Financial Crisis1

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The financial crisis - in pictures. Created by David C. Jones, Chartered Public Finance Accountant and Chartered Certified Accountant (UK)

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Financial Crisis1

  1. 1. The International Financial Crisis The Fall – 2008 The slides – into recession! [How long will it last?]
  2. 2. Accountability A well regulated community or business entity, being necessary to the security of a free society, the right of the people to keep informed and to be armed with bare facts, shall not be infringed. US Constitution, Second Amendment [Amended]
  3. 3. The Life of a Turkey TIME SUSTAINING ACTIVITY Thanksgiving Day FORMULA FEED
  4. 4. The Life of a Financial Market Place TIME SUSTAINING ACTIVITY T FORMULA for GROWTH & PROFIT A BLACK SWAN! CORPORATIONS HOUSES MORTGAGES BONDS STOCKS INVESTMENTS DERIVATIVES (CDOs, CDSs & CMOs) BANKERS’ FEES COMMISSIONS PROFITS If things cannot go on for ever, they will eventually and inevitably STOP! [Herbert Stein – Chairman, President Reagan’s Council of Economic Advisors and Professor of Economics at the University of Virginia]
  5. 5. The Life of the Financial Market Place – A Black Swan! An event or occurrence that  deviates beyond what is normally expected of a situation and that would be extremely difficult to predict .  This term was popularized by Nassim Nicholas Taleb, a finance professor and former Wall Street trader.
  6. 6. The Corporate Crisis [A Massive Shift of Financial Power] <ul><li>In [John Kenneth Galbraith’s] New Industrial State , published in an age of low interest rates and easy credit for large corporations (1967), the bank was considered secondary to the large corporation. In my father’s judgment, the bank was too remote from the details of corporate operations to control them effectively </li></ul><ul><li>The high interest rates of the 1980s changed all that. Suddenly, after being secondary for decades, the cost of funds became a predominant consideration for enterprise survival </li></ul><ul><li>Monetarism thus made the industrial firm dependent, once again, on its source of finance.. In this way, it reestablished the preeminent power of financial institutions…Wall Street was back in charge. </li></ul><ul><li>The result…was the rise of “short-termism”. Financial targets were set and had to be met, whatever the implications for the long-term viability of the enterprise. A company that failed to do so could be punished by a declining stock price and, ultimately, the discipline of a hostile takeover, followed by aggressive disruption of the technostructure. </li></ul><ul><li>Who could survive? </li></ul><ul><li>[The Predator State: James K. Galbraith] </li></ul>
  7. 7. Crown Water Company [High Interest Rates & Increasing Debt/Equity Ratio] <ul><li>Decision-making power over the management of the assets of </li></ul><ul><li>the Crown Water Company (Community Assets) will gradually </li></ul><ul><li>shift from the Community's Managers (its Municipal </li></ul><ul><li>Government, other Ownership Board or Private Shareholders) </li></ul><ul><li>to Financial Investors. </li></ul><ul><li>[Credit-rating Entities may also be Involved] </li></ul><ul><li>To protect their investments, the Financial Investors will </li></ul><ul><li>likely insist on loan conditionality or on increasing control </li></ul><ul><li>over the Enterprise. </li></ul><ul><li>Such conditionality or management </li></ul><ul><li>control will almost certainly be designed to engender more </li></ul><ul><li>adequate internal generation of funds, especially by higher </li></ul><ul><li>consumer charges and/or improved operational productivity. </li></ul><ul><li>[The Crown Water Company: David C. Jones] </li></ul>
  8. 8. The computer room at King's College Cambridge, is named after Alan Turing, a student there in 1931 and a Fellow in 1935 Computers – fathered by Turing - are now ubiquitous, notably in accounting, finance and investment .
  9. 9. Mapping the Future [County of Cambridgeshire UK.] [What has This to do With Anything?] Alan Turing , father of computers, went to King’s College, Cambridge, England
  10. 10. The International Financial Crisis The Fall - 2008 Newmarket Six Mile Bottom Cambridge
  11. 11. The Crash @ Six Mile Bottom - 1954!! Type: English Electric Canberra B.2 Operator: RAF 231 OCU Registration: WD981 C/n / msn: 71051 Fatalities: Fatalities: 3 / Occupants: 3 Airplane damage: Written off (damaged beyond repair) Location: .5 mile W of Six Mile Bottom, Newmarket , Cambridgeshire, England
  12. 12. After The Crash: We shall need a New Market! <ul><li>There are reasons to believe that credit from taxpayers can’t and won’t be repaid for many years , in that this credit is financing the correction of huge financial and trading imbalances between the western and eastern economies. </li></ul><ul><li>We’ve witnessed a semi-permanent nationalization of the banking system and will soon see significant taxpayer support for real companies in the real economy. </li></ul><ul><li>Thus, our banks and private-sector companies will have to work much harder to sustain the goodwill of those who are keeping them alive: millions and millions of taxpayers. </li></ul><ul><li>Robert Peston, 8 December 2008 [BBC NEWS] </li></ul>
  13. 13. After The Crash: We shall need a New Market! <ul><li>The biggest lesson of all is that we are a million miles from having created the political and regulatory institutions to help us contain the risks of globalization. We and most of the world may well have been beneficiaries of the open global economy. But as millions lose their jobs in Europe and the US in the coming year, the benefits will be forgotten. </li></ul><ul><li>That means that those running our biggest commercial businesses will have to be more visible . They’ll have to manifest a genuine understanding not only of the anxieties of their employees but of all taxpayers. Those chief executives who succeed will be those who imbue in their businesses very simple, commonsense standards of decency . </li></ul><ul><li>Robert Peston, 8 December 2008 [BBC NEWS] </li></ul>
  14. 14. After The Crash: We shall need a New Market! <ul><li>They’ll almost certainly be paid less for doing more , because the pricking of the debt bubble has undermined the institutions – the private-equity firms, hedge funds and investment banks – that were ratcheting up the pay of all business leaders. </li></ul><ul><li>If the unfettered movement of capital, goods and services is going to survive, if there’s not going to be a retreat into national fortresses that could impoverish all of us over the longer term, we’ll have to find a far better way of monitoring global risks and of bringing governments together to deal with these risks. </li></ul><ul><li>Robert Peston, 8 December 2008 [BBC NEWS] </li></ul>
  15. 15. After The Crash: We shall need a New Market! <ul><li>Some may see this as a threat to national sovereignty, as the thin end of an anti-democratic wedge that’ll see the world ruled by unaccountable bureaucrats. Reconciling our political traditions with the imperative of making safe the globalised world will be a challenge , to put it mildly. But it’s not a challenge we can shirk. </li></ul><ul><li>Robert Peston, 8 December 2008 [BBC NEWS] </li></ul>
  16. 16. The International Financial Crisis Telling “Slides!” – 2008 From The Washington Post [Next 10 slides are © The Washington Post]
  17. 17. THE FALLING DARKNESS © The Washington Post From The Washington Post [Next 7 slides are © The Washington Post]
  18. 18. THE FALLING DARKNESS © The Washington Post
  19. 19. THE FALLING DARKNESS © The Washington Post
  20. 20. THE FALLING DARKNESS © The Washington Post
  21. 21. THE FALLING DARKNESS © The Washington Post
  22. 22. THE FALLING DARKNESS © The Washington Post
  23. 23. THE FALLING DARKNESS © The Washington Post
  24. 24. THE FALLING DARKNESS
  25. 25. THE FALLING DARKNESS © The Washington Post
  26. 26. © The Washington Post
  27. 27. Marketplace Myths (1) Government is, always and everywhere: wasteful, spendthrift, incompetent, inefficient, uneconomical and ineffective Business is, always and everywhere: ethical, frugal, thrifty, competent, efficient, economical and effective Private enterprise can, always and everywhere, operate more efficiently and effectively than a public enterprise. Excuse Me?
  28. 28. Marketplace Myths (2) The commercial market-place can, always and everywhere: allocate resources more efficiently than governments . There is no market failure. Always and everywhere, there is only governmental interference, together with policy and regulatory failure. [Even Federal Reserve ex-Chairman, Alan Greenspan does not believe this any more!]
  29. 29. &quot;Adam Smith&quot; Economics or &quot;Adam's Myth&quot; Economics? <ul><li>US President George W. Bush has admitted (2008) that the financial system needs reforming, but insists that the credit crunch was not a failure of the free-market system. </li></ul><ul><li>Question: What the hell WAS it the failure of, then? </li></ul><ul><li>Excuse me? </li></ul>
  30. 30. &quot;Adam Smith&quot; Economics or Neo-comics? Enron, WorldCom, etc. Madoff The US Economy The Global Economy <ul><li>Never Under-estimate: </li></ul><ul><li>Stupidity; </li></ul><ul><li>Obtuseness; </li></ul><ul><li>Unwillingness to Rock the Boat. </li></ul><ul><li>[Paul Krugman (Nobel Economics Laureate): </li></ul><ul><li>Address to the National Press Club – 19, December 2008] </li></ul>
  31. 31. Efficiency & Ethics The pseudo-science of economics and the myth of unconstrained economic efficiency. Economics – like tanks and banks – does not care whom it helps and whom it hurts!
  32. 32. Efficiency & Ethics The military tank is a marvel of science and technology. Like the “science” of economics, it very efficiently ( but indiscriminately ) controls, supports, kills, wounds, destroys & damages.
  33. 33. Hungary: Soviet Military Intervention - 1956 <ul><li>To suppress a demonstration that was reaching an ever greater and unprecedented scale, by 2 a.m. on 24 October, under orders of the Soviet defense minister, Soviet tanks entered Budapest. </li></ul><ul><li>“ The Soviet tanks have gone. Western banks have now replaced them! Is market capitalism any better, for we ordinary people , than communism?” </li></ul><ul><li>[A Hungarian worker: PBS News, 16 December, 2008] </li></ul>
  34. 34. Hungary: IMF Financial Intervention - 2008 <ul><li>Hungarian stocks and the currency soared on Wednesday, after the country secured more than $25 billion in backing from global institutions led by the International Monetary Fund. </li></ul><ul><li>The financial sector hit the skids when credit began drying up over the summer. Roughly 30 percent of Hungary's public debt and 60 percent of loans to businesses and individuals are in foreign currencies, making the country extremely vulnerable to a sinking  domestic currency. </li></ul><ul><li>Many home mortgages, for example, were denominated in Swiss francs, as borrowers sought lower rates than they could get at home. </li></ul><ul><li>That raised a danger that house payments would soar if the currency tanked , a danger that was realized as the local currency plummeted, losing 22 percent against the euro from mid-July to mid-October. </li></ul>
  35. 35. Weapons of Violence: Tanks or Banks? “ Violence is not just about bombing or shooting or hitting people. Violence is any way we have of violating the integrity of the other . Racism and sexism are violence. Derogatory labeling of any sort constitutes violence. Rendering other people invisible or irrelevant is an act of violence. So is manipulating people towards our ends as if they were objects that existed only to serve our purposes .” © Parker Palmer: Repossessing Virtue – Economic Crisis, Morality and Virtue
  36. 36. Economic Efficiency: Tanks or Banks? “ [The man of system] seems to imagine that he can arrange the different numbers of a great society with as much ease as the hand arranges the different pieces of a chess-board; he does not consider that the pieces of a chess-board have no other principle of motion besides that which the hand impresses on them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own , different from that which the legislature might seem to impress on it.” [Adam Smith: The Theory of Moral Sentiments]  
  37. 37. “ Marxist&quot; Economics or “Capitalist&quot; Economics? <ul><li>“ From each according to his ability , to each according to his need .” </li></ul><ul><li>or </li></ul><ul><li>“ From each, according to vulnerability , to each according to his greed .” </li></ul>
  38. 38. The Predatory Bank <ul><li>This [Banking] House shall be called a House of Preyers; and we have made it a Den of Thieves </li></ul>
  39. 39. Cut-throat Competition “ We worshiped in the temple of cut-throat competition, and so some cooked the books, because the treasure is so great .” [Archbishop Tutu]
  40. 40. Davos Finds no Answers to Crisis [The World Economic Forum] <ul><li>One top money market manager said: &quot;If you believe that the world economy will turn the corner at the end of this year, or in [the first quarter] of 2010, I tell you we have not turned the corner, we can't see the corner, we don't even know where the corner is.&quot; </li></ul><ul><li>          </li></ul><ul><li>Another participant summed up the state of the discussion as &quot;we don't know what to do, only that we need to do something and we need to do it fast&quot;. With the old certainties of the free market gone, even free marketeers accept the need for more regulation, quick. </li></ul>
  41. 41. Alan Greenspan and Adam Smith &quot;I made a mistake,&quot; Greenspan said, &quot;in presuming that the self-interests of organizations , specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” [a.k.a. “I refute Adam Smith!”] [* Lying to Congress is a felony] “ It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.... “ ....He intends only his own gain , and he is in this as in many other cases, led by an invisible hand* to promote an end which was no part of his intention . Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” [Adam Smith “Wealth of Nations”] US Senate Banking Committee*
  42. 42. Actually, Alan Greenspan Missed the Point! Adam Smith Knew Better! Read it again, this time with different emphasis: “ It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.... “ ....He intends only his own gain, and he is in this as in many other cases , led by an invisible hand* to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” [Adam Smith “Wealth of Nations”]
  43. 43. Actually, Adam Smith Knew Better! “… as in many other cases…”: BUT – NOT in ALL of them! . “… Nor is it always the worse for society…”: BUT – sometimes – it IS! “… he frequently promotes…”: BUT – sometimes – he does NOT! “… than when he really intends to promote it…” BUT – not, always, when he really does NOT so intend! [Adam Smith “Wealth of Nations”]
  44. 44. The Standard Neoclassical Economic Model “ I argue that the first fundamental theorem of welfare economics - asserting the efficiency of competitive markets - is fundamentally flawed . Quite contrary to that theorem, competitive economies are almost never efficient...” Joseph E. Stiglitz - Whither Socialism (2001 Nobel Laureate in Economics) Extracted from: “ Adam’s Myth Economics” A Slide Show, by David C. Jones
  45. 45. THE CRASH: What Went Wrong - Frenzy When the housing market began to tank in 2005, Wall Street ran through the yellow light of caution and created even riskier investments – and Washington had no mechanism for finding out what was going on. [© Washington Post: 16 December, 2008]
  46. 46. What Went Wrong? <ul><li>Economic theory had long explained why unfettered markets were not self-correcting, why regulation was needed, why there was an important role for government to play in the economy. But many, especially people working in the financial markets, pushed a type of “market fundamentalism.” </li></ul><ul><li>The misguided policies that resulted – pushed by, among others, some members of US President Barack Obama’s economic team – had earlier inflicted enormous costs on developing countries. </li></ul><ul><li>The moment of enlightenment came only when those policies also began inflicting costs on the US and other advanced industrial countries. [Joseph E. Stiglitz] </li></ul>
  47. 47. Regulation of Derivatives (1a) <ul><li>The President's Working Group on Financial Markets brought together, in 1998: </li></ul><ul><ul><li>Federal Reserve Chairman Alan Greenspan ; </li></ul></ul><ul><ul><li>Treasury Secretary Robert E. Rubin ; and, </li></ul></ul><ul><ul><li>Securities and Exchange Commission Chairman Arthur Levitt Jr. </li></ul></ul><ul><li>All were Wall Street legends, all opponents to varying degrees of tighter regulation of the financial system that had earned them wealth and power. </li></ul><ul><li>Their adversary, was Brooksley E. Born, head of the “Commodities Futures Trading Commission” (CFTC) . </li></ul><ul><li>Greenspan, Rubin and Levitt had reacted with alarm at Born's persistent interest in derivatives, so called because they derive their value from something else, such as bonds or currency rates. </li></ul>
  48. 48. Regulation of Derivatives (1b) Many newer derivatives weren't traded on an exchange, constituting what some traders call the &quot;dark markets.&quot; There were now millions of such private contracts, involving many of Wall Street's top firms. But there was no clearinghouse holding collateral, to settle a deal gone bad, no transparent records of who was trading what. Born wanted to shine a light into the dark.…she now wanted to open a formal discussion about whether to regulate them -- and if so, how. Greenspan, Rubin and Levitt were determined to derail her effort . At a meeting, in April, 1998, the trio's message was clear: “ Back off, Born!”
  49. 49. Regulation of Derivatives (1c) <ul><li>The stalemate persisted. Then, in September 1998, a crisis arose that gave credence to Born's concerns. </li></ul><ul><li>Long Term Capital Management, a huge hedge fund heavily weighted in derivatives , told the Fed that it could not cover $4 billion in losses, threatening the fortunes of everyone, from tycoons to pension funds. The Federal Reserve was TERRIFIED! </li></ul><ul><li>Two days later, Born warned the House Banking committee: </li></ul><ul><ul><li>&quot;This episode should serve as a wake-up call about the unknown risks that the derivatives market may pose to </li></ul></ul><ul><ul><li>the U.S. economy and to financial stability around the </li></ul></ul><ul><ul><li>world.&quot; She spoke of an &quot;immediate and pressing need to address whether there are unacceptable regulatory gaps.&quot; </li></ul></ul>
  50. 50. Regulation of Derivatives (1d) <ul><li>The near collapse of Long Term Capital Management didn't change anything! The battle left Born politically isolated. </li></ul><ul><li>In April 1999, the President's Working Group issued a report that raised some alarm over excess leverage and the unknown risks of the derivative market , but called for only one legislative change </li></ul><ul><li>A recommendation was that brokerages' unregulated affiliates be required to assess and report their financial risk to the government. </li></ul><ul><li>Greenspan dissented on that recommendation. </li></ul><ul><li>By May, Born had had enough. </li></ul><ul><li>In 2000, Greenspan and Rubin's successor at the Treasury, Larry Summers, still held sway on keeping the CFTC out of the swaps market. </li></ul>
  51. 51. The near collapse of Long Term Capital Management The Federal Reserve was TERRIFIED! Question : As a result, how much was done, by regulation or investigation, to prevent a recurrence? Answer : On a scale of 1 to 10 - Nothing!
  52. 52. Regulation of Derivatives (2) <ul><li>The crisis has prompted second thoughts. </li></ul><ul><li>Goldschmid, the former SEC commissioner and the agency's general counsel under Levitt, looks back at the long history of missed opportunities and sighs: &quot; In hindsight, there's no question that we would have been better off if we had been regulating derivatives -- and had a clearinghouse for it.“ </li></ul><ul><li>Levitt, too, thinks about might-have-beens. &quot;In fairness, while Summers and Rubin and I certainly gave in to this, we were not in the same camp as the Fed,&quot; he said. </li></ul><ul><li>&quot;The Fed was really adamantly opposed to any form of regulation whatsoever . I guess if I had to do it over again, I certainly would have pushed for some way to give greater transparency to products which turned out to be injurious to our markets.&quot; </li></ul>
  53. 53. Accountability Investors in and Sellers of Mortgage-backed Securities (Derivatives): “ We were intending to use Arthur Andersen to help us to prepare our financial statements. “ But, after “Waste Management Incorporated” and “Enron,” Andersen went out of business!”
  54. 54. Accountability Investors in and Sellers of Mortgage-backed Securities (Derivatives): “ We used three “reputable” (??) credit-rating agencies, to value our investments”: “ Sub -Standard and Very- Poor”; “ Very Moody ” and “Fi l ch Ratings ”
  55. 55. Accountability – Credit Rating Agencies <ul><li>The G-20 Financial Crisis meeting last weekend committed to exercising strong oversight of credit rating agencies . </li></ul><ul><li>Many of the financial instruments that are at the heart of the financial crisis had been given AAA ratings, meaning they were supposed to be of the highest quality. That turned out to be wrong . </li></ul><ul><li>[National Public Radio 21 November, 2008] </li></ul>
  56. 56. Accountability – Credit Rating Agencies [Perverse Incentives - A Metaphor from School] <ul><li>I need good grades, to: </li></ul><ul><ul><li>Please my parents; and </li></ul></ul><ul><ul><li>Get into a “good” university </li></ul></ul><ul><ul><li>SO </li></ul></ul><ul><li>I pay my school-teachers – money – to give me good grades. </li></ul><ul><li>He/she makes a good profit out of grading for money. </li></ul><ul><li>QUESTION? </li></ul><ul><li>What’s the essential difference? </li></ul>
  57. 57. Accountability – Credit Rating Agencies ANSWER? Not very much, apparently! As part of a new set of rules adopted today, the Securities and Exchange Commission will prohibit credit rating agencies from helping to structure the same financial products they rate. Raters become the first industry to be handed new regulations as a result of the credit crisis. [CFO Magazine – CFO.com – 4 Dec. 2008]
  58. 58. Accountability – Credit Rating Agencies ANSWER? Not very much, apparently <ul><li>The regulator — which was given formal oversight of the rating agencies two years ago — will also require the raters to keep better records of their rating processes and third-party complaints, as well as make them decline gifts of more than $25 from securities issuers. </li></ul><ul><li>The changes are designed to mend a credibility-tainted industry by reducing the firms' conflicts of interests and making them more accountable for their evaluations. </li></ul>
  59. 59. Emergency Economic Stabilization Act (2008) [ Bailout of the U.S. financial system] <ul><li>Why not give some of the (October 2008) “Bail-out” money to the credit rating agencies? </li></ul><ul><li>In exchange, they could then reassure the US taxpayers that the $10-11-? trillion dollars of US Sovereign Federal Debt will continue to be rated as AAA!! </li></ul>QUESTION?
  60. 60. The Market for Lemons (Asymmetrical Information) <ul><li>George Akerlof (Nobel Laureate) describes how interaction between perception of indefinite quality and lack of information can lead to the disappearance of a market. </li></ul><ul><li>As a consequence, markets may fail – or find it very difficult – to exist altogether in certain situations involving quality uncertainty. Examples include markets for: used cars; start-ups of speculative ventures and overly-complex monetary investment instruments. </li></ul>
  61. 61. Accountability <ul><li>Investors in and Sellers of Mortgage-backed Securities (Derivatives): </li></ul><ul><li>We have used a model of “Fool disclosure” accounting; </li></ul><ul><li>“ Fool disclosure” accounting has been applied to financial statements and supporting information of: investors, mortgage-backed securities, other derivatives, loan originators, banks and other financial institutions; </li></ul><ul><li>&quot;Fool me once, Shame on you; Fool me twice, Shame on me.&quot; </li></ul><ul><li>[Chinese Proverb] . </li></ul>
  62. 62. TRANSPARENCY <ul><li>Transparency of activities is reflected in (but is not limited to) information disclosed in financial statements </li></ul><ul><li>This information must, moreover, address a great variety of inputs </li></ul><ul><li>One structured methodology for this can be in the form of the following “pseudo-equation.” </li></ul>S = f (P 4 Q + P 3 Q + P 2 Q + PQ + P) Where: “S” represents a degree of total satisfaction and symbols “P” and “Q” designate inputs, necessary to achieve this satisfaction
  63. 63. TRANSPARENCY <ul><li>One may object that the earlier equation is not “real,” following logical and mathematical principles. Does this criticism refer to its “form” or to its “substance?” </li></ul><ul><li>Mathematical symbols are merely shorthand for some basic truths, which, when fully written out in text, appear more complex and take up more space. </li></ul><ul><li>This equation, therefore, is at least as valid, for this purpose, as many used by (say) economists, for their own purposes. Form might be valid – but substance is often very weak! [“Life's but a walking shadow, a poor player that struts and frets his hour upon the stage and then is heard no more: it is a tale told by an idiot, full of sound and fury, signifying nothing.&quot; Macbeth (Act V, Scene V).] </li></ul>
  64. 64. INTERNAL & EXTERNAL CONTROLS Price of Inputs Purpose Quantity of Inputs Questioning Capacity Pay Inputs Expenditure Permission Prestige Quality of inputs Productivity Probity Publicity Procedures Questing Intensity Power Production Characteristics of Activity
  65. 65. ECONOMIC COMPUTATIONS <ul><li>While [economist] Walrus’s ideas were novel, what was truly revolutionary was his use of sophisticated mathematics borrowed from physics …..Walrus’s willingness to make trade-offs in realism for the sake of mathematical predictability would set a pattern followed by economists over the next century. [“The Origin of Wealth”, Eric D. Beinhocker]. </li></ul><ul><li>“ The only function of economic forecasting is to make astrology look respectable….We must always remember that economists make forecasts not because they know, but because they are asked to.” [John Kenneth Galbraith] </li></ul>
  66. 66. FULL DISCLOSURE ACCOUNTABILITY <ul><li>Potential Investors in the “Amazon.com” Search for its Initial Capitalization: </li></ul><ul><li>The more information they learned, about electronic book selling, the less likely they wanted to invest in it! </li></ul><ul><li>[Jeff Bezos – Amazon.com Founder and CEO (C-SPAN)]. </li></ul><ul><li>Potential Investors in Mortgage-backed Securities (Derivatives): </li></ul><ul><li>The more information they learned, about these instruments, the less likely they wanted to invest in them! </li></ul><ul><li>[An analogy to Bezos – borne out of the facts!]. </li></ul>
  67. 67. “ The financial statements have been prepared in accordance with standards for “Financial Reporting and Accounting for Un-priceble Derivatives” (FRAUD). “Therefore, using “Creatively Regulated Accounting Practices” (CRAP) we hereby certify that these financial statements represent a true and fair view of the state of affairs of the company, as at the date of the balance sheet and of the activities for the year then ended. Arthur Underhand and Company Certified Public Accountants (Retired) Accountability [Model Financial Reporting Statement]
  68. 68. … viewing the financial world from an evolutionary perspective argues for weeding out what the political scientist Joseph Schumpeter called &quot;the hopelessly unadapted&quot; -- and quickly… …&quot;The experience [ of Japan in the 1990s ],&quot; Ferguson comments, &quot;stands as a warning to legislators and regulators that an entire banking sector can become a kind of economic dead hand if institutions are propped up, despite underperformance, and bad debts are not written off . &quot; [emphasis added] Shelby Coffey III: Review of “The Ascent of Money”: Niall Ferguson © Washington Post (Book World) Nov. 30, 2008. Accountability [Credible Financial Reporting]
  69. 69. Responsible and Accountable Activities <ul><li>Commentators, policy-makers, evaluators and critics have invariably approached (almost) every issue by: </li></ul><ul><ul><ul><li>establishing a preconditioned and prejudiced posture; </li></ul></ul></ul><ul><ul><ul><li>seeking and using evidence that supports this posture, whilst ignoring any evidence that does not; and then, </li></ul></ul></ul><ul><ul><ul><li>taking – or recommending – action, without ever considering the total and overall economic, financial, fiscal and social consequences! </li></ul></ul></ul><ul><li>This can be referred to as the KNEE-JERK response: </li></ul><ul><ul><ul><li>the [K] NEEDs are large, urgent and important; yet, </li></ul></ul></ul><ul><ul><ul><li>we are often satisfied to rely upon JERKS to deal with them! </li></ul></ul></ul>
  70. 70. Accountability “ Fair Value Accounting is causing a large part of the problem at this moment…” Steve Bartlett, President and CEO Financial Services Roundtable Testimony to: U.S. House of Representatives Financial Services Committee 18 November, 2008
  71. 71. Fair Value Accounting David C. Jones, CPFA, FCCA, had heard this statement, when listening to his car radio. He was so astonished that he nearly crashed into a tree! (Not believing his ears, he later needed to verify it from the C-SPAN web-site, which carried the hearing of the US House of Representatives Financial Services Committee!)
  72. 72. Regulator Let IndyMac Bank Falsify Report [Agency Didn't Enforce Its Rules, Inquiry Finds] <ul><li>A senior federal banking regulator approved a plan by IndyMac Bank to exaggerate its financial health in a May federal filing, allowing the California company to avoid regulatory restrictions only two months before it collapsed, a federal inquiry has found. </li></ul><ul><li>The same regulatory agency, the Office of Thrift Supervision (OTS), allowed similar legerdemain by other banks , according to a letter sent yesterday to members of Congress by the Treasury Department's inspector general. </li></ul><ul><li>OTS on several occasions &quot;blessed a fiction,” …in the collapse this year of several of the nation's largest thrifts, including Washington Mutual and Countrywide Financial . </li></ul><ul><li>The Washington Post reported, last month, that OTS allowed thrifts to lend massively while reserves against future losses dwindled … </li></ul>
  73. 73. Regulator Let IndyMac Bank Falsify Report <ul><li>IndyMac's initial filing, with regulators, for the first quarter [2008] showed that the amount of money it had on hand to cover potential losses was just large enough to meet regulatory requirements . </li></ul><ul><li>But, days after it submitted the filing, IndyMac was told by Ernst & Young that some numbers needed to be adjusted. Such a downgrade would threaten IndyMac's survival. Thrifts classified as &quot;adequately capitalized&quot; instead of &quot;well capitalized” need special permission from regulators to gather deposits through brokers, who funnel money from investors </li></ul><ul><li>IndyMac executives, who learned about the problem in early May, wanted permission to inject $18 million into the company's capital cushion. But that would solve the problem only if the bank could pretend that the money was injected at the end of March. </li></ul><ul><li>Securities experts said the filing could raise legal issues because it is a crime to knowingly make false statements in the financial records of a public company. </li></ul>
  74. 74. The English Common Law: Fraud <ul><li>As far back as 1889 in Derry v Peek, Lord Herschell said &quot;…fraud is proved when it is shown that a false representation has been made knowingly; without belief in its truth ; or recklessly, careless whether it be true or false…&quot;. </li></ul><ul><li>In the case Angus v Clifford(1891), Lord Justice Bowen said about a fraudster…&quot; did he know that the statement was false , was he conscious when he made it that it was false, or if not, did he make it without knowing whether it was false and without caring?….&quot; </li></ul>
  75. 75. An English Common [F]law: Fraud <ul><li>Over fifty years ago, my wife was an auditor, for a British firm of Chartered Accountants, in (rural) Isle of Wight, England; </li></ul><ul><li>Many clients were farmers, with accounts that were incomplete, typically lacking information about values of: debtors; creditors; loan liabilities; and, assets; </li></ul><ul><li>The farms were – often – under-capitalized! </li></ul><ul><li>The farmers came to town on (free!) market -day. </li></ul><ul><li>My wife recalls that many of the clients often smelled of horse manure! [by whatever name described!] </li></ul>
  76. 76. To be..or not to be? That is the question [William Shakespeare (1564 – 1616) [British economist] ] <ul><li>That said, as we've seen with the Bank of America debacle, there are two other issues confronting all banks . </li></ul><ul><li>Have they got enough capital to absorb the losses being incurred on loans that are going bad? And can they be remotely confident that they can estimate quite how many loans will go bad, and how big the consequential losses will be? </li></ul><ul><li>The arrival of a painful recession, of uncertain length and depth, makes that calculation almost impossible. Guess what? We, as taxpayers, are going to have to ride to the rescue yet again. </li></ul><ul><li>As I've been saying for the past few weeks, one option under consideration is the creation of a state-owned toxic bank , into which our banks would transfer their stinky assets . </li></ul><ul><li>[Robert Peston: BBC News] </li></ul>
  77. 77. Expensive Fancy Funerals [Ashes to ashes; dust to dust] We brought nothing into this world and it is certain that we can carry nothing out! The Lord gave and the Lord hath taken away. Blessed be the name of the Lord! [BCP: 1662] [Robert Peston: BBC News]
  78. 78. Accounting A quote, from Ken Wagstaffe, a British professional colleague, and fellow accountant, who wrote a paper, about this kind of thing: &quot;......it is based on some completely and fundamentally wrong notions about what accounting is. The level of ignorance about accounting is breathtaking. &quot;
  79. 79. Fundamental Accounting Rule <ul><li>Rule for Writers and Authors: If you do not know how to spell a word, do not use it! [If you do, you will end up looking foolish.] </li></ul><ul><li>Rule for Innovative Financial Instruments: </li></ul><ul><li>If you – or your accountants – do not know how to account for an investment instrument, most especially a derivative, such as a “collateralized debt obligation (CDO)” or a “mortgage-backed” security(MBS), do not design, invent, offer, market or otherwise use such instruments! [If you do, you will end up looking foolish.] </li></ul>
  80. 80. Fundamental Accounting Rule (Corollary) <ul><li>If you end up looking foolish – and lose money - do not blame, nor seek to blame : </li></ul><ul><ul><li>Accounting systems; </li></ul></ul><ul><ul><li>Standard accounting requirements; </li></ul></ul><ul><ul><li>Accountants; </li></ul></ul><ul><ul><li>Auditors; or </li></ul></ul><ul><ul><li>Regulators </li></ul></ul><ul><li>Instead: Blame yourselves! </li></ul><ul><li>[We have seen the enemy and it is US!] </li></ul>
  81. 81. “ I’m as mad as Hell and I’m not going to take this any more” [David C. Jones: Chartered Public Finance Accountant; Chartered Certified Accountant (UK)]
  82. 82. Fair Value Accounting “ Forgetting all dishonesty, let us speak the truth to our neighbour, for we are all members of one another.” Letter of Paul to the Ephesians [The Christian New Testament ] <ul><li>Stewardship of Public and Private Funds </li></ul><ul><li>Performance in Delivery of Goods and Services </li></ul><ul><li>Control over Assets, Liabilities and Funds </li></ul>“ Give just measure and weight, nor withhold from the people the things that are their due.” [The Holy Quran]. 
  83. 83. Accounting Standards and Principles [Unhealthy Financial Statements – Based on an English Prayer from 1662*] <ul><li>We have erred and strayed from the right ways like lost sheep </li></ul><ul><li>We have followed, too much, the devices and desires of our own hearts </li></ul><ul><li>We have left undone those things which we ought to have done </li></ul><ul><li>We have done those things which we ought not to have done </li></ul><ul><li>And there is no financial health in us. </li></ul>
  84. 84. Fair Value Accounting <ul><li>&quot;....double-entry book-keeping attempts, through two parallel records, to present two distinct but closely related sets of facts. These are: </li></ul><ul><li> (i) a record, in detail, of what one owns and what one owes. </li></ul><ul><ul><li>(ii) a record of how much one was originally worth, and subsequent changes, whether additions to or subtractions from, that original sum. </li></ul></ul><ul><li>The first set of records deals with items of wealth, both positive and negative. The positive items - that is, what one owns - are called assets. The negative items - that is, what one owes - are called liabilities..... </li></ul><ul><li>The second set of records, constituting the other aspect of double-entry book-keeping, does not deal with items of actual wealth. It has nothing to say as to the kinds of things owned. It does not record the form nor the amount of the debts owed. It deals solely with changes in the amount which the proprietor is worth.“ </li></ul><ul><li>[Accounting Principles and Practice, by Hatfield, Sanders and Burton] </li></ul>
  85. 85. Accounting <ul><li>Accounting is NOT Rocket Science </li></ul><ul><li>[Nor – is it supposed to be – “racket science!”] </li></ul><ul><li>It Can All Be Shown on a Single Page [see Slide 88 – ( © David C. Jones )] </li></ul><ul><li>It is the “Churchill Chart” of accounts </li></ul><ul><li>“ Pray let me have, by this evening, on one page , the status of our tank deployment…” [Winston Churchill, British Prime Minister – World War II] </li></ul>
  86. 86. The “Churchill Chart” of Accounts <ul><li>The famous man – almost – got it dead right! He might, well, have said: </li></ul><ul><li>“ Pray let me have, by this evening, on one page , the status of our BANK deployment…” </li></ul><ul><li>[Winston Churchill, British Prime Minister – World War II] </li></ul><ul><li>[The BANKS HAVE TANKED !] </li></ul><ul><li>Never in the field of human conflict was SO MUCH OWED BY SO MANY TO SO FEW …. </li></ul><ul><li>[Winston Churchill on the Battle of Britain: August 20, 1940] </li></ul>
  87. 87. Fundamental Accountability Requirements <ul><li>Retain (real) net capital intact [including non-monetary capital!]. </li></ul><ul><li>Maintain inter-generational equity (current users bear their fair share of all costs, including capital financing costs ) </li></ul><ul><li>Compute “ Omar’s Car Runs ” costs </li></ul><ul><ul><ul><li>O peration </li></ul></ul></ul><ul><ul><ul><li>M aintenance </li></ul></ul></ul><ul><ul><ul><li>A dministration & Taxes </li></ul></ul></ul><ul><ul><ul><li>R ent : </li></ul></ul></ul><ul><ul><ul><ul><li>C onsumption of capital (depreciation) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Adjustment of value (asset valuation) – including monetary investments </li></ul></ul></ul></ul><ul><ul><ul><ul><li>R eturn on investment (interest, dividends, retained earnings) </li></ul></ul></ul></ul><ul><ul><ul><li>S urplus (to cover): </li></ul></ul></ul><ul><ul><ul><ul><li>R isk </li></ul></ul></ul></ul><ul><ul><ul><ul><li>U ncertainty </li></ul></ul></ul></ul><ul><ul><ul><ul><li>N ew Activities </li></ul></ul></ul></ul><ul><ul><ul><ul><li>S tability </li></ul></ul></ul></ul><ul><li>Fully utilize “Churchill Chart” of accounts ( see slide 88 ) </li></ul><ul><ul><ul><li>“ Pray let me have, by this evening, on one page , the status of our tank deployment…” </li></ul></ul></ul><ul><ul><ul><li>[Winston Churchill, British Prime Minister – World War II] </li></ul></ul></ul>
  88. 88. Churchill Chart TRADING MANUFACTURE OR OPERATING ACCOUNT PROFIT AND LOSS ------------------------- INCOME AND EXPENDITURE NET EARNINGS ------------------------- GENERAL FUND SURPLUS EXPENSES CASH AND BANK DEPRECIATION OR CAPITAL FINANCING RESERVE -------------------------- FIXED ASSETS STOCK OF GOODS AND MATERIALS SALES -------------------------- REVENUE INCOME SPECIAL FUNDS -------------------------- PROVISION FOR EXPENSES MONETARY INVESTMENT DEBTORS (RECEIVABLES) CAPITAL & RESERVES (INCLUDING FIXED ASSET REVALUATION) 12 11 7 5 3 20 16 8 25 13 10 26 14 9 24 19 1 2 2 1 4 8 4 9 5 6 23 23 15 17 22 6 6 14 12 13 10 3 6 7 18 21 11 27 28 27 28 NOT ALL THERE IS TO IT
  89. 89. Churchill Chart – Production v. Financing TRADING MANUFACTURE OR OPERATING CASH AND BANK FIXED ASSETS -------------------------- DEPRECIATION STOCK OF GOODS AND MATERIALS SALES -------------------------- REVENUE INCOME RECEIVEABLES & INVESTMENTS EXPENSES PROFITS & LOSSES EQUITY CAPITAL FINANCIAL MANAGEMENT (& MISMANAGEMENT) PRODUCTION SELLING & MARKETING EARNINGS
  90. 90. The Neutrality of Investment, Credit & Lending [“Finance]… is but a walking shadow, a poor player that struts and frets his hour upon the stage and then is heard no more: it is a tale told by an idiot, full of sound and fury, signifying nothing.“ (Shakespeare) A MONETARY INVESTMENT (ASSET) IS ANOTHER’S DEBT (LIABILITY): RECEIVEABLES & INVESTMENTS
  91. 91. Financial Services I keep six honest serving-men (They taught me all I knew); Their names are What and Why and When And How and Where and Who. I send them over land and sea, I send them east and west; But after they have worked for me, I give them all a rest. [ Rudyard Kipling] Finance is merely serving-men (To show us what is due); Their names are What and Why and When And How and Where and Who. I send it over land and sea, I send it east and west; But after it has worked for me, I give MYSELF the rest!
  92. 92. Financial Services I keep six honest serving-men (They taught me all I knew); Their names are What and Why and When And How and Where and Who. I send them over land and sea, I send them east and west; But after they have worked for me, I give them all a rest. [Rudyard Kipling]
  93. 93. Financial Services Finance is merely serving-men (To show us what is due); Their names are What and Why and When And How and Where and Who. I send it over land and sea, I send it east and west; But after it has worked for me, I give MYSELF the rest!
  94. 94. KEYS TO SYMBOLS
  95. 95. KEYS TO SYMBOLS
  96. 96.
  97. 97.
  98. 98.
  99. 99.
  100. 100. Accounting <ul><li>“ Although I...with all modern economists, owe an enormous debt to Keynes' brilliance of insight and imaginative sweep, his system shows a number of weaknesses that have not been corrected by his followers. </li></ul><ul><li>“ One of these weaknesses is a general failure to distinguish between two very different processes in economic life, the exchange or payments process , on the one hand, by which existing assets, including money, are circulated among various owners, and the processes of production, consumption, income and outgo on the other, by which assets are created, destroyed and accumulated”. </li></ul><ul><ul><li>[A (1950) text &quot;A Reconstruction of Economics , &quot; by Kenneth Boulding (1910-1993) ] </li></ul></ul>
  101. 101. Economics and Accounting <ul><li>&quot;The usual marginal analysis treats the firm as if it had nothing but an income account; it has no balance sheet, no capital problems and no dynamics; ...Consequently, the economist has been able to give only fragmentary accounts of inventory changes, investment structures, liquidity positions and like problems.&quot; </li></ul><ul><ul><li>[A (1950) text &quot;A Reconstruction of Economics , &quot; by Kenneth Boulding (1910-1993) ] </li></ul></ul>
  102. 102. POSITIVE [ Δ &  ] AND NEGATIVE [  ] RESOURCES [ASSETS AND LIABILITIES] <ul><li>= (POSITIVE RESOURCES) = MANUFACTURED PRODUCTS [THE PRODUCTS OF YESTERYEAR – THE MANUFACTURING INDUSTRY] </li></ul><ul><li>PRODUCTION OF EQUIPMENT GOODS AND SERVICES IS – ALWAYS AND EVERYWHERE – FOR ACTUAL USE: IN CONSUMPTION OR IN PHYSICAL AND PRODUCTIVE INVESTMENT: IT IS A POSITIVE-SUM GAME! </li></ul><ul><li>CREATED = ADDED VALUE </li></ul><ul><li>= (NEGATIVE RESOURCES) = DEBT [THE PRODUCT OF OUR TIMES – THE DEBT INDUSTRY!!] </li></ul><ul><li>A MONETARY INVESTMENT (ASSET) IS – ALWAYS AND EVERYWHERE – ANOTHER’S DEBT (LIABILITY): IT IS A ZERO-SUM GAME! </li></ul><ul><li>CREATED = MONEY: “THE ROOT OF ALL EVIL” </li></ul><ul><li>[PRINTING MONEY!] </li></ul>
  103. 103. Diminished Power of Money <ul><li>Skeptics invoked a warning that went against the tide: this faith in finance was not new but old – and it had played wayward pied piper to prior leading world economic powers. </li></ul><ul><li>On the edge of decline, the Spanish had gloried in their new world gold and silver; the Dutch in their investment income and lending to princes and tsarinas; and, the British in their banks, brokers and global financial network. </li></ul><ul><li>In none of these situations, however, could financial services succeed, in upholding the national preeminence that had been earlier built by explorers, conquistadors, maritime skills, innovative science and engineering. Invariably, power and greatness passed to new explorers, innovators and industrialists. </li></ul><ul><li>[Kevin Phillips: “Bad Money”] </li></ul>
  104. 104. Money and banking: Resources § or Results? * “ Granted, you are the clearing house of the world [but] are you entirely beyond anxiety as to the permanence of your great position?...Banking is not the creator of our prosperity, but is the creation of it. It is not the cause of our wealth § , but it is the consequence * of our wealth.” [Joseph Chamberlain (British colonial secretary): statement to bankers – 1904] * § “An accountant records and interprets, in money values, the results of variations during any period of time, at the end of which he can balance Net Results * (of past operations) against Net Resources § (available for future operations)”. [David C. Jones]
  105. 105. [PRINTING MONEY!] <ul><li>The bank has, quite literally, in both the commercial and the economic senses, &quot;printed money.&quot; IF the result of this is an increase of commercial activity, because the money attracts new goods and services into the market place, there will be reasonable economic stability. </li></ul><ul><li>Suppose, for example, that it is Christmas – and that: manufacturers make many more: “toys” (computers, gadgets and devices) than at other times of the year; brewers brew more “ale”; people travel to their families; and, entertainers perform many more activities. Prices would be less likely to rise. </li></ul><ul><li>However, now suppose the market-place is in the doldrums. No one is buying, selling or entertaining - perhaps because of a fear of attack from (say) terrorists (e.g. debt collecting agencies!) . Then, more money would be chasing the same quantity of goods and services as before, forcing up prices and causing inflation. </li></ul><ul><li>Alternatively, the economy could be booming, with virtually no idle resources ready to be coaxed into activity. Again, there would be additional money with nothing extra to spend it on, another inflationary situation. </li></ul><ul><li>[“Managing Masonia’s Money”: David C. Jones, George Mason University, USA] </li></ul>
  106. 106. [INFLATION – WITH “PRINTED” MONEY!] <ul><li>“ In God – [ NOT Gold] – we trust” (US Dollar bill) </li></ul><ul><li>“ Render to Caesar the things that are Caesar's, and to God the things that are God's”. [Bible: Mark 12:17] </li></ul><ul><li>“ Friends, Romans, countrymen, lend me your ears: I come to bury Caesar, not to praise him. </li></ul><ul><li>“ The evil that men do lives after them; The good is oft interred with their bones……… </li></ul><ul><li>“ Whose ransoms did the general coffers fill?……… </li></ul><ul><li>“ And men have lost their reason! Bear with me ……… And I must pause till it come back to me. </li></ul><ul><li>William Shakespeare (1564 – 1616) [British economist] </li></ul>
  107. 107. A MONETARY INVESTMENT – & DEBT – TRANSFER [ Δ &  ] IS A ZERO-SUM GAME? <ul><li>WELL! NOT EXACTLY! </li></ul><ul><li>MONETARY INVESTMENT TRANSFER IS A NEGATIVE SUM GAME </li></ul><ul><li>TRANSACTION COSTS ARE INCURRED </li></ul><ul><li>TRANSFER AGENTS ARE INVOLVED </li></ul><ul><li>FEES ARE PAID TO TRANSFER AGENTS </li></ul><ul><li>TRANSACTION COSTS ARE DERIVED FROM THE INVESTMENTS (OR ARE PAYABLE BY TRANSFERORS OR RECIPIENTS OF THE INVESTMENTS) </li></ul><ul><li>INVESTMENT VALUES ARE AFFECTED BY MARKET PRICES – BASED ON EXPECTATIONS OF FUTURE INCOMES OR LOSSES </li></ul><ul><li>THUS: CHANGES IN VALUES OF INSTRUMENTS ARE BORNE BY – OR EARNED BY – INVESTMENT TRANSFERORS OR RECIPIENTS </li></ul>
  108. 108. “ Robinson Crusoe” Economics – Main Street <ul><li>On Robinson Crusoe’s Island, there has just been a very heavy three-day rainstorm. During the storm, a tree-branch fell and severely injured Robinson Crusoe’s arm. So, he cannot catch any fish. </li></ul><ul><li>The fish supply was exhausted during the storm, so that Robinson Crusoe lends the fishing rod to Man Friday. Man Friday has a peak load problem , for he has to catch fish: to feed himself and Crusoe; to replace the depleted supplies; and; to establish bigger reserves, in case of another storm. </li></ul><ul><li>Crusoe is disabled. He cannot work. Also, he has no fish to trade, for the work of Friday, in catching more fish, for consumption and storage. No market transactions are possible , unless Friday grants Crusoe credit! Or pays rent for the fishing-rod! Friday must work overtime and also make a gift, of his labor and of fish, to keep Crusoe alive, and in recovery. And provides health-care! [A “welfare” situation!] </li></ul>
  109. 109. “ Robinson Crusoe” Economics – Main Street <ul><li>Because he cannot work, Robinson Crusoe’s credit status is that of a sub-prime borrower . He can only get a “NINJA” loan [No Income, No Job or Assets] </li></ul><ul><li>Moreover, according to “Adam Smith” Economics: </li></ul><ul><li>“ It is not from the benevolence of the butcher, the </li></ul><ul><li>brewer, the baker or the fisherman (Man Friday) that Crusoe expects his dinner, but from Friday’s regard </li></ul><ul><li>to his (Friday’s) own interest .... [Excuse ME?] </li></ul><ul><li>According to the “Tragic of the Market-place,” therefore, there will be NO credit for Crusoe and NO welfare for him </li></ul><ul><li>Robinson Crusoe will, therefore, quickly die, of his sickness and of starvation. </li></ul><ul><li>There will, now, be more resources for Friday – BUT less of a work-force to help him to exploit, to harvest and to use them. Moreover, Friday will have no companionship, no help and be lonely [Negative Economic Externalities!] </li></ul>
  110. 110. “ Robinson Crusoe” Economics – The Rent-seeker <ul><li>Ponder Robinson Crusoe’s fishing rod . It is the only real capital that exists on the island and it is absolutely necessary – but also sufficient – to catch fish, which is the only available food. </li></ul><ul><li>How did Robinson Crusoe come by the fishing rod? He: made it from the materials, from the island and the wreckage; had it bequeathed to him by his father; found it floating in the sea, very close to the beach; bought it, for cash, aboard the ship, before his shipwreck; rents it from Mr. Warren or Mr. Buffett; whatever! </li></ul><ul><li>It does not matter how he got it. R.C. owns (controls, has a monopoly of) the only capital on the island. He can rent it out to Friday and (eventually) to his friends and relations, so that they can catch the fish, for eating, storage and to pay R.C. for the rent. </li></ul><ul><li>The well-fed R.C. lives a life of leisure, earning all that he needs from his capital. This will continue, only if there is a rule of law ! </li></ul><ul><li>If Friday no longer accepts the capitalist system then, in “ The October Revolution” he, together with his friends and relations will overpower R.C. and make him catch fish. The rent is cancelled! </li></ul>
  111. 111. The “Folk Theorem” or “Folk Fable” of the “Free Market” Economics of Adam Smith Adam Smith also wrote (implying major and fundamental aspects of market inefficiency and failure, through the tendency towards monopoly): “ People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy to raise prices” and “ ....to widen the market and to narrow the competition, is always the interest of the dealers.....an order of men, whose interest is never exactly the same with that of the public, and who accordingly have, upon many occasions, both deceived and oppressed it.”
  112. 112. “ Robinson Crusoe” Biblical Economic Capitalism <ul><li>Before the “October Revolution” Robinson Crusoe owns the only fishing rod . He also employs Friday and (eventually) his friends and relations, as his staff , to catch the fish. </li></ul><ul><li>By this method – capitalism – R.C. prevents his death, from starvation. </li></ul><ul><li>Thus, in a conversation with Friday, he says: </li></ul><ul><li>“ Yea, though I walk through the valley of the shadow </li></ul><ul><li> of death, I will fear no evil: for thou art with me; my </li></ul><ul><li>rod and my staff, they comfort me.” </li></ul><ul><li>[Psalm 23 – KJV] </li></ul>
  113. 113. “ The October Revolution” “I’m as mad as Hell and I’m not going to take this any more” [Man Friday and Friends]
  114. 114. Biblical Economic Capitalism [Psalm 23 – KJV] Psalmist’s Prophecy Application Thou shalt prepare a table before me Table of toxic derivatives & bad debts Against them that trouble me Sub-prime mortgages [ and the accounting profession – re “fair value accounting!”] Thou annointest my head with oil Traders in oil futures And my cup shall be full Corporate chief executives But thy loving-kindness and mercy shall follow me all the days of my life Recipients of corporate redundancy and retirement packages.
  115. 115. “ Robinson Crusoe” Economics – Wall Street! <ul><li>Meanwhile, five thousand miles away, in a place called Wall Street, over a cup of coffee, the island and the fishing rod are sold for $1,000,000, by “Mr. Warren” to “Mr. Buffett”. $50,000 is taken by Mr. Goldman, as commission, for arranging the sale! </li></ul><ul><li>Mr. “Goldman” puts the $50,000 into one of his “Sachs” where he keeps his money. This all results from managing other people’s money ! </li></ul><ul><li>There is NO new capital; NO productive activity; yet money is made! [A zero – or negative – sum game!] </li></ul><ul><li>Who cares? [but…Half the media news is about this! “Today, the DOW went up, down, whatever..!]” </li></ul>
  116. 116. “ Phantom” Economics – Wall Street! <ul><li>Did the vendor have good title to the island? </li></ul><ul><li>Were the title documents destroyed by the 9/11 attack? </li></ul><ul><li>Does anyone know – or care – where the island is? </li></ul><ul><li>Does the island really exist? </li></ul><ul><li>Who's Buried in Grants Tomb? </li></ul><ul><li>Is there any gold in Fort Knox? </li></ul><ul><li>If there is, does anyone know how much is there and who it belongs to? </li></ul><ul><li>Does it make any real difference to anything, in an era of fiat money? </li></ul><ul><li>Does any of it make any real difference – or is it just a great big game? </li></ul><ul><li>[“Life's but a walking shadow, a poor player that struts and frets his hour upon the stage and then is heard no more: it is a tale told by an idiot, full of sound and fury, signifying nothing.“] </li></ul><ul><li>William Shakespeare (1564 – 1616) [British economist] </li></ul>
  117. 117. “ Phantom” Finance – Wall Street! <ul><li>The former chairman of the Nasdaq stock market has been arrested and charged with securities fraud, in what may be one of the biggest fraud cases yet. [BBC News: 12 December, 2008] </li></ul><ul><li>Bernard Madoff ran a hedge fund which ran up $50bn (£33.5bn) of fraudulent losses and which he called &quot;one big lie&quot;, prosecutors allege. </li></ul><ul><li>He said he was &quot;finished&quot;, that he had &quot;absolutely nothing&quot; and that &quot;it's all just one big lie&quot; , and that it was &quot;basically, a giant Ponzi scheme“. Mr. Madoff is alleged to have used money from new investors to pay off existing investors in the fund. </li></ul><ul><li>[( “A Ponzi scheme is )…but a walking shadow, a poor player that struts and frets his hour upon the stage and then is heard no more: it is a tale told by an idiot, full of sound and fury, signifying nothing.“] </li></ul><ul><li>William Shakespeare (1564 – 1616) [British economist] </li></ul>
  118. 118. “ Phantom” Finance – Wall Street! <ul><li>Bernard Madoff didn't accept money from just anyone. Clients ideally had to have at least $10 million to open an account with his New York investment firm. </li></ul><ul><li>While such wealthy people don't turn up just anywhere, the Palm Beach Country Club provided enough to make Madoff's membership in the predominantly Jewish club worthwhile. </li></ul><ul><li>On Friday, many of those who had considered themselves lucky to invest their millions with the part-time Palm Beacher were calling their accountants, their brokers and each other, wondering whether they had lost it all. </li></ul><ul><li>But, according to federal investigators, that's exactly what happened: Madoff had made off with their money! [$50billion!] </li></ul>
  119. 119. FIDDLING – WITH CASH – WHILST ROME – REAL ASSETS – BURNS!
  120. 120. A “Folk Theorem” or “Folk Fable” <ul><li>Marginal expenditure, by the US public (already literate and well-fed) on goods produced by the private sector, is largely on amenities (i.e. STUFF!) . These comprise: living space; cars; boats; plasma TVs; restaurant meals; health-care; alcohol; recreation; etc. </li></ul><ul><li>Necessary public services, engendered by this private spending, especially for: </li></ul><ul><ul><li>extra: road-space, water and sewer utilities; other public services; fossil fuels; and, perhaps, most critically: </li></ul></ul><ul><ul><li>disposal and renewal of: household and commercial trash; obsolete equipment; wastewater; and, medical wastes </li></ul></ul><ul><ul><li>cannot, safely and efficiently, be provided – by the public sector – because it is (seriously) deprived of necessary tax revenues! </li></ul></ul>“ Folk Fable” Mitigation “ The PRIVATE SECTOR (in capitals, out of “Due Reverence”) knows better than the government how to produce goods and services that the public “needs.” So ”cut taxes and reduce government spending!” (Common political “anti-tax” rhetoric)
  121. 121. The (Former) Colonial Version of Trade The (Modern) Reverse-Colonial Version of Trade The colonial powers – notably Britain; Netherlands; France; Portugal; Spain. – traded trinkets with, e.g. Indians; Chinese; Africans; Native Americans, in exchange for (real) gold, silver, spices and other items of wealth. The former colonial, colonized and other, powers – notably USA; Canada; Australasia; Western Europe; and, Japan. – buy trinkets and toys (including economy cars; computers; electronics; etc., from e.g. The: Indian sub-continentals; Chinese; Koreans; Malaysians; and, many others, in exchange for (valuable) Foreign Exchange Reserves
  122. 122. The Former (Hollywood) Version of Bank Robbery “ Hand over the money – or we’ll shoot!” [Bank Robbers – armed with guns ] ________________ The Modern (Woolly-head) Version of Bank Grabbery “ Hands out for our money – or we’ll shout!” [U.S. Treasury Department – armed with tons (of money)]
  123. 123. U.S. Treasury – Handing Out Bail-out Money <ul><li>Community banking executives around the country responded with anger yesterday to the Bush administration's strategy of investing $250 billion in financial firms, saying they don't need the money, resent the intrusion and feel it's unfair to rescue companies from their own mistakes....And in offices around the country, bankers simmered. </li></ul><ul><li>Peter Fitzgerald, chairman of Chain Bridge Bank in McLean, said he was &quot;much chagrined that we will be punished for behaving prudently by now having to face reckless competitors who all of a sudden are subsidized by the federal government.“ </li></ul><ul><li>At Evergreen Federal Bank in Grants Pass, Ore., chief executive Brady Adams said he has more than 2,000 loans outstanding and only three borrowers behind on payments. &quot;We don't need a bailout, and if other banks had run their banks like we ran our bank, they wouldn't have needed a bailout, either,&quot; Adams said. </li></ul><ul><li>[© The Washington Post] </li></ul>
  124. 124. Fiscal Management in the USA: A Taxing Responsibility BILL MOYERS: &quot;Time&quot; magazine this week says that while no one is looking, Congress and the IRS have been quietly changing the tax code to lower corporate taxes for years to come . Are they receiving bailout money through the front door while they're getting tax breaks and other privileges through the backdoor? EMMA COLEMAN JORDAN: That's a change which was done at the Department of Treasury without statutory authorization to do it. BILL MOYERS: They did it arbitrarily? EMMA COLEMAN JORDAN: They did it on their own, with no consultation with Congress to get permission for this change , since it was absolutely antithetical to the statutory requirement. And I've looked at the comments of tax specialists. I'm not a tax specialist. But the tax specialists say this is unheard of and clearly in violation of the statute which protects the Treasury by not allowing banks that acquire failing banks to get the benefit of the losses of the failed bank and carry those losses over for the benefit of the acquiring bank. [© Bill Moyers’ Journal – PBS-TV: 12 December, 2008]
  125. 125. Fiscal Management in the USA: A Taxing Responsibility <ul><li>This is contrary to the Bill [Declaration] of Rights, enacted by the British Parliament in1689, forming a foundation of the US Constitution. It gave to England “The rights of Englishmen”, avidly sought after by the American colonists in the Revolutionary War. </li></ul><ul><li>The Declaration, emanating from the “Glorious Revolution” of 1688, was signed by William and Mary – after whom were named Virginia’s “College of William and Mary,” as well as “Williamsburg”, as a condition of replacing King James II (earlier overthrown) as the joint monarchs of the United Kingdom. It was enacted by Parliament. </li></ul><ul><li>The Declaration states that: “…the pretended power of suspending the laws or the execution of laws by regal (i.e. executive) authority, without consent of Parliament, is illegal .” </li></ul><ul><li>And, “…that levying money for or to the use of the Crown (i.e., the executive) by pretence of prerogative, without grant of Parliament, for longer time, or in other manner than the same is or shall be granted, is illegal .” </li></ul>
  126. 126. BALANCE SHEETS <ul><li>PP&E CAP </li></ul><ul><li>C&I </li></ul><ul><li>Δ INV  LOAN </li></ul>c <ul><li>PPE CAP </li></ul><ul><li>C&I </li></ul><ul><li>Δ INV  LOAN </li></ul><ul><li>PPE CAP </li></ul><ul><li>C&I </li></ul><ul><li>Δ INV  LOAN </li></ul>c <ul><li>PPE CAP </li></ul><ul><li>C&I </li></ul><ul><li>Δ INV  LOAN </li></ul>c c GLOSSARY CAP = EQUITY CAPITAL PP&E = PROPERTY, PLANT & EQUIPMENT C&I = CASH & INVENTORY INV = MONETARY INVESTMENT LOAN = LONG-TERM LOANS & SIMILAR A MONETARY INVESTMENT (ASSET) IS ANOTHER’S DEBT (LIABILITY): A MONETARY INVESTMENT (ASSET) IS ANOTHER’S DEBT (LIABILITY):
  127. 127. CONSOLIDATED BALANCE SHEETS c PRODUCTIVE ASSETS ADD TO CAPITAL
  128. 128. PROFIT & LOSS ACCOUNTS <ul><li>PP&E INC </li></ul><ul><li>C&E </li></ul><ul><li>INT- INT+ </li></ul>C c c <ul><li>PP&E INC </li></ul><ul><li>C&E </li></ul><ul><li>INT- INT+ </li></ul>C c c <ul><li>PP&E INC </li></ul><ul><li>C&E </li></ul><ul><li>INT- INT+ </li></ul>C c c <ul><li>PP&E INC </li></ul><ul><li>C&E </li></ul><ul><li>INT- INT+ </li></ul>C c c GLOSSARY CAP = EQUITY CAPITAL PP&E = PROPERTY, PLANT & EQUIPMENT C&I = CASH & INVENTORY INT- = INTEREST PAYABLE INT+ = INTEREST RECEIVABLE PRODUCTIVE ASSETS GENERATE REAL INCOME ONE’S OWN INTEREST PAYABLE IS ANOTHER’S INTEREST RECEIVABLE
  129. 129. CONSOLIDATED PROFIT & LOSS ACCOUNTS c CAP = EQUITY CAPITAL PPE = PROPERTY, PLANT & EQUIPMENT C&I = CASH & INVENTORY INT - = INTEREST PAYABLE (CANCELLED AGAINST INTEREST RECEIVABLE) INT + = INTEREST RECEIVABLE (CANCELLED AGAINST INTEREST PAYABLE) PRODUCTIVE ASSETS GENERATE REAL INCOME
  130. 130. NET GLOBAL POSITIONING SYSTEM <ul><li>PPE Δ INVEST </li></ul><ul><li>C&I *  LOANS </li></ul><ul><li>CONS*  (LOANS) </li></ul>PPE = PROPERTY, PLANT & EQUIPMENT (PRODUCING FOR LOCAL OR EXPORT)* [* IF OWNED BY FOREIGN RESIDENTS, THIS WILL GAIN FOREIGN CURRENCY, IN EXCHANGE FOR LOSS OF OWNERSHIP AND/OR CONTROL] C&I = CASH & INVENTORY (FOR DOMESTIC USE, TO BUY FOREIGN EXCHANGE, OR FOR DEBT SERVICE (DOMESTIC OR FOREIGN) INVEST = FOREIGN DIRECT INVESTMENT IN NON-DOMESTIC ASSETS LOANS = LOANS FROM FOREIGN SOURCES (PRIVATE AND PUBLIC SECTORS) (LOANS) = NET FOREIGN DEBT POSITION OF THE DOMESTIC ECONOMY: [( ) = < 0] CONS = FINAL (DOMESTIC) CONSUMPTION OF GOODS AND SERVICES [CONS* = ONLY CONSUMPTION BY FOREIGN RESIDENTS CAN BE USED TO BUY FOREIGN EXCHANGE, [OR] FOR DEBT SERVICE ON FOREIGN DEBT] “ PRODUCTIVE” ASSETS NET FOREIGN DEBT GOODS FOR USE/EXPORT & CONSUMPTION DOMESTIC & FOREIGN CONSUMPTION FOREIGN BORROWING FOREIGN INVESTMENT
  131. 131. DO THE MATH! ( Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ ) – (  +  +  +  +  +  +  +  +  +  ) = 0 VALUATIONS AT HISTORICAL COST [MONETARY INVESTMENTS (ASSETS)] [LONG-TERM DEBT – AND SIMILAR (LIABILITIES)]
  132. 132. DO THE MATH! ( Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ ) – (  +  +  +  +  +  +  +  +  +  ) = 0 VALUATIONS AT “FAIR VALUE” [MONETARY INVESTMENTS (ASSETS)] [LONG-TERM DEBT – AND SIMILAR (LIABILITIES)] IMPAIRED (TOXIC) INVESTMENTS IMPAIRED (TOXIC) (DEBT)
  133. 133. DO THE MATH! ( Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ + Δ ) – (  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  ) = 0 VALUATIONS, AT HISTORICAL COST – OR FAIR VALUE (BUT) TOO MANY LOANS – CREATING TOO LARGE A TOTAL [MONETARY INVESTMENTS (ASSETS)] [LONG-TERM DEBT – AND SIMILAR (LIABILITIES)]
  134. 134. LAW OF DIMINISHING RETURNS FINANCIAL, ECONOMIC & SOCIAL BENEFITS VALUE OF LOAN PORTFOLIO B V 0 STEEPLY ACCELERATING BENEFITS GRADUALLY DECELERATING BENEFITS ABSOLUTE BENEFITS FALLING GRADUALLY ACCELERATING BENEFITS THE LOAN PORTFOLIO IS TOO LARGE TO BE VIABLE! IT IS “OUT OF CONTROL.”
  135. 135. THE NATIONAL LOAN PORTFOLIOS THE LOAN PORTFOLIOS ARE TOO LARGE TO BE VIABLE! THEY ARE “OUT OF CONTROL.” <ul><li>Morgan Stanley </li></ul><ul><li>Royal Bank of Scotland </li></ul><ul><li>Washington Mutual </li></ul><ul><li>Citigroup </li></ul><ul><li>Indy Mac </li></ul><ul><li>Goldman Sachs </li></ul><ul><li>(More?) </li></ul><ul><li>Bank of America </li></ul><ul><li>Bear Stearns </li></ul><ul><li>Fannie Mae </li></ul><ul><li>Freddie Mac </li></ul><ul><li>Lehman Brothers </li></ul><ul><li>Northern Rock </li></ul><ul><li>(More?) </li></ul>GREED MUTATED INTO FEAR!
  136. 136. Too Big to Fail? <ul><li>American International Group, Bank of America, Citigroup and Morgan Stanley are among the companies that are getting bailed out by U.S. taxpayers while having subsidiaries in locations where they can avoid paying U.S. taxes, according to the Government Accountability Office </li></ul><ul><li>Of the 100 largest public companies, 83 do business in tax-haven hotspots like the Cayman Islands, Bermuda and the British Virgin Islands, where they can move their income into tax-free accounts. It is all legal, but it could come to an end, given the dire condition of the U.S. economy </li></ul><ul><li>The GAO did not independently review company transactions to see if the companies purposely created tax-haven businesses to avoid U.S. taxes. But it said that historically, offshore subsidiaries are used for reducing tax costs and shielding transactions from public view. </li></ul>“ Whose ransoms did the general coffers fill? And men have lost their reason.. Bear with me and I must pause till it come back to me.” William Shakespeare (1564 – 1616) [British economist]
  137. 137. Too Big to Fail – or Two Figs* to Bail Bank of America is among the companies being bailed by U.S. taxpayers out while having subsidiaries where they can avoid paying U.S. taxes. (Damian Dovarganes -- Associated Press) * They “don't give two figs&quot; = complete lack of care or concern for the situation!
  138. 138. “ LAW” OF DIMINISHING CAPITAL COVERAGE VALUES OF LOAN PORTFOLIOS B V 0 RATIO OF CAPITAL TO (MONETARY) ASSETS: LOANS HANGING IN BY A THREAD!  MONETARY ASSETS: LOANS MADE CAPITAL & RESERVES
  139. 139. All this may seem arcane to some readers. Yet the ratio of a bank’s capital to its assets , technical though it sounds, is of more than merely academic interest … If US banks have lost significantly more than the $255 billion to which they have so far admitted [ early 2008 ] as a result of the subprime mortgage crisis and credit crunch, there is a real danger that a much larger – perhaps tenfold larger – contraction in credit may be necessary, to shrink the banks’ balance sheets in proportion to the decline of their capital . [emphasis added] If the shadow banking system of securitized debt and off-balance-sheet institutions is to be swept away completely by this crisis, the contraction could be still more severe. “The Ascent of Money”: Niall Ferguson [© Niall Ferguson – 2008] [Credible Capital Management]
  140. 140. OVERLOADED & UNSAFE TO OPERATE! [WHERE WERE THE (“CAPITAL”) POLICE?]
  141. 141. Excess Leverage – The Wrong Track
  142. 142. Who was Monitoring the Signals?
  143. 143. The Big Banks <ul><li>Hundreds of billions have been spent to preserve these dysfunctional institutions. Nothing has been done to address perverse incentive structures, which encourage short-sighted behavior and excessive risk taking.  </li></ul><ul><li>With private rewards so markedly different from social returns, it is no surprise that pursuit of self-interest (greed) led to socially destructive consequences. Not even the interests of their shareholders have been served well. </li></ul><ul><li>Meanwhile, too little is being done to help banks that actually do what banks are supposed to do – lend money and assess creditworthiness.  </li></ul><ul><li>[Joseph E. Stiglitz] </li></ul>
  144. 144. IMF warns of 'disturbing' UK debt The level of debt in the UK is &quot;disturbing,&quot; the head of the International Monetary Fund has said. But Dominique Strauss-Kahn told the BBC that given the severity of the economic downturn, more government borrowing was the lesser of two evils. He said 2009 would be &quot;a really bad year&quot; and more state spending was necessary to stimulate growth. [BBC News: 21 December, 2008]
  145. 145. David C. Jones Warns US Congress of ‘Disturbing' Washington DC Debt Emergency Long-term Borrowing by the District of Columbia It is certainly not a standard municipal finance practice to permit long term borrowing, merely to cover a general accumulated budgetary deficit. Thus, the situation in which the D.C. government finds itself, measured against normal [municipal] financing principles, is about the worst that could possibly be imagined… … although the proposal to issue long term debt instruments technically violates all normal principles of [municipal] finance , it is one that should - in this special instance - be given serious consideration, because all the other choices are likely worse . That is really its only redeeming feature . All seem to acknowledge…that the most that can be done, at present, is to &quot;make the best of a bad job.“ [Testimony of David C. Jones to the U.S. House of Representatives – July 25, 1991]
  146. 146. The Balance of Accounting RESOURCES RESULTS DEBIT DEBIT CREDIT CREDIT Resources must always equal Results
  147. 147. The Balance of Accounting RESOURCES (WHAT IS OWNED AND IS OWED) RESULTS (HOW & WHY OVERALL RESOURCES CHANGE) <ul><li>Capital Expenditure on Land, Buildings, Infrastructure, Plant and Equipment. </li></ul><ul><li>Provision of Working Capital (Cash and Credit). </li></ul><ul><li>Funding of Capital Expenditure and Working Capital from Loans (Financial Capital Investment). </li></ul><ul><li>Funding of Capital Expenditure and Working Capital from Equity (Financial Capital Investment). </li></ul><ul><li>Profits and Losses (or Income and Expenditure) from Productive Employment of Capital Resources – in Current Business Operations or Public Sector Activities. </li></ul><ul><li>Lack of (or Lower than) Expected Business Operations or Public Sector Activities – Engenders Losses, from Under-utilization of Capital in Currently Productive Activities. </li></ul>
  148. 148. The Balance of Accounting INCOMPETENCE OR FRAUD: CONFUSING CAPITAL AND CURRENT ACTIVITIES <ul><li>IMF/IBRD and Other International Entities [& Private Investors]: </li></ul><ul><li>Misreading the “Asian Miracle” and the Subsequent Currency Crash! </li></ul><ul><li>WorldCom: </li></ul><ul><li>Deliberately Mis-accounting for Current Expenditures as Capital Expenditures – resulting in Massive Fraud and Bankruptcy! </li></ul><ul><li>Many State and Local Governments (Worldwide) – including the State of California and Washington DC: </li></ul><ul><li>Raising Long-term Debt to Cover Operating Expenditures or Current Budgetary Deficits! and, </li></ul><ul><li>Raising Long-term Debt to Cover Deferred Maintenance of Deteriorated Buildings, Infrastructure, Machinery and Vehicles! </li></ul>
  149. 149. Under-utilized Capital (e.g. Building Capacity) OCCUPIED AND/OR PRODUCTIVE USE (ONLY A PART - OR NONE) UNOCCUPIED AND/OR NO PRODUCTIVE USE (REMAINDER) VERSUS LAND AND INFRASTRUCTURE BUILDINGS
  150. 150. Diminishing Returns <ul><li>The problem is that over the past several years, the U.S. economy over-expanded in response to surge in debt-financed spending by American households and government. </li></ul><ul><li>It made sense as long as home prices and commercial real estate prices and stock prices and commodity prices were what the markets said they were and we could draw on that paper wealth to support a higher lifestyle. [Steve Pearlman: Washington Post] </li></ul>
  151. 151. Diminishing Returns <ul><li>Unfortunately, it was all a mirage. Once the cheap credit disappeared and the asset values plummeted and consumers began to pull back on their spending…, </li></ul><ul><li>… it suddenly became clear that we didn't have the income to support all those shops and restaurants, hotel rooms and airline seats, auto lines and steel plants and media outlets . [Steve Pearlman: Washington Post] </li></ul>
  152. 152. LEVELS OF FINANCIAL CONCERN NEW DEBT OR EQUITY FINANCE CAPITAL COST & DEBT SERVICE ADEQUATE CASH-FLOW ESSENTIAL CONCERNS CAPITAL STRUCTURE EXPANSION & DEVELOPMENT SURVIVAL NEW OPERATING COST & INTEREST PROFITABILITY SUSTAINABILITY POTENTIALS FOR DISRUPTION INSTITUTION GOING CONCERN (STEADY STATE) PROJECTS (DISRUPTIVE) OVERALL ACHIEVEMENT FINANCIAL REQUIREMENTS
  153. 153. Resources and Results <ul><li>The concepts of “Resources” and “Results,” when applied to overall accounting principles, were originally devised, for teaching and illustrative purposes, by David C. Jones. [ Emanating from the work of J.B.Woodham ]. For example, in his definitive textbook “Municipal Accounting for Developing Countries,” the following appears (p2): </li></ul><ul><li>“ An accountant records and interprets variations in financial position. He records, in money values, the results of variations during any period of time, at the end of which he can balance Net Results (of past operations) against Net Resources (available for future operations)”. </li></ul>
  154. 154. Resources and Results <ul><li>These theories, expounded by the author, are grounded in principles enunciated by ( inter alia ) eminent British writer and (government) district auditor, Carson Roberts and from a US book, 'Accounting principles and practice', by Hatfield, Sanders and Burton. </li></ul><ul><li>They have also been interpreted by a former president of the Chartered Institute of Public Finance and Accountancy, Mr. J.B.Woodham, Borough Treasurer, and later Chief Executive, of Middlesborough and of Cleveland County, England. </li></ul><ul><li>Woodham referred to “Resources” as “What” accounts (what one owns and what one owes) and “Results” as “How” accounts (how the changes in resources came about). The concepts fit very neatly with those relating to (on the one hand) balance sheets and (on the other hand) income and expenditure accounts. </li></ul><ul><li>International Accounting and Reporting Standards are fully consistent with these theories. </li></ul><ul><li>[Indeed, they are the only ones that make any sense!] </li></ul>
  155. 155. International Accounting and Reporting Standards are fully consistent with these theories. [Indeed, they are the only ones that make any sense!] <ul><li>IN THE “PLAIN ENGLISH” OF ACCOUNTING </li></ul><ul><li>If you are a credit to your organization – you are NOT an asset ; you are a liability ! [ liabilities are shown as credits in the accounts!] </li></ul><ul><li>If you credit money to your bank account, it is NOT a credit ; it is a debit , in your accounts. </li></ul><ul><li>BUT – if your bank sends you a statement, THEN it IS a credit ; because to the bank, YOU are a liability ! </li></ul><ul><li>Excuse Me? </li></ul><ul><li>[The BANKS are NO CREDIT to anyone!] </li></ul>
  156. 156. What do I know about it? I am just an old book-keeper! Bank Balance Sheet as at 31 December, 2008 Assets [On the Left , There is Nothing Left !] Liabilities and Capital [On the Right , There is Nothing Right! ] “ Impact of the credit crunch on the 2008 financial statements: 18 November 2008” By Willeke Ong en Jens Osinga [©PricewaterhouseCoopers]
  157. 157. “ Woodham’s Principles” <ul><li>“ What” Accounts – Assets and Liabilities </li></ul><ul><li>In accounts dealing with assets and liabilities, all assets are recorded as debits , and all liabilities as credits . It follows from this that: </li></ul><ul><ul><ul><li>(a) increases in assets are debits; </li></ul></ul></ul><ul><ul><ul><li>(b) decreases in assets are credits; </li></ul></ul></ul><ul><ul><ul><li>(c) increases in liabilities are credits; and </li></ul></ul></ul><ul><ul><ul><li>(d) decreases in liabilities are debits. </li></ul></ul></ul><ul><li>“ How” Accounts – Gains and Losses </li></ul><ul><li>In accounts dealing with gains and losses, all gains are recorded as credits and all losses as debits . It therefore follows that: </li></ul><ul><ul><ul><li>(a) increases in gains or surpluses are credits; </li></ul></ul></ul><ul><ul><ul><li>(b) decreases in gains or surpluses are debits; </li></ul></ul></ul><ul><ul><ul><li>(c) increases in losses or deficiencies are debits; and </li></ul></ul></ul><ul><ul><ul><li>(d) decreases in losses or deficiencies are credits. </li></ul></ul></ul><ul><ul><ul><li>©“Municipal Accounting for Developing Countries” [David C. Jones] </li></ul></ul></ul>
  158. 158. Use of Economic Resources (Figure 13f) RESULTS RESOURCE MOBILIZATION CAPITAL CONTRIBUTIONS ASSET SALES LONG-TERM DEBT TEMPORARY DEBT SUPPLIERS (CREDIT) RESOURCE ACTIVATION INFORMATION RAW MATERIALS SERVICES ENERGY LABOR CUSTOMERS & CLIENTS THE COMMON WEALTH NATURAL RESOURCES MONETARY INVESTMENT INVENTORIES WORK IN PROGRESS CUSTOMERS (CREDIT) CASH RESOURCE ALLOCATION (& RESOURCE CONSERVATION) LAND PERMANENT WORKS BUILDINGS EQUIPMENT & MACHINERY RESOURCE UTILIZATION PRODUCTION DISTRIBUTION OPERATION MAINTENANCE ADMINISTRATION TAXES DEPRECIATION INTEREST DIVIDEND RETAINED EARNINGS PROPERTY DISPOSAL HUMAN CAPITAL* MANAGEMENT (ENTERPRISE)* * CREATIVE, INNOVATIVE (RIGHT-BRAIN) TALENT COMMERCIAL, SOCIAL & ECOLOGICAL RETURN & REINVESTMENT WASTE, DAMAGE & DESTRUCTION COMMERCIAL, SOCIAL & ECOLOGICAL CONSUMPTION (SATISFACTION) COMMERCIAL, SOCIAL & ECOLOGICAL STIMULATION
  159. 159. RESULTS OF ACTIVITY (USE OF RESOURCES) COMMERCIAL, SOCIAL & ECOLOGICAL RETURN & REINVESTMENT WASTE, DAMAGE & DESTRUCTION INNOVATION - CONSUMER SATISFACTION , REINVESTMENT & PRODUCT DEVELOPMENT COMMERCIAL, SOCIAL & ECOLOGICAL ECOLOGICAL CONSUMPTION (SATISFACTION) COMMERCIAL, SOCIAL & ECOLOGICAL IMPORTANT SUCCESS CRITERIA AND PRINCIPAL FOCUS OF ATTENTION PERFORMING USEFUL & HIGH-QUALITY ACTIVITIES AT APPROPRIATE PLACES AND TIMES LONG-TERM OPTIMIZATION OF RESOURCE USE (PRODUCTIVITY & WASTE CONTROL) DEBT SERVICE QUALITY OF ENVIRONMENT PAYMENT OF TAXES MAXIMIZATION OF PROFIT QUALITY OF SOCIAL LIFE OPERATIONAL & FINANCIAL RELIABILITY WASTE DISPOSAL PRODUCT & SERVICE QUALITY QUALITY OF LABOR LIFE DAMAGE RECTIFICATION Resource Consumption v. Results
  160. 160. “ Cost” Cutting by Wolfgang Amadeus Mozart (“W.A.M.” Principles) <ul><li>W IZE </li></ul><ul><li>A CCOUNTABLE </li></ul><ul><li>M ANAGEMENT </li></ul>
  161. 161. “ Cost” Cutting by Wolfgang Amadeus Mozart (“W.A.M.” Principles) Conversation Emperor of Austria to Mozart: Methinks your symphony is a trifle too long, young sir! There are too many notes! Mozart: Indeed your Majesty, and precisely which notes would you have me remove? [“Amadeus”-Movie] Conclusion It really is not about size or length, is it? It is, I think, about depth . Depth of perception, depth of appreciation, depth of acknowledgement of the sheer vastness of what we do not “know” - yet - but would: (a) “love or like” to know; (b) don’t know and don’t care; or (c) know very well and don’t care!! “ Remove those that are soiled!” (Like Toxic Derivatives) “ But – they are all mixed up together!” (Like Toxic & Other Derivatives)
  162. 162. RESULTS OF ACTIVITY – A SYMPHONY OF OUTCOMES COMMERCIAL, SOCIAL & ECOLOGICAL RETURN & REINVESTMENT WASTE, DAMAGE & DESTRUCTION INNOVATION - CONSUMER SATISFACTION , REINVESTMENT & PRODUCT DEVELOPMENT COMMERCIAL, SOCIAL & ECOLOGICAL CONSUMPTION (SATISFACTION) COMMERCIAL, SOCIAL & ECOLOGICAL (“W.A.M.” PRINCIPLES): IMPORTANT NOTES - SUCCESS CRITERIA AND PRINCIPAL FOCUS OF ATTENTION TO CUT “COSTS”: WHICH OF THESE NOTES WOULD YOU LIKE US TO REMOVE, OR DIMINISH – MR. MAYOR? PERFORMING USEFUL & HIGH-QUALITY ACTIVITIES AT APPROPRIATE PLACES AND TIMES LONG-TERM OPTIMIZATION OF RESOURCE USE (PRODUCTIVITY & WASTE CONTROL) DEBT SERVICE QUALITY OF ENVIRONMENT PAYMENT OF TAXES MAXIMIZATION OF PROFIT QUALITY OF SOCIAL LIFE (SHARP) OPERATIONAL & FINANCIAL RELIABILITY WASTE DISPOSAL PRODUCT & SERVICE QUALITY QUALITY OF LABOR LIFE DAMAGE RECTIFICATION Cost v Quality of Service ♯ ♫♪♫ ♯ ♫ ♫ ♯ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♫ ♯ ♫♪♫
  163. 163. Public and Private Enterprise The essence of “economics-in-community” is very much to provide meaningful and satisfying work, as it is a means to creating: adequate and quality goods and services; decent recreation; and, quiet cultural or spiritual reflection. Yet, the markets for goods and services is rarely emphasized and the market for labor is highlighted only as for a commodity, to the extent that an increase in employment (reduction in unemployment) of ordinary workers might threaten the monetary values of the wealth-tokens of money-traders! Even though the real (economic) values of these tokens are, in effect, zero! [Adapted from: “The Common Good” (Daly & Cobb)]
  164. 164. The Tragic of the Market-Place <ul><li>The (so-called) “market,” almost always, refers to financial or commodity markets. It concerns, almost entirely, the secondary financial or commodity markets, because only a minuscule proportion of this market activity is concerned with the creation of new capital or commodities. </li></ul><ul><li>Ironically, attention is focused almost entirely upon the only category of market transactions which creates no new assets, no material production and no public or private services . Instead, it trades only in the symbols of real economic production, (i.e. MONEY) by the exchange of monetary instruments of ownership (i.e. PAPER). It is a search for enrichment of those who wager on the future values of these symbols. Because this market creates no real resources , participants can only become rich at other people’s expense, including (but not exclusively) other participants in the market. This is known as the “zero-sum” model. </li></ul><ul><li>Participants (in its conversion to a “negative-sum” model) include the commission-seeking brokers, litigious lawyers, tax-gimmicky and creative accountants, credit-rating agencies, merger manipulators, greenmailers, bond dealers, advisers and other unproductive rent-seekers of all kinds. All are, effectively, gamblers . </li></ul><ul><li>[ Adapted from: “The Common Good” (Daly & Cobb)] </li></ul>
  165. 165. REPUTATION AS A MARKET FACTOR Quality P E A 0 C <ul><li>Interest rates. </li></ul><ul><li>Search costs for capital funding. </li></ul><ul><li>Regulation & loan conditions. </li></ul><ul><li>Choice of Public and/or Private Financing or Implementation Entity Partners </li></ul>B D Reputation > (Poor reputation = High costs) (Good reputation = low costs) COSTS
  166. 166. INFORMATION AS A MARKET FACTOR Information Quality VALUATION ACCURACY 0 Information > (Good Information = Accurate Valuation & Pricing) VALUE 100% 100% ( Poor Information = Flawed Valuation & Pricing)
  167. 167. Asymmetrical Information <ul><li>George Akerlof (Nobel Laureate) describes how interaction between quality heterogeneity and asymmetrical information can lead to the disappearance of a market where guarantees are indefinite. As quality is undistinguishable beforehand by the buyer, incentives exist for the seller to pass off a low-quality good as a higher-quality one. The buyer, however, takes this incentive into consideration, and takes the quality of the good to be uncertain. </li></ul><ul><li>Only the average quality of the good will be considered, which in turn will have the side effect that goods that are above average in terms of quality will be driven out of the market . This mechanism is repeated until a no-trade equilibrium is reached. </li></ul><ul><li>As a consequence, markets may fail to exist altogether in certain situations involving quality uncertainty. Examples include the market for used cars, the dearth of formal credit markets [in developing countries(?) (How about the USA – 2008?) ] and the unavailability of health insurance for the elderly and disabled (that is, in the absence of government programs, such as Medicare or Medicaid). </li></ul>The Market for Lemons
  168. 168. Fundamental Accountability Requirements <ul><li>Compute “ Omar’s Car Runs ” costs </li></ul><ul><ul><ul><li>O peration </li></ul></ul></ul><ul><ul><ul><li>M aintenance </li></ul></ul></ul><ul><ul><ul><li>A dministration & Taxes </li></ul></ul></ul><ul><ul><ul><li>R ent : </li></ul></ul></ul><ul><ul><ul><ul><li>C onsumption of capital (depreciation) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Adjustment of value (asset valuation) – including monetary investments </li></ul></ul></ul></ul><ul><ul><ul><ul><li>R eturn on investment (interest, dividends, retained earnings) </li></ul></ul></ul></ul><ul><ul><ul><li>Surplus (to cover): </li></ul></ul></ul><ul><ul><ul><ul><li>R isk </li></ul></ul></ul></ul><ul><ul><ul><ul><li>U ncertainty </li></ul></ul></ul></ul><ul><ul><ul><ul><li>N ew Activities </li></ul></ul></ul></ul><ul><ul><ul><ul><li>S tability </li></ul></ul></ul></ul>
  169. 169. Omar’s Car Runs [When it is Well-maintained] OMAR’S CAR
  170. 170. When Omar’s Car is NOT Well-maintained [IT IS A “LEMON!”] OMAR’S CAR WHAT PRICE WOULD YOU PAY FOR IT? ?
  171. 171. When Omar’s MORTAGE is NOT Well-Serviced : [ Principal and Interest NOT Paid On time and In Full] [IT IS A “LEMON!”] OMAR’S MORTGAGE WHAT PRICE WOULD YOU PAY FOR IT?? ? ?
  172. 172. A MORTAGE-BACKED SECURITY Includes several LEMONS [IT IS “ LEMON ADE !”] OMAR’S DERIVATIVE WHAT PRICE WOULD YOU PAY FOR IT?? ? ? ? ? ? }
  173. 173. When Omar’s HOUSE is NOT Well-Valued : [ And May Not be Well-Maintained] [IT IS A “LEMON!”] OMAR’S HOUSE WHAT PRICE WOULD YOU PAY FOR IT?? WOULD YOU ACCEPT IT AS COLLATERAL?? ?
  174. 174. Collateralized Debt Obligation
  175. 175. A House of Cards [Mortgage-backed Securities]
  176. 176. Collateralized Debt Obligation I’ll Huff and I’ll Puff and I’ll Blow Your House Down!” [The Big Bad Wolf]
  177. 177. A PERFECT STORM? <ul><li>Please spare us the &quot;perfect storm&quot; metaphor. It's hackneyed, for starters. It doesn't square with the facts. And for people who fancy themselves leaders, it's downright unbecoming. </li></ul><ul><li>The reason the perfect storm is such an appealing metaphor for these shipwrecked captains of industry is that it appears to let them off the hook. After all, who can blame you if the ship goes down in one of those freak, once-in-a-century storms that result when three weather systems collide? It's an act of nature that nobody could have predicted – or so the story goes . </li></ul>[© Steven Pearlstein: The Washington Post, December 10, 2008 ]
  178. 178. A PERFECT STORM? <ul><li>The first thing to understand about the perfect-storm defense is that these guys actually buy into this nonsense. </li></ul><ul><li>The rest of us want desperately to believe that what brought us this economic crisis was some combination of greed, fraud and negligence – and, no doubt, there was quite a bit of that. </li></ul><ul><li>What the populist critique ignores, however, is that at the heart of any economic or financial mania is an epidemic of self-delusion that infects…many of the smartest, most experienced and sophisticated executives and bankers. </li></ul>[© Steven Pearlstein: The Washington Post, December 10, 2008 ]
  179. 179. A PERFECT STORM? <ul><li>It's not that they don't see the excesses and dangers in front of them -- how could they not? </li></ul><ul><li>[But] even now, they still can't figure out what they might have done differently , given what they knew at the time and the various pressures they were under. Or put another way, they continue to think of themselves as victims of a perfect storm. </li></ul>[© Steven Pearlstein: The Washington Post, December 10, 2008 ]
  180. 180. A PERFECT STORM? <ul><li>In Junger's gripping account of a shipwreck, that popularized the notion of the perfect storm, Billy Tyne, the skipper of the Andrea Gail, received urgent and repeated warnings that he was heading into what could be a monster storm off the Grand Banks* – warnings that Tyne and his crew chose to ignore. </li></ul><ul><li>[* Pun never intended?? What? Never? Well! Hardly ever!!] </li></ul><ul><li>When it comes to self-delusion, however, Wall Street's top bankers and financiers take the prize…Everyone understood that housing prices and mortgage lending were out of control . What they didn't know was what to do about it. So they convinced themselves that the safer strategy was to keep running with the herd. </li></ul>[© Steven Pearlstein: The Washington Post, December 10, 2008 ]
  181. 181. A PERFECT STORM? NO! A FAILURE OF LEADERSHIP <ul><li>The second thing to understand is that, fundamentally, they're wrong. </li></ul><ul><li>What capsized the economy was no t a perfect storm but a widespread failure of business leadership – a failure that is only compounded when executives refuse to take responsibility for their misjudgments and apologize… </li></ul><ul><li>Until many bankers and dealmakers come clean, my guess is that the growing anger and resentment of ordinary Americans is likely to hamper any government effort to deal with the crisis. </li></ul>[© Steven Pearlstein: The Washington Post, December 10, 2008 ]
  182. 182. “ The Perfect Storm?” Bad “Tempest” or “Bad Temper” [ growing anger and resentment of ordinary Americans]
  183. 183. Conditions of Making Funds Available [Based on an English Prayer from 1662*] <ul><li>Have [some] mercy upon [some of] those miserable sinners </li></ul><ul><li>Spare [only] those which confess their faults </li></ul><ul><li>Restore [only] those that are penitent </li></ul><ul><li>That they may, hereafter, live righteous, honest, ethical and sober lives. </li></ul>[OR] Shall we continue to practice heresy? [Ironically, the author/complier of the Prayer – Archbishop Cranmer – was burned at the stake, in Oxford, England, for heresy! 21 March 1556]
  184. 184. EPILOGUE AND OBITUARY [Boris Fyodorov, a Russian economic reformer, died on November 20, 2008, aged 50] “ Without a moral basis , he (Fyodorov) said, capitalism would just become the means by which the powerful would concentrate their wealth”. “ Mr. Fyodorov used to lament the fact that that even he could not find the right phrase, in Russian, for ‘Corporate Governance’.” “ As a Russian patriot….he detested the practice of simply adapting an English word. Ofshorky (offshore accounts) was a pet hate, particularly because of its association with tax evasion”. [© The Economist: November 29 th 2008 ]
  185. 185. EPILOGUE AND OBITUARY Mr. Fyodorov used to lament the fact that that even he could not find the right phrase, in Russian, for “Corporate Governance”. All those concerned with “Western-style” capitalism must now, also, lament the fact that even they cannot find the right phrase, in English , for “ Corporate Governance!”.
  186. 186. A Nobel Economics Laureate <ul><li>Questioner : Dr. Krugman, what do you intend to do with your $1.4 million Nobel Prize money? </li></ul><ul><li>Paul Krugman : It is now worth only $1.2 million , because of the change in the US$ exchange rate. </li></ul><ul><li>Anyhow, I have not, yet, decided. Right now, I am just trying to find a safe bank , in which to deposit the money, whilst I make up my mind! </li></ul><ul><li>[Paul Krugman (Nobel Laureate): </li></ul><ul><li>Address to the National Press Club – 19, December 2008] </li></ul>

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