Prometheus 6

There are no perfect accounting rules, and forcing banks to consolidate everything might be unreasonable. But banks should have done more to let investors know the nature of the risks that were being taken. If the accountants had forced better disclosures, it is at least possible that managements would have spent more time evaluating the risks they were taking, and then made wiser business decisions.

...they'd be unemployed. 

The rules require that companies make some disclosures about off-balance-sheet vehicles even if they do not put them on their financial statements. They should discuss factors like the nature of the risk they face and the maximum loss that is possible. But those disclosures have often not been made, or have been made in such a general way as to be meaningless.

Why Surprises Still Lurk After Enron
By FLOYD NORRIS

Should we blame the accountants?

Surprises multiplied as the subprime problem of 2007 grew into the credit disruption of 2008. It is one thing to have a bank report losses because some of the loans on its balance sheet went bad. That is part of the business of banking. It is something else, however, for a bank to report a multibillion-dollar loss from taking some risk that had never been mentioned in its financial statements.

Haven’t we seen this movie before, involving a company called Enron? Didn’t Congress pass a law requiring that the problem of off-balance-sheet mysteries be solved? 

“After Enron, with Sarbanes-Oxley, we tried legislatively to make it clear that there has to be some transparency with regard to off-balance-sheet entities,” Senator Jack Reed, Democrat of Rhode Island and chairman of the Senate securities subcommittee, said this week. “We thought that was already corrected and the rules were clear and we would not be discovering new things every day.”

Senator Reed has sent letters to the Securities and Exchange Commission, as well as to the Financial Accounting Standards Board, which sets United States accounting rules, and the International Accounting Standards Board, which does the same for most of the rest of the world, asking detailed questions about what went wrong and how it should be fixed. Getting together answers to his questions could provide the S.E.C. with a road map to determine where the rules failed, as well as where companies failed to apply the rules properly.

One rule that needs scrutiny now — called 46-R — was passed after Enron. Essentially, it says companies can keep “variable special purpose entities” off their balance sheets if they conclude that the bulk of the rewards, and risks, lie with others.

But companies are supposed to evaluate those estimates regularly, and change the accounting if the conclusions change. A risk that seemed remote last year can seem all too real now, and that explains a lot of the surprising write-offs.

Suddenly, losses are booked. Investors learn that a company has taken a risk only after the risk has gone bad.