Groundhog Day for Boom and BustUKWatch.net - 19 Apr 2008ANYONE looking at the recent Financial Services Authority report on its failures to supervise Northern Rock properly would be struck by how it neglects the systemic aspects of the current financial crisis. The informed view is that the credit crunch will result in global losses of around $1.2 trillion (600 billion). About 40 per cent of these losses ? or $480 billion ? is expected to be absorbed by banks and financial institutions in the United States. Some expect the crisis to spread to the insurance sector. Britain does not come out unscathed. Gordon Brown?s Government has barely managed to bail out Northern Rock ? the cost of which could be anything from 25 billion upwards. Huge Government credits are being made available to other banks while the Government is unable find resources to fund a decent state pension, rebuild schools and hospitals. Not only have the financial regulators failed, there are also failures of other institutions. Credit rating agencies failed to downgrade banks holding toxic loans. Company accounts are supposed to alert markets and regulators, but failed to alert anyone. Company auditors collected huge fees, but their audit reports turned out to be worthless. Consider four examples. Northern Rock received a clean bill of health from its auditors on its 2006 accounts. The auditing firm also acted as a consultant to the bank and received 700,000 for the non-audit work. The fee dependence is always likely to dull any sense of inquisitiveness. On January 25 2008, Bear Stearns, America?s fifth largest bank, received a clean bill of health from auditors on the financial statements for the year to November 30 2007. Yet Bear Stearns could not sustain its financial position and, on March 17, it was sold to JP Morgan Chase for $2 (1) a share, valuing it at 118 million. Just 16 days earlier, it was valued at 30 billion. Under pressure from major investors, the offer was raised to $10 a share. On February 27 2008, Carlyle Capital Corporation, an 11-billion hedge fund registered in Guernsey, received a clean bill of health from auditors on its financial statements for the year to December 31 2007. The accounts stated that the directors were satisfied the group has adequate resources to continue to operate as a going concern for the foreseeable future. Two weeks later, Carlyle collapsed, as it could not reach financing agreements with its key creditors. On February 27 2008, Thornburg Mortgage, America?s second-largest independent mortgage provider, published its audited accounts for the year to December 31 2007. These accounts carried a clean bill of health from auditors. Six days later, the company explained that it was renegotiating its financial position. The auditors retracted their opinion. Although some financial institutions might grab headlines, similar failures have occurred in the recent past, most notably at Equitable Life, Independent Insurance, Barings, Johnson Matthey and Bank of Credit and Commerce International ? to name just a few. The usual response after each of these is to tweak the regulatory structures, but little has changed. Above all, no questions are asked about the values embedded within the regulatory and political positions. The regulatory Humpty-Dumpty cannot be put back together by re-arranging the deckchairs. There are too many institutionalised failures. The financial regulators are part of a political structure that is available for hire to the highest bidder. Corporations and a wealthy elite fund political parties and individual politicians with the aim of keeping threatening issues off the political agenda. They also fund think-tanks and various media to ensure that an ideological climate favourable to their interests is sustained. Through revolving doors, corporate executives become regulators and regulators looking for higher financial rewards and company jobs go easy on corporate misdemeanours. The possibilities of emancipatory change are stymied and institutionalised social squalor is the inevitable result. Effective financial regulation is unlikely to be developed without a major change to the institutions of politics. The crisis has been fuelled by the poverty of political policies. Successive governments have vacated the commanding heights and instead placed excessive reliance on interest rates to steer the economy. Companies wanted cheap money and successive governments obliged. With the low cost of borrowing, companies found it easier to make profits. Cheap money discouraged savings and fuelled a borrowing binge. Combined with speculative activities and cheap money, major companies doubled their profits. Yet regulators ask no questions about the quality of corporate earnings. Governments continue to mistake growth in company profits for economic renaissance. Regulators reflect the broader political culture and are too close to business interests. Banks have been allowed to get way with booking their profits offshore, avoiding taxes, not passing interest rate cuts on to borrowers, slapping exorbitant interest charges on credit cards, imposing excessive overdraft charges and closing branches even though banks make huge profits. Yet no government has charged the regulators to protect the wider social interest. That task would require them to keep a certain distance from the regulated and develop alternative values, vocabularies and agendas. Openness would be a vital part of that drive. Thus all correspondence between the FSA and any financial institution must be publicly available. Yet there is little sign of such changes proposed in the FSA report. Successive governments have refused to create effective regulatory structures on grounds of cost. Yet they fail to recognise that the lack of regulation also results in ?costs?. Just ask anyone suffering from the consequences of the credit crunch. Now, after Northern Rock, the FSA is promising to recruit additional staff and undertake annual reviews of banks? strategy and plans. The examples of Bear Stearns, Carlyle and Thornburg show that, with a fundamental shift in the role of finance, the situation changes very quickly and an annual review is simply not timely enough to deal with any crisis. The FSA needs to eliminate accounting firms and instead create a dedicated taskforce of bank auditors or inspectors who are permanently present at banks and conduct continuous audits of business strategy, plans, liquidity, solvency, financial products and accounts. Yet politicians are not ready to take on corporate interests to promote this change. Successive governments have shied away from doing anything about excessive executive remuneration. Yet this is central to the current financial crisis. At most banks and insurance companies, executive pay is linked to published profits. That provides plenty of temptations to massage company accounts, keep liabilities off balance sheets and even show bad debts as good. Ministers have no proposals to reform the executive reward system ? for example, by linking it to broader performance benchmarks which include innovation, services to the local community and free banking for the poor. The timidity of financial regulators has encouraged banks and financial businesses to become casinos above all. People?s savings and investments entrusted to them are gambled on the likely movement of the price of oil, gas, commodities, food, interest and exchange rate movements, often without adequate public accountability. This state of affairs is promoted as ?risk management?, but has inflicted hardship on millions of people. This system has produced neither responsible management nor a vibrant economy. Yet no financial regulator has shown the inclination to tackle these habitual gamblers. Without attention to the systemic factors and failures of institutions, such financial crises will continue to recur. Prem Sikka is professor of accounting at Essex University
