “Bail-out”
money to the credit rating agencies?
• In exchange, they could then reassure the US taxpayers
that the $10-11-? trillion dollars of US Sovereign Federal
Debt will continue to be rated as AAA!!
49
The Market for Lemons
(Asymmetrical Information)
• George Akerlof (Nobel Laureate) describes how
interaction between perception of indefinite quality and
lack of information can lead to the disappearance
of a market.
• As a consequence, markets may fail – or find it
very difficult – to exist altogether in certain
situations involving quality uncertainty. Examples
include markets for: used cars; start-ups of
speculative
ventures
and
overly-complex
monetary investment instruments.
Accountability
Investors in and Sellers of Mortgage-backed
Securities (Derivatives):
• We have used a model of “Fool disclosure”
accounting;
• “Fool disclosure” accounting has been applied to
financial statements and supporting information
of: investors, mortgage-backed securities, other
derivatives, loan originators, banks and other
financial institutions;
• "Fool me once, Shame on you; Fool me twice,
Shame on me."
[Chinese Proverb].
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51
FULL DISCLOSURE ACCOUNTABILITY
Potential Investors in the “Amazon.com” Search for
its Initial Capitalization:
• The more information they learned, about electronic
book selling, the less likely they wanted to invest in it!
[Jeff Bezos – Amazon.com Founder and CEO (C-SPAN)].
Potential Investors in Mortgage-backed Securities
(Derivatives):
• The more information they learned, about these
instruments, the less likely they wanted to invest in
them!
[An analogy to Bezos – borne out of the facts!].
Accountability
[Model Financial Reporting Statement]
“The financial statements have been prepared in accordance
with standards for “Financial Reporting and Accounting for
Un-priceble Derivatives” (FRAUD).
“Therefore, using “Creatively Regulated Accounting
Practices” (CRAP) we hereby certify that these financial
statements represent a true and fair view of the state of
affairs of the company, as at the date of the balance sheet
and of the activities for the year then ended.
Arthur Underhand and Company
Certified Public Accountants (Retired)
52
Accountability
[Credible Financial Reporting]
…viewing the financial world from an evolutionary perspective
argues for weeding out what the political scientist Joseph
Schumpeter called "the hopelessly unadapted" -- and quickly…
…"The experience [of Japan in the 1990s]," Ferguson comments,
"stands as a warning to legislators and regulators that an entire
banking sector can become a kind of economic dead hand if
institutions are propped up, despite underperformance, and
bad debts are not written off." [emphasis added]
Shelby Coffey III:
Review of “The Ascent of Money”: Niall Ferguson
© Washington Post (Book World) Nov. 30, 2008.
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54
Responsible and Accountable Activities
• Commentators, policy-makers, evaluators and critics have
invariably approached (almost) every issue by:
• establishing a preconditioned and prejudiced posture;
• seeking and using evidence that supports this
posture, whilst ignoring any evidence that does not; and
then,
• taking – or recommending – action, without ever
considering the total and overall economic, financial,
fiscal and social consequences!
• This can be referred to as the KNEE-JERK response:
• the [K]NEEDs are large, urgent and important; yet,
• we are often satisfied to rely upon JERKS to deal with
them!
55
Accountability
“Fair Value Accounting is causing a
large part of the problem at this
moment…”
Steve Bartlett, President and CEO
Financial Services Roundtable
Testimony to:
U.S. House of Representatives
Financial Services Committee
18 November, 2008
56
Fair Value Accounting
David C. Jones, CPFA, FCCA, had heard
this statement, when listening to his car
radio. He was so astonished that he
nearly crashed into a tree!
(Not believing his ears, he later needed to
verify it from the C-SPAN web-site, which
carried the hearing of the US House of
Representatives
Financial
Services
Committee!)
57
Regulator Let IndyMac Bank Falsify Report
[Agency Didn't Enforce Its Rules, Inquiry Finds]
• A senior federal banking regulator approved a plan by IndyMac Bank
to exaggerate its financial health in a May federal filing, allowing the
California company to avoid regulatory restrictions only two months
before it collapsed, a federal inquiry has found.
• The same regulatory agency, the Office of Thrift Supervision (OTS),
allowed similar legerdemain by other banks, according to a letter
sent yesterday to members of Congress by the Treasury Department's
inspector general.
• OTS on several occasions "blessed a fiction,” …in the collapse this
year of several of the nation's largest thrifts, including Washington
Mutual and Countrywide Financial.
• The Washington Post reported, last month, that OTS allowed thrifts
to lend massively while reserves against future losses dwindled…
58
Regulator Let IndyMac Bank Falsify Report
• IndyMac's initial filing, with regulators, for the first quarter [2008] showed
that the amount of money it had on hand to cover potential losses was just
large enough to meet regulatory requirements.
• But, days after it submitted the filing, IndyMac was told by Ernst & Young
that some numbers needed to be adjusted. Such a downgrade would
threaten IndyMac's survival. Thrifts classified as "adequately capitalized"
instead of "well capitalized” need special permission from regulators to
gather deposits through brokers, who funnel money from investors
• IndyMac executives, who learned about the problem in early May,
wanted permission to inject $18 million into the company's capital cushion.
But that would solve the problem only if the bank could pretend that the
money was injected at the end of March.
• Securities experts said the filing could raise legal issues because it is a
crime to knowingly make false statements in the financial records of a
public company.
59
The English Common Law: Fraud
• As far back as 1889 in Derry v Peek, Lord Herschell said
"…fraud is proved when it is shown that a false
representation has been made knowingly; without
belief in its truth; or recklessly, careless whether it be
true or false…".
• In the case Angus v Clifford(1891), Lord Justice Bowen
said about a fraudster…" did he know that the statement
was false, was he conscious when he made it that it was
false, or if not, did he make it without knowing whether
it was false and without caring?…."
An English Common [F]law: Fraud
• Over fifty years ago, my wife was an auditor, for a
British firm of Chartered Accountants, in (rural) Isle of
Wight, England;
• Many clients were farmers, with accounts that were
incomplete, typically lacking information about values
of: debtors; creditors; loan liabilities; and, assets;
• The farms were – often – under-capitalized!
• The farmers came to town on (free!) market-day.
• My wife recalls that many of the clients often smelled
of horse manure! [by whatever name described!]
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61
Accounting
A quote, from Ken Wagstaffe, a British
professional colleague, and fellow accountant,
who wrote a paper, about this kind of thing:
"......it is based on some completely and
fundamentally wrong notions about what
accounting is. The level of ignorance about
accounting is breathtaking."
“I’m as mad as Hell and I’m not going to
take this any more”
[David C. Jones: Chartered Public Finance Accountant;
Chartered Certified Accountant (UK)]
62
Fair Value Accounting
“Forgetting all dishonesty, let us speak the truth
to our neighbour, for we are all members of one
another.”
Letter of Paul to the Ephesians
[The Christian New Testament]
“Give just measure and weight, nor withhold
from the people the things that are their due.”
[The Holy Quran].
• Stewardship of Public and Private Funds
• Performance in Delivery of Goods and Services
• Control over Assets, Liabilities and Funds
63
64
Accounting Standards and Principles
[Unhealthy Financial Statements –
Based on an English Prayer from 1662*]
• We have erred and strayed from the right ways like
lost sheep
• We have followed, too much, the devices and
desires of our own hearts
• We have left undone those things which we ought
to have done
• We have done those things which we ought not to
have done
• And there is no financial health in us.
Fair Value Accounting
"....double-entry book-keeping attempts, through two parallel
records, to present two distinct but closely related sets of
facts. These are:
(i) a record, in detail, of what one owns and what one owes.
(ii) a record of how much one was originally worth, and
subsequent changes, whether additions to or
subtractions from, that original sum.
The first set of records deals with items of wealth, both
positive and negative. The positive items - that is, what one
owns - are called assets. The negative items - that is, what one
owes - are called liabilities.....
The second set of records, constituting the other aspect of
double-entry book-keeping, does not deal with items of actual
wealth. It has nothing to say as to the kinds of things owned. It
does not record the form nor the amount of the debts owed. It
deals solely with changes in the amount which the proprietor
is worth.“
[Accounting Principles and Practice, by Hatfield, Sanders and Burton]
65
66
Accounting
• Accounting is NOT Rocket Science
• [Nor – is it supposed to be – “racket science!”]
• It Can All Be Shown on a Single Page [see
Slide 69 – (© David C. Jones)]
• It is the “Churchill Chart” of accounts
• “Pray let me have, by this evening, on one
page, the status of our tank deployment…”
[Winston Churchill, British Prime Minister –
World War II]
67
The “Churchill Chart” of Accounts
• The famous man – almost – got it dead right!
He might, well, have said:
• “Pray let me have, by this evening, on one
page, the status of our BANK deployment…”
[Winston Churchill, British Prime Minister – World War II]
[The BANKS HAVE TANKED!]
• Never in the field of human conflict was SO
MUCH OWED BY SO MANY TO SO FEW….
[Winston Churchill on the Battle of Britain: August 20, 1940]
Fundamental Accountability Requirements
•
•
Retain (real) net capital intact [including non-monetary capital!].
Maintain inter-generational equity (current users bear their fair share of all
costs, including capital financing costs)
• Compute “Omar’s Car Runs” costs
• Operation
• Maintenance
• Administration & Taxes
• Rent:
– Consumption of capital (depreciation)
– Adjustment of value (asset valuation) – including monetary
investments
– Return on investment (interest, dividends, retained earnings)
• Surplus (to cover):
– Risk
– Uncertainty
– New Activities
– Stability
1. Fully utilize “Churchill Chart” of accounts (see slide 69)
– “Pray let me have, by this evening, on one page, the status of our
tank deployment…”
[Winston Churchill, British Prime Minister – World War II]
68
69
Churchill Chart
STOCK
OF
GOODS AND
MATERIALS
TRADING
MANUFACTURE
OR
OPERATING
ACCOUNT
1
SALES
-------------------------REVENUE
INCOME
2
1
4
6
5
6
3
9
3
10
PROFIT
AND LOSS
------------------------INCOME AND
EXPENDITURE
7
4
DEBTORS
(RECEIVABLES)
12
23
11
NET
EARNINGS
------------------------GENERAL FUND
SURPLUS
13
5
14
16
6
15
17
2
8
CAPITAL &
RESERVES (INCLUDING
FIXED ASSET
REVALUATION)
23
NOT ALL
THERE IS
TO IT
21
20
27
18
28
19
22
7
SPECIAL
FUNDS
-------------------------PROVISION
FOR EXPENSES
8
24
EXPENSES
25
MONETARY
INVESTMENT
9
6
10
11
12
CASH
AND
BANK
13
26
DEPRECIATION OR
CAPITAL FINANCING
RESERVE
-------------------------FIXED
ASSETS
28
14
27
Churchill Chart – Production v. Financing
STOCK OF
GOODS AND
MATERIALS
PRODUCTION
TRADING
MANUFACTURE OR
OPERATING
SELLING &
MARKETING
SALES
-------------------------REVENUE
INCOME
EQUITY
CAPITAL
RECEIVEABLES &
INVESTMENTS
EXPENSES
PROFITS & LOSSES
FINANCIAL MANAGEMENT
(& MISMANAGEMENT)
CASH
AND
BANK
FIXED
ASSETS
-------------------------DEPRECIATION
70
71
The Neutrality of
Investment, Credit & Lending
RECEIVEABLES &
INVESTMENTS
A MONETARY
INVESTMENT
(ASSET)
IS ANOTHER’S
DEBT
(LIABILITY):
[“Finance]… is but a walking shadow, a poor player
that struts and frets his hour upon the stage and
then is heard no more: it is a tale told by an idiot,
full of sound and fury, signifying nothing.“
(Shakespeare)
Financial Services
I keep six honest serving-men
(They taught me all I knew);
Their names are What and Why and When
And How and Where and Who.
I send them over land and sea,
I send them east and west;
But after they have worked for me,
I give them all a rest.
[Rudyard Kipling]
Finance is merely serving-men
(To show us what is due);
Their names are What and Why and When
And How and Where and Who.
I send it over land and sea,
I send it east and west;
But after it has worked for me,
I give MYSELF the rest!
72
73
Financial Services
I keep six honest serving-men
(They taught me all I knew);
Their names are What and Why and When
And How and Where and Who.
I send them over land and sea,
I send them east and west;
But after they have worked for me,
I give them all a rest.
[Rudyard Kipling]
74
Financial Services
Finance is merely serving-men
(To show us what is due);
Their names are What and Why and When
And How and Where and Who.
I send it over land and sea,
I send it east and west;
But after it has worked for me,
I give MYSELF the rest!
75
KEYS TO SYMBOLS
___________ Cash Flows

Legal Claims
(By the entity)

Legal Claims
(Against the
Entity)
KEY TO SYMBOLS
------------- Accounting Flows
POSITIVE 
RESOURCES
NEGATIVE 
RESOURCES
Tangible
Assets
Gains and
Losses
(Income and
Expenditures)
POSITIVE
RESOURCES
POSITIVE &
NEGATIVE
RESULTS
76
KEYS TO SYMBOLS
KEY TO SYMBOLS
------------- Accounting Flows
___________ Cash Flows

Legal Claims
(By the Entity)

Legal Claims
(Against the
Entity)

Debit
Amounts
Claimed
Credit
Amounts
Settled
Assets
Debit
Amounts
Settled
Credit
Amounts
Claimed

Debit
Increases in Assets
Credit
Decreases in
Assets
Gains and
Losses
Debit
(Income and
Expenditures)
Credit
Losses or
Expenses
Gains or
Income
Tangible
77
Accounting Chart
1. The attached chart illustrates the working of the entire accounting system of any
financially autonomous entity, keeping its accounts on an accrual basis. It can be
applied to private sector, public utility, enterprise or municipal accounting systems.
2. It is probable that well over ninety-five percent of accounting entries, for any kind of
business, are represented by the fourteen cash-flows and twenty-eight other book
entries represented on the chart. Thus, forty-two entries cover virtually all transaction
types.
3. Each class of account has been given a separate symbol. In the “Keys to Symbols”
box, those on the left represent “personal” accounts (debtors and creditors). Those on
the right represent “real” accounts (cash, stocks of goods / materials and fixed assets)
and “nominal” accounts (gains and losses - income and expenditures). Furthermore,
the symbols with straight sides (squares and triangles) represent resources (assets and
liabilities), whilst the circles represent the analysis of results (gains and losses).
4. Each line represents a class of business transaction or a generally recognized
accounting adjustment. Where a line touches the left-hand side of an accounting
symbol, it represents a debit entry to that class of account. Conversely, a line touching
the right-hand side represents a credit. Solid lines represent cash flows and broken
lines represent accounting entries not directly related to cash transactions.
78
Accounting Chart
5. The arrows on the lines are somewhat arbitrary. However, they attempt to
show the direction in which each transaction is normally understood to
flow. The entries are conceptual, not legal. For example, the transfer of
extra-ordinary losses (and fixed asset revaluations) direct to “Capital and
Reserves” is regarded as bad accounting practice in many systems but is
acceptable in others. In this chart, they have been shown as direct
transfers to “Capital and Reserves,” merely for simplicity.
6. The chart indicates that an accounting system, whilst complex, is
bounded and closed. For accountants, it may assist in systems and
computer work. For non-accountants, it may be useful in understanding
what accountants are doing (or supposed to be doing) and may also help
to develop an appreciation of what can and should be expected from an
accounting system. For students of accounting, the chart may represent a
useful learning tool, to be used in conjunction with other teaching
materials.
7. The chart covers most accounting procedures likely to be encountered. It
includes, moreover, the two main entries concerned with the conversion
of historical cost accounts to current values. This is still a matter of
uncertainty and contention among accountants and is not practiced in all
systems. However, unless recognized, especially where high rates of
inflation exist, fixed asset (and other non-monetary asset) values, based
only on historical costs, become increasingly meaningless. Furthermore,
depreciation (and other capital charges) based of these historic values will
cause the under-statement of costs and a corresponding over-statement of
profits.
79
Cash Flows
1.
2.
3.
4.
5.
6.
7.
Cash Purchases - Stock (Inventories)
Cash Sales or Revenue Income
Cash Settlement - Creditors (Payables)
Cash Settlement - Debtors (Receivables)
Dividends or Share (Stock) Repayment
New Share Capital
Payment from Funds
8. Investment Withdrawal
9. Cash Expenses
10. Investment of Cash in Monetary Instruments
11. Loan Repayments
12. Loans Raised
13. Capital Expenditure
14. Sales - Fixed Assets
80
Accounting Flows
1. Use of Stocks (Inventories)
2. Sales Income
3. Expenses (Trading, Operations, Manufacturing)
4. Revenue (Recurrent) Income
5. Credit Purchases
6. Cash Discount Received
7. Gross Profit (Trading, Operations, Manufacturing)
8. (Sales & Operational) Income Recoverable
9. Taxes Now Payable
10. Expenses (Profit and Loss or Income and Expenditure)
11. Net Loss or Net Expenditure
12. Net Earnings or Net Income
13. Allocated or Declared Dividends
14. Transfers to Reserves
15. Capital Repayable
16. Surplus on Investments (Credited as Income)
17. Future Income or Corporation Tax (Provision)
18. Extra-ordinary Losses
19. Expenses Paid in Advance
20. Surplus on Investments (Credited as Capital)
21. Bad Debts or Discounts Allowed
22. Transfer of Expenses1
23. Accrued Expenses
24. Transfers to Special Funds/Provision for Expenses
25. Investment Losses
26. Depreciation (Commercial or Enterprise Accounts) & Capital Discharged
- by Loans Repaid, Revenue Contributions to Capital or Special Funds
Applied (Municipal - Public Sector - Accounts)
27. Revaluation of Fixed Assets
28. Revaluation of Accumulated Depreciation
____________________________________________________________________
1
There are a great variety of expenses but all are accounted for in the same way: an
appropriate “expense” account is debited and either “cash” or “payables” is credited.
Transfers, for final accounts, will depend upon types of expenditure.
Accounting
“Although I...with all modern economists, owe an
enormous debt to Keynes' brilliance of insight and
imaginative sweep, his system shows a number of
weaknesses that have not been corrected by his
followers.
“One of these weaknesses is a general failure to
distinguish between two very different processes in
economic life, the exchange or payments process, on
the one hand, by which existing assets, including
money, are circulated among various owners, and the
processes of production, consumption, income and
outgo on the other, by which assets are created,
destroyed and accumulated”.
[A (1950) text "A Reconstruction of Economics," by Kenneth Boulding (1910-1993)]
81
82
Economics and Accounting
"The usual marginal analysis treats the firm as
if it had nothing but an income account; it has
no balance sheet, no capital problems and no
dynamics;...Consequently, the economist has
been able to give only fragmentary accounts
of inventory changes, investment structures,
liquidity positions and like problems."
[A (1950) text "A Reconstruction of Economics," by Kenneth Boulding (1910-1993)]
83
POSITIVE [Δ&] AND NEGATIVE [] RESOURCES
[ASSETS AND LIABILITIES]
 = (POSITIVE RESOURCES) = MANUFACTURED PRODUCTS [THE
PRODUCTS OF YESTERYEAR – THE MANUFACTURING INDUSTRY]
PRODUCTION OF EQUIPMENT GOODS AND SERVICES IS – ALWAYS AND
EVERYWHERE – FOR ACTUAL USE: IN CONSUMPTION OR IN PHYSICAL
AND PRODUCTIVE INVESTMENT: IT IS A POSITIVE-SUM GAME!
CREATED = ADDED VALUE
 = (NEGATIVE RESOURCES) = DEBT [THE PRODUCT OF OUR TIMES –
THE DEBT INDUSTRY!!]
A MONETARY INVESTMENT (ASSET) IS – ALWAYS AND EVERYWHERE –
ANOTHER’S DEBT (LIABILITY): IT IS A ZERO-SUM GAME!
CREATED = MONEY: “THE ROOT OF ALL EVIL”
[PRINTING MONEY!]
[PRINTING MONEY!]
• The bank has, quite literally, in both the commercial and the economic senses,
"printed money." IF the result of this is an increase of commercial activity, because
the money attracts new goods and services into the market place, there will be
reasonable economic stability.
• Suppose, for example, that it is Christmas – and that: manufacturers make
many more: “toys” (computers, gadgets and devices) than at other times of the
year; brewers brew more “ale”; people travel to their families; and, entertainers
perform many more activities. Prices would be less likely to rise.
• However, now suppose the market-place is in the doldrums. No one is buying,
selling or entertaining - perhaps because of a fear of attack from (say) terrorists
(e.g. debt collecting agencies!). Then, more money would be chasing the same
quantity of goods and services as before, forcing up prices and causing inflation.
• Alternatively, the economy could be booming, with virtually no idle resources
ready to be coaxed into activity. Again, there would be additional money with
nothing extra to spend it on, another inflationary situation.
[“Managing Masonia’s Money”: David C. Jones, George Mason University, USA]
84
85
[INFLATION – WITH “PRINTED” MONEY!]
• “In God – [NOT Gold]– we trust” (US Dollar bill)
•“Render to Caesar the things that are Caesar's, and to God the
things that are God's”. [Bible: Mark 12:17]
• “Friends, Romans, countrymen, lend me your ears: I come to
bury Caesar, not to praise him.
• “The evil that men do lives after them; The good is oft interred
with their bones………
• “Whose ransoms did the general coffers fill?………
• “And men have lost their reason! Bear with me ……… And I
must pause till it come back to me.
William Shakespeare (1564 – 1616) [British economist]
A MONETARY INVESTMENT – & DEBT – TRANSFER
[Δ&] IS A ZERO-SUM GAME?
WELL! NOT EXACTLY!
MONETARY INVESTMENT TRANSFER IS A NEGATIVE SUM GAME
• TRANSACTION COSTS ARE INCURRED
• TRANSFER AGENTS ARE INVOLVED
• FEES ARE PAID TO TRANSFER AGENTS
• TRANSACTION COSTS ARE DERIVED FROM THE INVESTMENTS
(OR ARE PAYABLE BY TRANSFERORS OR RECIPIENTS OF THE
INVESTMENTS)
• INVESTMENT VALUES ARE AFFECTED BY MARKET PRICES –
BASED ON EXPECTATIONS OF FUTURE INCOMES OR LOSSES
• THUS: CHANGES IN VALUES OF INSTRUMENTS ARE BORNE BY –
OR EARNED BY – INVESTMENT TRANSFERORS OR RECIPIENTS
86
“Robinson Crusoe” Economics – Main Street
• On Robinson Crusoe’s Island, there has just been a very
heavy three-day rainstorm. During the storm, a tree-branch
fell and severely injured Robinson Crusoe’s arm. So, he
cannot catch any fish.
• The fish supply was exhausted during the storm, so that
Robinson Crusoe lends the fishing rod to Man Friday. Man
Friday has a peak load problem, for he has to catch fish: to
feed himself and Crusoe; to replace the depleted supplies;
and; to establish bigger reserves, in case of another storm.
• Crusoe is disabled. He cannot work. Also, he has no fish to
trade, for the work of Friday, in catching more fish, for
consumption and storage. No market transactions are
possible, unless Friday grants Crusoe credit! Or pays rent for
the fishing-rod! Friday must work overtime and also make a
gift, of his labor and of fish, to keep Crusoe alive, and in
recovery. And provides health-care! [A “welfare” situation!]
87
“Robinson Crusoe” Economics – Main Street
• Because he cannot work, Robinson Crusoe’s credit status is
that of a sub-prime borrower. He can only get a “NINJA”
loan [No Income, No Job or Assets]
• Moreover, according to “Adam Smith” Economics:
“It is not from the benevolence of the butcher, the
brewer, the baker or the fisherman (Man Friday) that
Crusoe expects his dinner, but from Friday’s regard
to his (Friday’s) own interest....[Excuse ME?]
• According to the “Tragic of the Market-place,” therefore,
there will be NO credit for Crusoe and NO welfare for him
• Robinson Crusoe will, therefore, quickly die, of his sickness
and of starvation.
• There will, now, be more resources for Friday – BUT less of a
work-force to help him to exploit, to harvest and to use
them. Moreover, Friday will have no companionship, no
help and be lonely [Negative Economic Externalities!]
88
“Robinson Crusoe” Economics – The Rent-seeker
• Ponder Robinson Crusoe’s fishing rod. It is the only real capital
that exists on the island and it is absolutely necessary – but also
sufficient – to catch fish, which is the only available food.
• How did Robinson Crusoe come by the fishing rod? He: made it
from the materials, from the island and the wreckage; had it
bequeathed to him by his father; found it floating in the sea, very
close to the beach; bought it, for cash, aboard the ship, before his
shipwreck; rents it from Mr. Warren or Mr. Buffett; whatever!
• It does not matter how he got it. R.C. owns (controls, has a
monopoly of) the only capital on the island. He can rent it out to
Friday and (eventually) to his friends and relations, so that they
can catch the fish, for eating, storage and to pay R.C. for the rent.
• The well-fed R.C. lives a life of leisure, earning all that he needs
from his capital. This will continue, only if there is a rule of law!
• If Friday no longer accepts the capitalist system then, in “The
October Revolution” he, together with his friends and relations
will overpower R.C. and make him catch fish. The rent is cancelled!
89
90
The “Folk Theorem” or “Folk Fable” of the
“Free Market” Economics of Adam Smith
Adam Smith also wrote (implying major and fundametal
aspects of market inefficiency and failure, through the
tendency towards monopoly):
“People of the same trade seldom meet together, even for
merriment and diversion, but the conversation ends in a
conspiracy to raise prices” and
“....to widen the market and to narrow the competition, is always
the interest of the dealers.....an order of men, whose interest is
never exactly the same with that of the public, and who
accordingly have, upon many occasions, both deceived and
oppressed it.”
91
“Robinson Crusoe” Biblical Economic Capitalism
• Before the “October Revolution” Robinson Crusoe owns the
only fishing rod. He also employs Friday and (eventually) his
friends and relations, as his staff, to catch the fish.
• By this method – capitalism – R.C. prevents his death, from
starvation.
• Thus, in a conversation with Friday, he says:
“Yea, though I walk through the valley of the shadow
of death, I will fear no evil: for thou art with me; my
rod and my staff, they comfort me.”
[Psalm 23 – KJV]
92
“The October Revolution”
“I’m as mad as Hell and I’m not going to take
this any more” [Man Friday and Friends]
93
Biblical Economic Capitalism
Psalmist’s Prophecy
Application
Thou shalt prepare a table before Table of toxic derivatives &
me
bad debts
Against them that trouble me
Sub-prime mortgages [and
the accounting profession –
re “fair value accounting!”]
Thou annointest my head with oil
And my cup shall be full
But thy loving-kindness and
mercy shall follow me all the days
of my life
Traders in oil futures
Corporate chief executives
Recipients of corporate
redundancy and retirement
packages.
[Psalm 23 – KJV]
94
“Robinson Crusoe” Economics – Wall Street!
• Meanwhile, five thousand miles away, in a place
called Wall Street, over a cup of coffee, the island
and the fishing rod are sold for $1,000,000, by “Mr.
Warren” to “Mr. Buffett”. $50,000 is taken by Mr.
Goldman, as commission, for arranging the sale!
• Mr. “Goldman” puts the $50,000 into one of his
“Sachs” where he keeps his money. This all results
from managing other people’s money!
• There is NO new capital; NO productive activity; yet
money is made! [A zero – or negative – sum game!]
• Who cares? [but…Half the media news is about this!
“Today, the DOW went up, down, whatever..!]”
“Phantom” Economics – Wall Street!
•
•
•
•
•
•
•
Did the vendor have good title to the island?
Were the title documents destroyed by the 9/11 attack?
Does anyone know – or care – where the island is?
Does the island really exist?
Who's Buried in Grants Tomb?
Is there any gold in Fort Knox?
If there is, does anyone know how much is there and who it
belongs to?
• Does it make any real difference to anything, in an era of fiat
money?
• Does any of it make any real difference – or is it just a great big
game?
[“Life's but a walking shadow, a poor player that struts and
frets his hour upon the stage and then is heard no more: it is a
tale told by an idiot, full of sound and fury, signifying nothing.“]
William Shakespeare (1564 – 1616) [British economist]
95
“Phantom” Finance – Wall Street!
• The former chairman of the Nasdaq stock market has been
arrested and charged with securities fraud, in what may be one
of the biggest fraud cases yet. [BBC News: 12 December, 2008]
• Bernard Madoff ran a hedge fund which ran up $50bn (£33.5bn) of
fraudulent losses and which he called "one big lie", prosecutors
allege.
• He said he was "finished", that he had "absolutely nothing" and
that "it's all just one big lie", and that it was "basically, a giant
Ponzi scheme“. Mr Madoff is alleged to have used money from new
investors to pay off existing investors in the fund.
[(“A Ponzi scheme is)…but a walking shadow, a poor player
that struts and frets his hour upon the stage and then is heard
no more: it is a tale told by an idiot, full of sound and fury,
signifying nothing.“]
William Shakespeare (1564 – 1616) [British economist]
96
97
“Phantom” Finance – Wall Street!
• Bernard Madoff didn't accept money from just anyone. Clients
ideally had to have at least $10 million to open an account with his
New York investment firm.
• While such wealthy people don't turn up just anywhere, the Palm
Beach Country Club provided enough to make Madoff's
membership in the predominantly Jewish club worthwhile.
• On Friday, many of those who had considered themselves lucky to
invest their millions with the part-time Palm Beacher were calling
their accountants, their brokers and each other, wondering whether
they had lost it all.
• But, according to federal investigators, that's exactly what
happened: Madoff had made off with their money! [$50billion!]
98
FIDDLING – WITH CASH – WHILST
ROME – REAL ASSETS – BURNS!
A “Folk Theorem” or “Folk Fable”
“The Private Sector (in capitals, out of “Due Reverence”)
knows better than the government how to produce goods and
services that the public “needs.” So ”cut taxes and reduce
government spending!” (Common political “anti-tax” rhetoric)
“Folk Fable” Mitigation
• Marginal expenditure, by the US public (already literate and
well-fed) on goods produced by the private sector, is largely on
amenities (i.e. STUFF!). These comprise: living space; cars;
boats; plasma TVs; restaurant meals; health-care; alcohol;
recreation; etc.
• Necessary public services, engendered by this private
spending, especially for:
• extra: road-space, water and sewer utilities; other public
services; fossil fuels; and, perhaps, most critically:
• disposal and renewal of: household and commercial trash;
obsolete equipment; wastewater; and, medical wastes
cannot, safely and efficiently, be provided – by the public sector
– because it is (seriously) deprived of necessary tax revenues!
99
100
The (Former) Colonial Version of Trade
The colonial powers – notably Britain; Netherlands; France;
Portugal; Spain. – traded trinkets with, e.g. Indians; Chinese;
Africans; Native Americans, in exchange for (real) gold, silver,
spices and other items of wealth.
The (Modern) Reverse-Colonial Version
of Trade
The former colonial, colonized and other, powers – notably
USA; Canada; Australasia; Western Europe; and, Japan. –
buy trinkets and toys (including economy cars; computers;
electronics; etc., from e.g. The: Indian sub-continentals;
Chinese; Koreans; Malaysians; and, many others, in
exchange for (valuable) Foreign Exchange Reserves
101
The Former (Hollywood) Version
of Bank Robbery
“Hand over the money – or we’ll shoot!”
[Bank Robbers – armed with guns]
________________
The Modern (Woolly-head) Version
of Bank Grabbery
“Hands out for our money – or we’ll shout!”
[U.S. Treasury Department – armed with tons (of money)]
102
U.S. Treasury – Handing Out Bail-out Money
• Community banking executives around the country responded with
anger yesterday to the Bush administration's strategy of investing $250
billion in financial firms, saying they don't need the money, resent the
intrusion and feel it's unfair to rescue companies from their own
mistakes....And in offices around the country, bankers simmered.
• Peter Fitzgerald, chairman of Chain Bridge Bank in McLean, said he
was "much chagrined that we will be punished for behaving prudently
by now having to face reckless competitors who all of a sudden are
subsidized by the federal government.“
• At Evergreen Federal Bank in Grants Pass, Ore., chief executive
Brady Adams said he has more than 2,000 loans outstanding and only
three borrowers behind on payments. "We don't need a bailout, and if
other banks had run their banks like we ran our bank, they wouldn't
have needed a bailout, either," Adams said.
[© The Washington Post]
Fiscal Management in the USA:
A Taxing Responsibility
BILL MOYERS: "Time" magazine this week says that while no one is
looking, Congress and the IRS have been quietly changing the tax
code to lower corporate taxes for years to come. Are they
receiving bailout money through the front door while they're getting
tax breaks and other privileges through the backdoor?
EMMA COLEMAN JORDAN: That's a change which was done at the
Department of Treasury without statutory authorization to do it.
BILL MOYERS: They did it arbitrarily?
EMMA COLEMAN JORDAN: They did it on their own, with no
consultation with Congress to get permission for this change,
since it was absolutely antithetical to the statutory requirement. And
I've looked at the comments of tax specialists. I'm not a tax specialist.
But the tax specialists say this is unheard of and clearly in
violation of the statute which protects the Treasury by not allowing
banks that acquire failing banks to get the benefit of the losses of the
failed bank and carry those losses over for the benefit of the
acquiring bank.
[© Bill Moyers’ Journal – PBS-TV: 12 December, 2008]
103
Fiscal Management in the USA: A Taxing Responsibility
• This is contrary to the Bill [Declaration] of Rights, enacted by the
British Parliament in1689, forming a foundation of the US
Constitution. It gave to England “The rights of Englishmen”, avidly
sought after by the American colonists in the Revolutionary War.
•The Declaration, emanating from the “Glorious Revolution” of 1688,
was signed by William and Mary – after whom were named
Virginia’s “College of William and Mary,” as well as “Williamsburg”,
as a condition of replacing King James II (earlier overthrown) as the
joint monarchs of the United Kingdom. It was enacted by Parliament.
• The Declaration states that: “…the pretended power of suspending
the laws or the execution of laws by regal (i.e. executive) authority,
without consent of Parliament, is illegal.”
• And, “…that levying money for or to the use of the Crown (i.e.,
the executive) by pretence of prerogative, without grant of
Parliament, for longer time, or in other manner than the same is
or shall be granted, is illegal.”
104
105
BALANCE SHEETS
A MONETARY
INVESTMENT
(ASSET)
 PP&E c CAP
 C&I
Δ INV LOAN
 PPE c CAP
 C&I
Δ INV LOAN
GLOSSARY
CAP = EQUITY CAPITAL
PP&E = PROPERTY, PLANT &
EQUIPMENT
C&I = CASH & INVENTORY
INV = MONETARY INVESTMENT
LOAN = LONG-TERM LOANS &
SIMILAR
IS ANOTHER’S
DEBT
(LIABILITY):
 PPE c CAP
 C&I
Δ INV LOAN
 PPE c CAP
 C&I
Δ INV LOAN
106
CONSOLIDATED BALANCE SHEETS
 PP&E CAP
 C&I
Δ INV LOAN
c
PRODUCTIVE
ASSETS
ADD TO
CAPITAL
GLOSSARY
CAP = EQUITY CAPITAL
PP&E = PROPERTY, PLANT & EQUIPMENT
C&I = CASH & INVENTORY
INV = MONETARY INVESTMENT (CANCELLED AGAINST LOANS)
LOAN = LONG-TERM LOANS & SIMILAR (CANCELLED AGAINST INVESTMENTS)
107
PROFIT & LOSS ACCOUNTS
PRODUCTIVE
ASSETS
ONE’S OWN
INTEREST
PAYABLE IS
 PP&E
 C&E
c INT-
C
INC
c
INT+
GLOSSARY
CAP = EQUITY CAPITAL
PP&E = PROPERTY, PLANT &
EQUIPMENT
C&I = CASH & INVENTORY
INT- = INTEREST PAYABLE
INT+ = INTEREST RECEIVABLE
 PP&E
 C&E
c INT-
C
c
INC
GENERATE
REAL INCOME
INT+
ANOTHER’S
INTEREST
RECEIVABLE
 PP&E
 C&E
c INT PP&E
 C&E
c INT-
C
INC
c
INT+
C
INC
c
INT+
CONSOLIDATED
PROFIT & LOSS ACCOUNTS
 PPE
INC
 C&I
Δ INT - INT +
c
PRODUCTIVE
ASSETS
GENERATE
REAL INCOME
CAP = EQUITY CAPITAL
PPE = PROPERTY, PLANT & EQUIPMENT
C&I = CASH & INVENTORY
INT - = INTEREST PAYABLE (CANCELLED AGAINST INTEREST RECEIVABLE)
INT + = INTEREST RECEIVABLE (CANCELLED AGAINST INTEREST PAYABLE)
108
NET GLOBAL POSITIONING SYSTEM
“PRODUCTIVE”
ASSETS
GOODS FOR
USE/EXPORT &
CONSUMPTION
DOMESTIC &
FOREIGN
CONSUMPTION
 PPE
 C&I
*
CONS*
Δ INVEST
 LOANS
 (LOANS)
109
FOREIGN
INVESTMENT
FOREIGN
BORROWING
NET FOREIGN
DEBT
PPE = PROPERTY, PLANT & EQUIPMENT (PRODUCING FOR LOCAL OR EXPORT)*
[* IF OWNED BY FOREIGN RESIDENTS, THIS WILL GAIN FOREIGN
CURRENCY, IN EXCHANGE FOR LOSS OF OWNERSHIP AND/OR CONTROL]
C&I = CASH & INVENTORY (FOR DOMESTIC USE, TO BUY FOREIGN EXCHANGE,
OR FOR DEBT SERVICE (DOMESTIC OR FOREIGN)
INVEST = FOREIGN DIRECT INVESTMENT IN NON-DOMESTIC ASSETS
LOANS = LOANS FROM FOREIGN SOURCES (PRIVATE AND PUBLIC SECTORS)
(LOANS) = NET FOREIGN DEBT POSITION OF THE DOMESTIC ECONOMY: [( ) = < 0]
CONS = FINAL (DOMESTIC) CONSUMPTION OF GOODS AND SERVICES
[CONS* = ONLY CONSUMPTION BY FOREIGN RESIDENTS CAN BE USED TO BUY
FOREIGN EXCHANGE, [OR] FOR DEBT SERVICE ON FOREIGN DEBT]
110
DO THE MATH!
VALUATIONS AT HISTORICAL COST
(Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ) –
[MONETARY INVESTMENTS (ASSETS)]
(+++++++++) = 0
[LONG-TERM DEBT – AND SIMILAR (LIABILITIES)]
DO THE MATH!
VALUATIONS AT “FAIR VALUE”
IMPAIRED (TOXIC)
INVESTMENTS
(Δ +Δ+ Δ+ Δ+ Δ+ Δ+ Δ+ Δ+ Δ+ Δ) –
[MONETARY INVESTMENTS (ASSETS)]
IMPAIRED (TOXIC)
(DEBT)
(++ + ++ + + + +  ) = 0
[LONG-TERM DEBT – AND SIMILAR (LIABILITIES)]
111
DO THE MATH!
VALUATIONS, AT HISTORICAL COST – OR FAIR VALUE
(BUT)
TOO MANY LOANS – CREATING TOO LARGE A TOTAL
(Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+
Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ+Δ) –
[MONETARY INVESTMENTS (ASSETS)]
(++++++++++
+++++++++) = 0
[LONG-TERM DEBT – AND SIMILAR (LIABILITIES)]
112
113
LAW OF DIMINISHING RETURNS
B
FINANCIAL,
ECONOMIC
& SOCIAL
BENEFITS
THE LOAN PORTFOLIO IS
TOO LARGE TO BE VIABLE!
IT IS “OUT OF CONTROL.”
ABSOLUTE
BENEFITS FALLING
GRADUALLY
DECELERATING BENEFITS
STEEPLY ACCELERATING
BENEFITS
GRADUALLY
ACCELERATING BENEFITS
0
VALUE OF LOAN PORTFOLIO
V
114
THE NATIONAL LOAN PORTFOLIOS
• Bear Stearns
• Fannie Mae
• Freddie Mac
• Lehman Brothers
• Northern Rock
• (More?)
• Royal Bank of Scotland
• Washington Mutual
• Citigroup
• Indy Mac
• Goldman Sachs
• (More?)
THE LOAN PORTFOLIOS ARE
TOO LARGE TO BE VIABLE!
THEY ARE “OUT OF CONTROL.”
GREED MUTATED INTO FEAR!
115
“LAW” OF DIMINISHING CAPITAL COVERAGE
B
RATIO OF
CAPITAL TO
(MONETARY)
ASSETS:
LOANS
HANGING IN
BY A THREAD!
MONETARY
ASSETS:
LOANS MADE

CAPITAL &
RESERVES
0
VALUES OF LOAN PORTFOLIOS
V
[Credible Capital Management]
All this may seem arcane to some readers. Yet the ratio of a
bank’s capital to its assets, technical though it sounds, is of
more than merely academic interest…
If US banks have lost significantly more than the $255 billion to
which they have so far admitted [early 2008] as a result of the
subprime mortgage crisis and credit crunch, there is a real
danger that a much larger – perhaps tenfold larger – contraction
in credit may be necessary, to shrink the banks’ balance sheets
in proportion to the decline of their capital. [emphasis added]
If the shadow banking system of securitized debt and offbalance-sheet institutions is to be swept away completely by
this crisis, the contraction could be still more severe.
“The Ascent of Money”: Niall Ferguson
[© Niall Ferguson – 2008]
116
117
OVERLOADED & UNSAFE TO OPERATE!
[WHERE WERE THE (“CAPITAL”) POLICE?]
118
Excess Leverage – The Wrong Track
119
Who was Monitoring the Signals?
120
IMF warns of 'disturbing' UK debt
The level of debt in the UK is "disturbing," the head of
the International Monetary Fund has said.
But Dominique Strauss-Kahn told the BBC that given the
severity of the economic downturn, more government
borrowing was the lesser of two evils.
He said 2009 would be "a really bad year" and more state
spending was necessary to stimulate growth.
[BBC News: 21 December, 2008]
David C. Jones Warns US Congress
of ‘Disturbing' Washington DC Debt
Emergency Long-term Borrowing by the District of Columbia
It is certainly not a standard municipal finance practice to permit
long term borrowing, merely to cover a general accumulated
budgetary deficit. Thus, the situation in which the D.C. government
finds itself, measured against normal [municipal] financing
principles, is about the worst that could possibly be imagined…
…although the proposal to issue long term debt instruments
technically violates all normal principles of [municipal] finance,
it is one that should - in this special instance - be given serious
consideration, because all the other choices are likely worse.
That is really its only redeeming feature.
All seem to acknowledge…that the most that can be done, at
present, is to "make the best of a bad job.“
[Testimony of David C. Jones to the U.S. House of Representatives - July25, 1991]
121
The Balance of Accounting
CREDIT
DEBIT
RESOURCES
Resources
must
always equal
Results
DEBIT
CREDIT
RESULTS
122
123
The Balance of Accounting
RESOURCES (WHAT IS OWNED AND IS OWED)
• Capital Expenditure on Land, Buildings, Infrastructure, Plant and
Equipment.
• Provision of Working Capital (Cash and Credit).
• Funding of Capital Expenditure and Working Capital from Loans
(Financial Capital Investment).
RESULTS (HOW & WHY OVERALL RESOURCES CHANGE)
• Funding of Capital Expenditure and Working Capital from Equity
(Financial Capital Investment).
•Profits and Losses (or Income and Expenditure) from
Productive Employment of Capital Resources – in Current
Business Operations or Public Sector Activities.
• Lack of (or Lower than) Expected Business Operations or Public
Sector Activities – Engenders Losses, from Under-utilization
of Capital in Currently Productive Activities.
The Balance of Accounting
INCOMPETENCE OR FRAUD:
CONFUSING CAPITAL AND CURRENT ACTIVITIES
• IMF/IBRD and Other International Entities [& Private Investors]:
Misreading the “Asian Miracle” and the Subsequent Currency Crash!
• WorldCom:
Deliberately Mis-accounting for Current Expenditures as Capital
Expenditures – resulting in Massive Fraud and Bankruptcy!
• Many State and Local Governments (Worldwide) – including the State of
California and Washington DC:
Raising Long-term Debt to Cover Operating Expenditures or
Current Budgetary Deficits! and,
Raising Long-term Debt to Cover Deferred Maintenance of
Deteriorated Buildings, Infrastructure, Machinery and Vehicles!
124
125
Under-utilized Capital
(e.g. Building Capacity)
BUILDINGS
UNOCCUPIED
AND/OR NO
PRODUCTIVE USE
(REMAINDER)
VERSUS
OCCUPIED AND/OR
PRODUCTIVE USE
(ONLY A PART - OR
NONE)
LAND AND INFRASTRUCTURE
LEVELS OF FINANCIAL CONCERN
INSTITUTION
PROJECTS
(DISRUPTIVE)
GOING CONCERN
(STEADY STATE)
ESSENTIAL
CONCERNS
FINANCIAL
REQUIREMENTS
POTENTIALS
FOR DISRUPTION
SURVIVAL
ADEQUATE
CASH-FLOW
CAPITAL COST
& DEBT SERVICE
SUSTAINABILITY
PROFITABILITY
NEW OPERATING
COST & INTEREST
EXPANSION &
DEVELOPMENT
CAPITAL
STRUCTURE
NEW DEBT OR
EQUITY FINANCE
OVERALL
ACHIEVEMENT
126
127
Resources and Results
• The concepts of “Resources” and “Results,” when applied
to overall accounting principles, were originally devised,
for teaching and illustrative purposes, by David C. Jones.
[Emanating from the work of J.B.Woodham]. For
example, in his definitive textbook “Municipal
Accounting for Developing Countries,” the following
appears (p2):
• “An accountant records and interprets variations in
financial position. He records, in money values, the
results of variations during any period of time, at the end
of which he can balance Net Results (of past operations)
against Net Resources (available for future operations)”.
128
Resources and Results
• These theories, expounded by the author, are grounded in principles
enunciated by (inter alia) eminent British writer and (government)
district auditor, Carson Roberts and from a US book, 'Accounting
principles and practice', by Hatfield, Sanders and Burton.
• They have also been interpreted by a former president of the
Chartered Institute of Public Finance and Accountancy, Mr.
J.B.Woodham, Borough Treasurer, and later Chief Executive, of
Middlesborough and of Cleveland County, England.
• Woodham referred to “Resources” as “What” accounts (what one
owns and what one owes) and “Results” as “How” accounts (how
the changes in resources came about). The concepts fit very neatly
with those relating to (on the one hand) balance sheets and (on the
other hand) income and expenditure accounts.
• International Accounting and Reporting Standards are fully
consistent with these theories.
• [Indeed, they are the only ones that make any sense!]
129
International Accounting and Reporting Standards are
fully consistent with these theories.
[Indeed, they are the only ones that make any sense!]
IN THE “PLAIN ENGLISH” OF
ACCOUNTING
• If you are a credit to your organization – you are
NOT an asset; you are a liability! [liabilities are
shown as credits in the accounts!]
• If you credit money to your bank account, it is NOT
a credit; it is a debit, in your accounts.
• BUT – if your bank sends you a statement, THEN it
IS a credit; because to the bank, YOU are a liability!
Excuse Me?
[The BANKS are NO CREDIT to anyone!]
130
Bank Balance Sheet as at 31 December, 2008
Assets
Liabilities and Capital
[On the Left,
There is Nothing Left!]
[On the Right,
There is Nothing Right!]
“Impact of the credit crunch on the 2008 financial statements:
18 November 2008”
By Willeke Ong en Jens Osinga [©PricewaterhouseCoopers]
What do I know about it?
I am just an old book-keeper!
131
“Woodham’s Principles”
“What” Accounts – Assets and Liabilities
In accounts dealing with assets and liabilities, all assets are recorded as
debits, and all liabilities as credits. It follows from this that:
(a) increases in assets are debits;
(b) decreases in assets are credits;
(c) increases in liabilities are credits; and
(d) decreases in liabilities are debits.
“How” Accounts – Gains and Losses
In accounts dealing with gains and losses, all gains are recorded as credits
and all losses as debits. It therefore follows that:
(a) increases in gains or surpluses are credits;
(b) decreases in gains or surpluses are debits;
(c) increases in losses or deficiencies are debits; and
(d) decreases in losses or deficiencies are credits.
©“Municipal Accounting for Developing Countries” [David C. Jones]
Use of Economic Resources (Figure 13f)
RESOURCE ALLOCATION
(& RESOURCE CONSERVATION)
RESOURCE MOBILIZATION
CAPITAL CONTRIBUTIONS
ASSET SALES
LONG-TERM DEBT
TEMPORARY DEBT
SUPPLIERS (CREDIT)
LAND
PERMANENT WORKS
BUILDINGS
EQUIPMENT & MACHINERY
MONETARY INVESTMENT
THE COMMON WEALTH
INVENTORIES
WORK IN PROGRESS
CUSTOMERS (CREDIT)
CASH
NATURAL RESOURCES
RESOURCE UTILIZATION
PRODUCTION
DISTRIBUTION
OPERATION
MAINTENANCE
ADMINISTRATION
TAXES
DEPRECIATION
INTEREST
DIVIDEND
RETAINED EARNINGS
PROPERTY DISPOSAL
RESOURCE ACTIVATION
STIMULATION
INFORMATION
RAW MATERIALS
SERVICES
ENERGY
LABOR
CUSTOMERS & CLIENTS
HUMAN CAPITAL*
MANAGEMENT
(ENTERPRISE)*
* CREATIVE, INNOVATIVE
(RIGHT-BRAIN) TALENT
RESULTS
WASTE, DAMAGE
& DESTRUCTION
CONSUMPTION
(SATISFACTION)
RETURN &
REINVESTMENT
COMMERCIAL,
SOCIAL &
ECOLOGICAL
COMMERCIAL,
SOCIAL &
ECOLOGICAL
COMMERCIAL,
SOCIAL &
ECOLOGICAL
132
Resource Consumption v. Results
RESULTS OF ACTIVITY (USE OF RESOURCES)
WASTE, DAMAGE
& DESTRUCTION
CONSUMPTION
(SATISFACTION)
RETURN &
REINVESTMENT
COMMERCIAL,
SOCIAL &
ECOLOGICAL
COMMERCIAL,
SOCIAL &
ECOLOGICAL
COMMERCIAL,
SOCIAL &
ECOLOGICAL
ECOLOGICAL
IMPORTANT SUCCESS CRITERIA AND PRINCIPAL FOCUS OF ATTENTION
PERFORMING USEFUL & HIGH-QUALITY
ACTIVITIES AT APPROPRIATE PLACES AND TIMES
MAXIMIZATION OF
PROFIT
LONG-TERM OPTIMIZATION OF RESOURCE USE
(PRODUCTIVITY & WASTE CONTROL)
DEBT SERVICE
QUALITY OF ENVIRONMENT
WASTE
DISPOSAL
INNOVATION - CONSUMER SATISFACTION ,
REINVESTMENT & PRODUCT DEVELOPMENT
DAMAGE
RECTIFICATION
PRODUCT &
SERVICE QUALITY
PAYMENT
OF TAXES
OPERATIONAL & FINANCIAL
RELIABILITY
QUALITY OF
LABOR LIFE
QUALITY OF
SOCIAL LIFE
133
134
“Cost” Cutting
by
Wolfgang Amadeus Mozart
(“W.A.M.” Principles)
• WIZE
• ACCOUNTABLE
• MANAGEMENT
“Cost” Cutting by Wolfgang Amadeus Mozart
(“W.A.M.” Principles)
Conversation
Emperor of Austria to Mozart: Methinks your symphony is a trifle
too long, young sir! There are too many notes!
Mozart: Indeed your Majesty, and precisely which notes would
you have me remove?
[“Amadeus”-Movie]
“Remove those that
are soiled!”
(Like Toxic
Derivatives)
“But – they are all
mixed up together!”
(Like Toxic & Other
Derivatives)
Conclusion
It really is not about size or length, is it? It is, I think, about
depth. Depth of perception, depth of appreciation, depth of
acknowledgement of the sheer vastness of what we do not
“know” - yet - but would: (a) “love or like” to know; (b) don’t know
and don’t care; or (c) know very well and don’t care!!
135
Cost v Quality of Service
RESULTS OF ACTIVITY – A SYMPHONY OF OUTCOMES
♫
WASTE, DAMAGE
& DESTRUCTION
♫
COMMERCIAL,
SOCIAL &
ECOLOGICAL
CONSUMPTION
(SATISFACTION)
♫
♯ ♫♪♫
136
COMMERCIAL,
SOCIAL &
ECOLOGICAL
♯ ♫♪♫
RETURN &
REINVESTMENT
COMMERCIAL,
SOCIAL &
ECOLOGICAL
(“W.A.M.” PRINCIPLES): IMPORTANT NOTES - SUCCESS CRITERIA AND PRINCIPAL FOCUS OF ATTENTION
TO CUT “COSTS”: WHICH OF THESE NOTES WOULD YOU LIKE US TO REMOVE, OR DIMINISH – MR. MAYOR?
DEBT SERVICE
INNOVATION - CONSUMER SATISFACTION ,
REINVESTMENT & PRODUCT DEVELOPMENT
QUALITY OF
SOCIAL LIFE
♫
♫
♫
♫
♫
♫
♫
QUALITY OF
LABOR LIFE
PAYMENT
OF TAXES
♫
♫
PRODUCT &
SERVICE QUALITY
♫
♫
QUALITY OF ENVIRONMENT
♫ ♫ ♫ ♫
♫
♫ ♫ ♫ ♫ ♫
♫
♫
♫
♫
OPERATIONAL &
♯(SHARP)
FINANCIAL RELIABILITY
♫
DAMAGE
RECTIFICATION
MAXIMIZATION OF
PROFIT
♫
WASTE
DISPOSAL
♫
♫
♫
LONG-TERM OPTIMIZATION OF RESOURCE USE
(PRODUCTIVITY & WASTE CONTROL)
♫
♯
PERFORMING USEFUL & HIGH-QUALITY
ACTIVITIES AT APPROPRIATE PLACES AND TIMES
The Tragic of the Market-Place
• The (so-called) “market,” almost always, refers to financial or commodity
markets. It concerns, almost entirely, the secondary financial or
commodity markets, because only a minuscule proportion of this market
activity is concerned with the creation of new capital or commodities.
• Ironically, attention is focused almost entirely upon the only category of
market transactions which creates no new assets, no material production
and no public or private services. Instead, it trades only in the symbols of
real economic production, (i.e. MONEY) by the exchange of monetary
instruments of ownership (i.e.PAPER). It is a search for enrichment of those
who wager on the future values of these symbols. Because this market
creates no real resources, participants can only become rich at other
people’s expense, including (but not exclusively) other participants in the
market. This is known as the “zero-sum” model.
• Participants (in its conversion to a “negative-sum” model) include the
commission-seeking brokers, litigious lawyers, tax-gimmicky and creative
accountants, credit-rating agencies, merger manipulators, greenmailers,
bond dealers, advisers and other unproductive rent-seekers of all
kinds. All are, effectively, gamblers.
[Adapted from: “The Common Good” (Daly & Cobb)]
137
Public and Private Enterprise
The essence of “economics-in-community” is very
much to provide meaningful and satisfying work, as
it is a means to creating: adequate and quality goods
and services; decent recreation; and, quiet cultural
or spiritual reflection. Yet, the markets for goods and
services is rarely emphasized and the market for
labor is highlighted only as for a commodity, to the
extent that an increase in employment (reduction in
unemployment) of ordinary workers might threaten
the monetary values of the wealth-tokens of moneytraders! Even though the real (economic) values of
these tokens are, in effect, zero!
[Adapted from: “The Common Good” (Daly & Cobb)]
138
139
REPUTATION AS A MARKET FACTOR
P
COSTS
•
Interest rates.
•
Search costs for
capital funding.
•
•
A
(Poor reputation = High costs)
B
C
Regulation &
loan conditions.
D
Choice of Public
and/or Private
Financing or
Implementation
Entity Partners
0
E
(Good reputation
= low costs)
Quality
Reputation >
INFORMATION AS A MARKET FACTOR
100%
VALUATION
ACCURACY
(Good Information = Accurate
Valuation & Pricing)
VALUE
( Poor Information = Flawed
Valuation & Pricing)
0
Information >
Information
Quality
100%
140
The Market for Lemons
Asymmetrical Information
• George Akerlof (Nobel Laureate) describes how interaction
between quality heterogeneity and asymmetrical information can
lead to the disappearance of a market where guarantees are
indefinite. As quality is undistinguishable beforehand by the buyer,
incentives exist for the seller to pass off a low-quality good as a
higher-quality one. The buyer, however, takes this incentive into
consideration, and takes the quality of the good to be uncertain.
• Only the average quality of the good will be considered, which in
turn will have the side effect that goods that are above average in
terms of quality will be driven out of the market. This mechanism is
repeated until a no-trade equilibrium is reached.
• As a consequence, markets may fail to exist altogether in certain
situations involving quality uncertainty. Examples include the market
for used cars, the dearth of formal credit markets [in developing
countries(?) (How about the USA – 2008?)] and the unavailability
of health insurance for the elderly and disabled (that is, in the
absence of government programs, such as Medicare or Medicade).
141
Fundamental Accountability Requirements
• Compute “Omar’s Car Runs” costs
• Operation
• Maintenance
• Administration & Taxes
• Rent:
– Consumption of capital (depreciation)
– Adjustment of value (asset valuation) –
including monetary investments
– Return on investment (interest, dividends,
retained earnings)
• Surplus (to cover):
– Risk
– Uncertainty
– New Activities
– Stability
142
Omar’s Car Runs
[When it is Well-maintained]
OMAR’S CAR
143
When Omar’s Car is NOT Well-maintained
[IT IS A “LEMON!”]
?
OMAR’S CAR
WHAT PRICE WOULD YOU PAY FOR IT?
144
When Omar’s MORTAGE is NOT Well-Serviced:
[Principal and Interest NOT Paid On time and In Full]
[IT IS A “LEMON!”]
?
?
OMAR’S MORTGAGE
WHAT PRICE WOULD YOU PAY FOR IT??
145
?
?
?
A MORTAGE-BACKED SECURITY
Includes several LEMONS
[IT IS “LEMONADE!”]
?
?
OMAR’S DERIVATIVE
WHAT PRICE WOULD
YOU PAY FOR IT??
146
When Omar’s HOUSE is NOT Well-Valued:
[And May Not be Well-Maintained]
[IT IS A “LEMON!”]
OMAR’S HOUSE
WHAT PRICE WOULD YOU PAY FOR IT??
WOULD YOU ACCEPT IT AS COLLATERAL??
147
148
Collateralized Debt Obligation
149
A House of Cards
[Mortgage-backed Securities]
150
Collateralized Debt Obligation
I’ll Huff and I’ll Puff and I’ll Blow Your
House Down!” [The Big Bad Wolf]
151
A PERFECT STORM?
• Please spare us the "perfect storm" metaphor. It's
hackneyed, for starters. It doesn't square with the facts.
And for people who fancy themselves leaders, it's
downright unbecoming.
• The reason the perfect storm is such an appealing
metaphor for these shipwrecked captains of industry is
that it appears to let them off the hook. After all, who can
blame you if the ship goes down in one of those freak,
once-in-a-century storms that result when three weather
systems collide? It's an act of nature that nobody could
have predicted – or so the story goes.
[© Steven Pearlstein: The Washington Post, December 10, 2008]
152
A PERFECT STORM?
• The first thing to understand about the perfect-storm
defense is that these guys actually buy into this nonsense.
• The rest of us want desperately to believe that what
brought us this economic crisis was some combination of
greed, fraud and negligence – and, no doubt, there was
quite a bit of that.
• What the populist critique ignores, however, is that at the
heart of any economic or financial mania is an epidemic
of self-delusion that infects…many of the smartest, most
experienced and sophisticated executives and bankers.
[© Steven Pearlstein: The Washington Post, December 10, 2008]
153
A PERFECT STORM?
• It's not that they don't see the excesses and dangers in
front of them -- how could they not?
• [But] even now, they still can't figure out what they
might have done differently, given what they knew at
the time and the various pressures they were under. Or
put another way, they continue to think of themselves as
victims of a perfect storm.
[© Steven Pearlstein: The Washington Post, December 10, 2008]
154
A PERFECT STORM?
• In Junger's gripping account of a shipwreck, that
popularized the notion of the perfect storm, Billy Tyne,
the skipper of the Andrea Gail, received urgent and
repeated warnings that he was heading into what could
be a monster storm off the Grand Banks* – warnings
that Tyne and his crew chose to ignore.
[* No pun intended??]
• When it comes to self-delusion, however, Wall Street's
top bankers and financiers take the prize…Everyone
understood that housing prices and mortgage
lending were out of control. What they didn't know was
what to do about it. So they convinced themselves that
the safer strategy was to keep running with the herd.
[© Steven Pearlstein: The Washington Post, December 10, 2008]
155
A PERFECT STORM?
NO! A FAILURE OF LEADERSHIP
• The second thing to understand is that, fundamentally,
they're wrong.
• What capsized the economy was not a perfect storm but
a widespread failure of business leadership – a failure
that is only compounded when executives refuse to take
responsibility for their misjudgments and apologize…
• Until many bankers and dealmakers come clean, my
guess is that the growing anger and resentment of
ordinary Americans is likely to hamper any government
effort to deal with the crisis.
[© Steven Pearlstein: The Washington Post, December 10, 2008]
“The Perfect Storm?”
Bad “Tempest” or “Bad Temper”
[growing anger and resentment of ordinary Americans]
156
157
Conditions of Making Funds Available
[Based on an English Prayer from 1662*]
• Have [some] mercy upon [some of] those miserable
sinners
• Spare [only] those which confess their faults
• Restore [only] those that are penitent
• That they may, hereafter, live righteous, honest,
ethical and sober lives.
[OR]
Shall we continue to practice heresy?
[Ironically, the author/complier of the Prayer –
Archbishop Cranmer – was burned at the stake,
in Oxford, England, for heresy! 21 March 1556]
EPILOGUE AND OBITUARY
158
[Boris Fyodorov, a Russian economic reformer,
died on November 20, 2008, aged 50]
“Without a moral basis, he (Fyodorov) said,
capitalism would just become the means by which
the powerful would concentrate their wealth”.
“As a Russian patriot….he detested the practice of
simply adapting an English word. Ofshorky (offshore
accounts) was a pet hate, particularly because of its
association with tax evasion”.
“Mr. Fyodorov used to lament the fact that that even
he could not find the right phrase, in Russian, for
‘Corporate Governance’.”
[© The Economist: November 29th 2008]
159
EPILOGUE AND OBITUARY
Mr. Fyodorov used to lament the fact that that even
he could not find the right phrase, in Russian, for
“Corporate Governance”.
All those concerned with “Western-style” capitalism
must now, also, lament the fact that even they cannot
find the right phrase, in English, for
“Corporate Governance!”.
160
A Nobel Economics Laureate
• Questioner: Dr. Krugman, what do you intend to
do with your $1.4 million Nobel Prize money?
• Paul Krugman: It is now worth only $1.2 million,
because of the change in the US$ exchange rate.
• Anyhow, I have not, yet, decided. Right now, I
am just trying to find a safe bank, in which to
deposit the money, whilst I make up my mind!
[Paul Krugman (Nobel Laureate):
Address to the National Press Club – 19, December 2008]