The hall of shame of those deemed responsible for the subprime mess has been extended.
Until now, those mainly blamed for engendering the crisis, which could yet tip us into a global recession, have included the ratings agencies, banks and other market participants (notably Bear Stearns, Citigroup and Merrill Lynch and Morgan Stanley), financial regulators and central bankers.
However a new party has recently been added to this rogues’ gallery: the accountants.
In a recent article published on the Guardian’s Comment is Free section, Prem Sikka, professor of accounting at the University of Essex, accuses the beancounters, especially the “big four” firms — Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers — of being hugely complicit in the whole affair.
This is largely because they helped banks to disguise the true level of their assets and exposure to risk through the widespread use of creative accountancy.
The beancounters were so eager to get their hands on the scores of millions in audit and non-audit fees they can earn for auditing major banks that they turned off their ethical antenna.
How bank investors were deceived by creative accounting
Essentially they tolerated, or perhaps even promoted, accounting methodologies that permitted the banks to deceive their shareholders about the true state of their balance sheets — for example through the widespread abuse of off-balance-sheet vehicles including SIVs and conduits and by valuing structured credit according to mark-to-model fantasies .
The beancounters’ ethical lapses mean that the financial statements of many banks may be as full of holes as Tony Blair’s “dodgy dossier”. The credibility of auditors could end up in tatters
The accountancy profession would have us believe that it cleaned out the Augean stables after the scandals of Enron, WorldCom and Parmalat in 2000-03, arguing it is now taking a tougher line when auditing bank assets than it did when auditing these collapsed giants.
The suggestion is that accountants should no longer* be prepared to tolerate the “mark to make-believe” creative accounting practices that became so prevalent in the valuation of financial instruments such as collaterised debt obligations (CDOs). However Sikka suggests that, at the least, this is to shut the stable door after the horse has bolted, suggesting that captured regulators including the Financial Reporting Council rolled over backwards to tolerate this disturbing game of smoke and mirrors.
The beneficiaries of all this creative accounting include bank executive directors, such as the “invisible man” (HBOS chief executive Andy Hornby), who may have been driven to obfuscate through a desire to get their hands on large bonuses. The losers include anyone, including members of pension funds and other investors, who was duped into buying bank shares.
“The accounts of companies in the sub-prime debacle received a clean bill of health from auditors, who received millions in fees, but within a few short weeks have been exposed as fiction worthy of the Man Booker prize.”
“The sub-prime crisis has once again shown that all the watchdogs are too close to the very interests that are to be regulated and are thus unable to deliver. Will any government break this mould?”
This blog post on creative accounting was published on 4 December 2007. To read Professor Prem Sikka’s ‘Toothless Watchdogs’ column click here.
* If accountants were tolerating “mark to make-believe” accounting beforehand, why were they doing so?