Re:Balance -- Jim Peterson

Happy Thanksgiving -- and Thank You

A brief note to advise that until mid-December it will be quiet around here -- if nowhere else in the financial and accountancy world -- while I will be traveling, largely beyond the reach of e-mail and daily news.

Thanksgiving is a special holiday in the United States, and with the arrival of Advent as well, this is an excellent time:

     To pause in grateful reflection -- in the midst of widespread turmoil, need and strife -- on many reasons to be thankful.

    To translate a spirit of gratitude into actions by which energy, commitment and compassion can better a troubled world.

So reach out. We can bring some peace -- do some good -- share some loving -- with family, friends and communities.

My thanks for your interest and support -- I'll be back with you soon. 

Autos and Auditors -- Could the Big Four Learn from the Big Three?

I've been thinking this week of the impending fate of the large accounting firms -- after watching the CEO’s of GM, Ford and Chrysler, who slouched home empty-handed from Washington after flying in separate corporate jets to plead for rescue from the industry’s history of mismanagement and reality-avoidance.

There are plenty of similarities. Come this winter, after Barack Obama takes office amid another couple months of disruptions in the financial markets, attention is going to turn back to the perilous condition and doubtful viability of the Big Four and their franchise to audit the world’s large companies.

I’ve suggested before that in this environment nobody really cares – here – at least enough to act.

But if we could mark up the carmakers’ talking points – what might the auditors learn to re-frame their so-far unsuccessful case?

They have this in common: just as failure of one of the auto companies would quickly envelop the others, so too the collapse of another large accounting firm will unravel the remaining international networks, leaving large companies with no available source for their obligatory audit reports.

The carmakers argue the ripple effect of their impending failures: not only their own workers, but the galaxy of suppliers and dealers and peripheral blue-collar workers country-wide.  

No such argument for the auditors. Professional and support staff in their people-driven business would be dislocated by the tens of thousands, to be sure, but nobody else’s jobs are at risk. And most of the casualties would re-locate, to fill the needs of industry or to re-build the new niche firms that would emerge from the wreckage.

The Big Three also have the alternative of Chapter 11 reorganization, as familiarly done by the airlines. No similar plan is feasible for the Big Four, whose very structures would evaporate with the mobility of their highly-trained and migratory partners and staff.

Given the bankruptcy chance to do a real re-engineering, the Big Three might actually bring cars to market that would be models of technology and efficiency. Again, no such opportunity for the auditors, who under their present model are locked into obsolete reporting and assurance – the standard auditors’ report – in part through their own failure to escape the leaden hand of regulation and compliance.

Tellingly, perhaps, the carmakers’ rescue balloon deflates with the reality of excess capacity: those dinosaur companies have lost their edge to the lower cost and superior quality of their more agile foreign competitors, who can make profits by winning the battle for consumer loyalty right on US soil.

By contrast, the auditors’ clients have nowhere else to go. Failure of the Big Four audit franchise confronts a stark proposition: unlike the migration to other auto brands, with the sales and jobs and peripheral economic benefits, it would require a complete post-collapse re-tooling to replace the present but out-dated assurance model.

The auditors do have a miserable record of bringing their message of peril to the public – partly lacking the clout of a unionized labor force, but also because the public at large has difficulty developing the passion for audited financial statements that it has about the family car, truck or SUV.

Still, although seven-figure per-partner compensation may have eroded their tradition of eye-shaded modesty, the accountants are not known to travel by private jet, and look positively threadbare compared to the bankers and hedge fund managers paraded this fall through the halls of Congress.

Finally, there’s the contrasting economics of government support. Nobody really believes that $25 billion will rescue the Big Three, who would only be jetting back to Washington next spring for another re-fuelling of their empty fiscal tanks.

By contrast the auditors don’t need and aren’t asking for money. Here is their message – and it needn’t cost the public purse a single dollar:

    “As calculated – here – we just don’t have the money. To survive, we’ll have to give up public company auditing.

    “Or else, there has to be a de-coupling of our survival as firms from the threat to our existence from the PCAOB, the SEC and especially claim for shareholder protection by way of class action lawsuits.

    “This won’t be easy, and it’s definitely not the same as the “litigation reform” of liability caps previously touted. But models are available – here. And we’re prepared to do our part.”

Unlike the Big Three carmakers, who won’t live to get new models off their drawing boards that anybody wants to buy, the Big Four have re-tooling potential. It’s not about rescue money – but only the vision, cooperation and leadership needed to get there.

One last thing. When the Big Four auditors go to see their Congressmen – take the bus. 

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To Bail Out the Big Three Auto Makers? The Taxpayers Deserve the Credit

The image is another taxpayers’ nightmare, although a vision for the editorial cartoonists: a lame-duck American legislature, quacking towards Detroit with a $25 billion gift bag slung over its shoulder.

Grant the importance of an industry that sells sixteen million vehicles a year, employs a quarter of a million people and provides some four million jobs in the concentric circles of suppliers and support.

But a drip-feed of life support for the Big Three auto-makers, a trio of zombie companies who over the decades have achieved walking-dead status by impeding innovation and environmental progress, surrendering on quality to their foreign competitors and inflicting obsolete designs with voracious energy appetites? It’s too dreary to contemplate.

And how would they use the money? As attributed to the late English footballer George Best, describing the dissipation of his fortune: “I spent ninety percent of my money on strong drink, fast cars and hot women. The rest I just squandered.”

Rather than be the incinerator of last resort for government cash, the Big Three need to be out there selling cars – generating real revenue and proving (if they can) that they deserve to survive. So as my Chicago friend Fred Siegman proposes, instead of the heedless delivery of funds into the hands of the unworthy, there is a more wholesome use – oriented to relief of the US industry as a whole.

He suggests that the government extend a “purchase tax credit,” to the buyer of any new American car.

Brand and model choice would be up to the consumer. So the Big Three would have to compete with the domestically manufactured Toyotas and Hondas and the others. No matter, from a national interest perspective, because an industry job saved by sustained sales would as well be in Tennessee or Georgia, after all, as Michigan or Ohio.

There’s current precedent a-plenty. The Energy Policy Act of 2005 provided credits of up to $4000 per vehicle, but for limited new models and only up to 60,000 units per manufacturer. And the current $700 billion bail-out bill has buried in it a tax credit for the purchase of plug-in electric cars, although they won’t start to reach the market until late next year – and Chevy has to live long enough to get the Volt on the street.

Calibration of a new and broader tax credit would be required – striking a balance between cars that are smaller, thus more green and economical, or more upscale models consuming more steel, plastic, glass and rubber.

The program could also be made tax-progressive, if desirable to target car buyers by income level. The credits could be phased out for higher income buyers, for example, or could be made non-transferable for the better-off. On the other hand, with the primary motivation being to sustain industry sales, whether a buyer was making a first purchase or a tenth might not matter.

As for the size of the program? All elements here are subject to argument, of course, but suppose a target of a million vehicle units. A basic tax credit could be $5000 – plus $2500 for a hybrid or high-mileage model – plus an additional $2500 to a buyer with family income below $100,000.

Fully used, that’s $10 billion – delivered in a form that put sales onto the accounts of the car-builders, but obliging them to satisfy the tastes and demands of customers empowered to shop for themselves.

The impact on the federal budget would be mitigated by a timing factor: a buyer would earn the credit at the time of purchase, when the manufacturer would get the sales bump and the impact of the credit. But the taxpayer would receive the actual benefit as of his next tax return filing – and only then would the treasury miss the foregone tax collection.

Filling that timing gap suggests a variety of financing devices: The credit could, for example, cover a down payment. Or, since a buyer might prefer immediate cash, a secondary market in the credits might develop, since they could be factored like any other receivable, but with no collection risk as a government-issued benefit.

Speaking of which, this all would assume successful diplomatic handling of the international politics – taxpayer-led support to private industry being hardly more obnoxious under the array of trade agreements being evaded than the straight subsidy of a direct bail-out.

As a side benefit, by the way, irrespective of the implementation details, a policy favoring renewal of the national auto fleet by replacing polluting junkers with new and more efficient vehicles would appeal to the environmental side of the debate.

And unlike the form of direct support to car-makers whose ability to self-manage is open to serious doubt, a tax credit program has a multiplier potential – not only outward to the manufacturer’s’ galaxy of suppliers, but via the re-cycling of any cash a buyer might realize that did not go right to a purchase price, and also through the balance sheet support to institutions handling the secondary market for the credits.

Administration of the program would be simple and straightforward, with information coordinated among the consumers, the auto dealers, and any third-party lender or factor -- with a single form added to filings with the Internal Revenue Service.

Economists and others interested are invited to address this question: So why not?

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The Carnival of Trust: November Edition

“Credere”: verb (Latin), “to trust.” From which we have creed, and credibility. And importantly, credit. As in “credit markets” – where recent events have seen trust erode along with the bail-out, collapse or take-over of a roster of venerable institutions once believed to be fortresses of durable integrity. 

A central theme on this site as it approaches its first anniversary is the trust on which strength and reputation are based – hard won, demanding to maintain, and easily lost. Trust lies at the heart of the enterprises of trade, commerce and finance, as well as their gate-keepers – management and directors; lawyers, rating agencies and accountants – and all branches of government alike.

It’s my pleasure to host this month’s Carnival of Trust, at the kind invitation of Charlie Green, who writes on trust related matters at Trusted Advisor. The Carnival is a traveling review of the month’s best posts on aspects of trust. (For prior editions, see here.)

With my thanks to Charlie for the opportunity, and to Ian Welsh for his support, here for your consideration are ten selections, made with some difficulty from a deep and stimulating set of offerings. Please share with us and the authors your reactions and comments.

Coming just after the American presidential elections and the world’s anticipation of new approaches to governance and diplomacy, George Ambler’s compact checklist of “The behaviors that create or break trust” is a handy guide and reference with broad applicability to all those engaged in, as he titles it, the Practice of Leadership.

Here are two studies on the direct relationship of trust to the state of an economy: the Greater Good Blog, arguing for a regulatory structure that prefers trust-worthy financial institutions to the providing of bailouts and subsidies, concludes that “When trust declines, so does the economy”; while Simon Djankov, at the Doing Business Blog, introduces a paper that queries “Regulation and Trust: Substitutes?” -- examining the extent to which the level of government regulation is correlated with measures of cultural trust.

And for tight focus on a specific example, Natasa Kovacevic’s article in the Harvard International Review, “Risky Business: Microcredit in Argentina“, examines the inhibitions on trust-building in a country suffering from lack of faith in both government and lending institutions, and the techniques for success of micro-lenders seeking to serve borrowers mainly among the country’s poorest women. 

Hard pressed to think of an area that generates more jargon and blather, I rely on Lucy Kellaway at the Financial Times as an old-media source of fresh air and incisive analysis – no reference here, just a recommendation. Meanwhile John Strande at the Business Evolutionist strips out great quantities of needless verbiage by working a single anecdote into this persuasive case: “Work is Personal … Trust Matters.”

By putting a plaque on your office wall with the four concisely-stated elements of trust-building aimed by David Newman at "Small Business Marketing – The Power of Trust" -- a proposition no less applicable in enterprises of any size and scope – you could open a lot of bookshelf space and spare a lot of trees.

And yet, appreciating a classic that has stood the test of time, Richard Parkes Cordock’s recommendation of a book by Richard Lomax invokes the classic Ogilvy on Advertising in order to “train your workforce to become your salesforce” – highlighting the importance of current customers and employees in the success of business growth.

A theme to these three offerings is the scrutiny of trust-building into the future, where a key is the establishment of authority and expertise:

John Bell treats the challenge of retail banks in marketing to customers in very scary times, “How Banks Must Regain Trust (hint: Not Via Advertising)”.

Chris Wright’s blog Magic and Lies takes up “Influence and Authority in a Web 2.0 World” – an inquiry that should be dear to the heart of bloggers and other aspirants to success as internet-based enterprises.

And appropriately as a way to conclude, Ford Harding provides a provocative exchange on the value of LinkedIn to the selling of professional services – Liking LinkedIn? – opening the door on a discussion that will no doubt evolve as rapidly as tomorrow’s new modes of communication themselves.  

Thanks for joining in this dialog – and please do let us have your views.

And as a note for next month’s Carnival of Trust, Stephanie Westallen of Idealawg will be the host. Articles on trust can be submitted for consideration here.

 

Evil Accounting Spirits on the Loose -- A Scary Halloween in Germany

With the mist beginning to clear after the American elections, it’s time to observe how countries differently observe the holiday known to some as Halloween.

In the US, children canvas their neighbors for candy – a ritual seemingly designed to benefit pediatric dentists, aerobic instructors and obesity consultants.

In France, Toussaint mainly presents an excuse for a ten-day school holiday. While in Germany, the souls of the dead supposedly walk the earth on Allerheiligentag until released when the church bells chime.

This season in Germany was particularly uneasy for the departed spirits of dependable financial reporting, transparent governance and stable market regulation, with ominous implications for the elusive goal of global convergence toward good-quality reporting and compliance standards.

All Hallows Eve saw Deutsche Bank report quarterly net income of € 414 million – thanks only to the bank’s avoidance of € 845 million in asset write-downs made possible by the reclassification of € 25 billion of loans originally intended for onward sale. The change was enabled by the success of the European banks in lobbying the accounting regulators for relief from the “mark-to-market” rules for impaired loans, if permissibly treated instead as “held to maturity.” 

Doubtless a precursor to similar ghoulish accounting by equally motivated banks across Europe, the D Bank move will only be credibly testable over the collection life of the underlying loans – assuming of course that the bank itself is around that long. Investors are essentially being asked to take on considerable faith the ability of bank management to wave the wand of reclassification and stir up ultimate value out of a witches’ cauldron incapable of valuation by more rigorous standards.

Among others, Tom Selling at The Accounting Onion has inveighed against the readiness of the International Accounting Standards Board to rationalize such witchcraft. Deutsche Bank’s eager adoption in practice is a signal that the IASB's accommodationism will unloose malign spirits across the accounting landscape.

The same week saw Porsche’s trick-or-treat on the hedge funds, who were caught by the extent of its option-based creeping take-over of Volkswagen. Plunging short the ordinary shares of VW and long its preference shares, a herd of funds are said to be squeezed as much as € 20 billion by their self-inflicted need to cover with a free float of less than 6%.

Meanwhile the financial sorcery of Porsche chief Wendelin Wiedeking, by which the company made three times more last year in options trading than it did building cars, has him the highest-paid warlock in the German corporate coven.

Shed no tears for the hedge funds who walked into Porsche’s strategy. But do be concerned for the wrong-footed German regulators, who will be scrambling to plug the loopholes that permitted the stealth accumulation of control over VW by way of cash-settled options not disclosable under BaFin’s presently porous rules.

And it cannot be reputation-building for Deutsche Börse, that it reacted to the run-up in VW’s stock price, reaching fully 27% of the Dax-30 index, by making a one-time adjustment to put a 10% cap on the company’s weighting.

The very essence of a credible index – stability of constituent components and adjustments that are infrequent, predictable and transparent – is traduced by such ad hoc fiddling.

These recent events in Germany remind investors and other financial information users of an inevitability: creative and agile corporate chieftains will run ahead of their slower-witted over-seers. When regulation comes too late and standard-setting yields to pressure, it’s no surprise that the nightmares are real: creepy things lurk in dark corners, never to be reached by the disinfectant of sunshine.

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