Credit crunch humour

Here is a piece of internet humour about the credit crunch, I'd attribute it if I knew the author. For the moment credit it to 'anon'.



The Credit Crunch Explained

At last! An explanation I understand...

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she
decides to allow her loyal customers, most of whom are unemployed
alcoholics, to drink now but pay later. She keeps track of the drinks
consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of unemployed alcoholics
flood into Heidi's bar.

Taking advantage of her customers' freedom from immediate payment
constraints, Heidi increases her prices for wine and beer, the most popular
drinks. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognizes
these customer debts as valuable future assets and increases Heidi's
borrowing limit. He sees no reason for undue concern since he has the debts
of the alcoholics as collateral.

At the bank's corporate headquarters, expert bankers transform these
customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities
are then traded on markets worldwide. No one really understands what these
abbreviations mean and how the securities are guaranteed. Nevertheless, as
their prices continuously climb, the securities become top-selling items
because (insert here the name of your financial advisor) recommended them as
a good investment.

One day, although the prices are still climbing, a risk manager of the bank,
(subsequently of course fired due to his negativity), decides that the time
has come to demand payment of the debts incurred by the drinkers at Heidi's
bar. But of course they cannot pay back the debts.

Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95%. PUKEBOND performs better,
stabilizing in price after dropping by 80%.

The suppliers of Heidi's bar, having granted her generous payment-due dates,
and having invested in the securities, are faced with a new situation. Her
wine supplier claims bankruptcy, her beer supplier is taken over by a
competitor.

The bank is saved by the Government following dramatic round-the-clock
consultations by leaders from the governing political parties.

The funds required for this purpose are obtained by a tax levied on the
non-drinkers.

Some serious arguments against fair value accounting

The title link is to a very thoughtful and authoritative set of arguments against fair value accounting by a previous chair of the Federal Deposit Insurance Corporation. William Isaac argues, cogently, that the current recession is largely caused by mark-to-market, aka 'fair value', accounting and that the previous, historical cost system served us well for decades. He argues the Savings and Loan crisis of the 1980s had the potential to be much worse than the current crisis but serious harm was averted because banks were permitted to carry items at the lower of cost or economic value rather than being required to mark them to temporary unrealistic values.

My thanks to Stella Fearnley for pointing this piece out to me.

Sue the auditors

Former Chancellor Nigel Lawson and 'semi-house trained polecat' Lord Tebbit have both suggested that the auditors of failed banks might be sued by the government. If they did so the auditors would doubtless rely on the defence that they reported the fair values of the assets held by the banks. It would be an interesting case and well worth arguing in court in order to clarify the role of the auditors.

The FSA report on the current crisis is likely to make some interesting observation of the pro-cyclical nature of banks' accounting.

Sants and sinners

All right the title is a bit forced, but the link is to one of Peston's Picks on the BBC website. Peston examines a speech by Hector Sants of the Financial Services Authority where Sants says

"Markets have shown not to be rational; excesses have not been corrected by market discipline".

Peston draws the lesson that markets won't stop management making stupid decisions. He doubts that the FSA would be able to stem the tide of irrational exuberance on its own and concludes that only expert non-executive directors would be up to the job.

Jack Welch says shareholder value a 'dumb idea'. Last 28 years a mistake.

In an article in its 'Future of Capitalism' series the FT has interviewed Jack Welch the legendary ex-CEO of General Electric and the man widely regarded as the father of 'shareholder value'. He now rejects shareholder value as a strategy, calling it 'insane', but suggests shareholder value is an outcome of good strategy based on employees, customers and products.

This is yet another straw in the wind indicating the end of Anglo-Saxon capitalism as we know it, and it is to be hoped, the equating of 'liberal democracy' with the freedom to make as much money as possible.

Along with squadrons of flying pigs, look out for Francis Fukuyama explaining that history wasn't dead, merely tired and shagged out after a long squawk.

Costing: a warning for the unwary

A widely used text book, Jones's 'Accounting' says

... costing concerns (1) setting a price for a product or service so that a profit is made and (2) arriving at a correct valuation for stock. (p379)

This is seriously in error and we shouldn't be teaching it to vulnerable young minds. Using costs to set prices is a way of going bankrupt quickly. Prices need to be set at the price that will optimise profits, which is largely determined by the market. Using costs to set prices is likely either to set prices too cheap, in which case profit opportunities are lost, or too expensive, in which case volumes will be too low earn the best profit.

Valuation of stock is a relatively minor function of costing, since it is only about finding a number to attach to stock in the financial statements and should have no substantial economic consequences. The notion that there is a 'correct' value is something beginners in management accounting should be warned about. All management accounting valuations are essentially arbitrary to some degree. What is important is to know how the application of the arbitrary rules is likely to affect decision taking and distribution of wealth.

In my view, management accounting is firstly about maintenance of control within organisations. Costing is a process of accumulating costs so that someone is made responsible for keeping them under control.

The second purpose of management accounting is to provide information for taking decisions - but the people taking the decisions really ought to understand where the numbers come from so they can work out what is going on. Sadly, that is often not the case.

The third thing that management accounting does is to consolidate the position of those in power in the organisation, for good or ill. Not only are they provided with information that others don't have, but they also get to decide on resource allocation through the budgeting system. By labelling your group or department as being in deficit (for example by allocation of central overheads) the people in power get the chance to intervene, demand cuts, veto appointments and do all sorts of other damage. Again, sadly, people often believe deficits have more substance than they do. Management accountants like deficits. Deficits give them power. They get asked to write reports and join task forces looking for cost savings and all kinds of other exciting stuff. People defer to them and ask their opinion. When everyone is making a profit, accountants don't have much to contribute. Their role is not to comment on strategy and they don't know about marketing or product development issues so they tend to be ignored or reduced to number-crunchers.