If ever there was a time for questioning, this is it. How did the collapse of credit and its ensuing crisis creep up so suddenly on the most sophisticated, best informed, global financial community in history? What are its lessons? Do all the frantic short-term expedients provide real solutions? Or will they generate their own disasters, equally unforeseen? And how does the role played by financial reporting figure in the messy matrix that confronts us at the start of the second decade of the 21st century?

Those to whom we would expect to turn for answers are patently as bemused as the rest of us

Those to whom we would expect to turn for answers are patently as bemused as the rest of us. In step with our Prime Minister’s announcement, as Chancellor, that his policies would guarantee an end to the cycle of ‘boom and bust’, there are few leaders in politics, business or economics who do not regret earlier thoughtless utterances. Their seemingly wise pronouncements turned out to be no more prescient than the last words allegedly spoken by William Gladstone, ‘I’m feeling better now…’, or its contemporary equivalent on the investment scene: ‘This time, it’s different’. 

Eating their words

A rational, utterly plausible declaration that turns out to be arrogant, pseudo-technical hogwash is exemplified by this 2002 quote from Alan Greenspan, former Chairman of the US Federal Reserve:: ‘The use of a growing array of derivatives and the related application of more sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial institutions… As a result, not only do individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more stable’.

Even the seemingly unchallengeable eminence of the standard share valuation method, the ‘Capital Asset Pricing Model’, which earned Nobel laureates for its originators, was shown up as just so much theory when its principal users, the major credit-rating agencies, were found to be happily attaching AAA ratings to ephemeral derivatives that were, actually, parceled junk.

If even the sages are shown, like the emperor, to have no clothes, where is the leadership to plot an exit strategy from the current morass of government debt, rising unemployment, declining tax base and burgeoning public sector superstructure?

Maybe it is futile, so early in an election year, to seek policy indicators for a way through the mire.  But we can pray that those charged with the task will understand the futility of tax rises as a means of reducing the budget deficit. Increases in VAT, for example, simply raise the cost of living for an already beleaguered population – the only segment of the economy that cannot pass it on and hence, with whom, the proverbial ‘buck’ literally stops.

National Insurance and income tax are plainly taxes on jobs

National Insurance and income tax are plainly taxes on jobs, and to exacerbate the perilous unemployment situation by making it still more expensive to employ people is utterly perverse; a veritable death-wish. Only the committed excision of waste in a public sector now absorbing 60 per cent of national income can succeed.

Accounting amnesia

Regardless of the baseless pleadings of the apologists, the role played by financial reporting has been shown up as a major contributor to a malaise characterized by the neglect of a simple basic accounting truth: ‘Cash is king’.

This negligence allowed (no, required) bonus-hungry managements to treat unrealized market-based valuation surpluses on current assets as ‘profits’ regardless of whether those ‘markets’ had any objective existence; it prohibited provision for ‘expected’ (contrasted with ‘incurred’) losses; it encouraged set-off between good and bad assets in an amorphous portfolio; and it generated a monumental rule-book so impenetrable (to normal people) that those charged with governance were rendered stupefied and senseless.

Result? The accounting rules served to legitimize dividends and bonuses from de facto unrealized profits, eroding a capital base that was already in large part fiction.