Comments on: NY Times: Freddie Overstated Its Capital

By: Matt Dubuque

Matt Dubuque — Sun, 07 Sep 2008 14:15:00 +0000

A principal reason why I have stated for the last several months that we may well stave off the meltdown until February of next year deals with this very issue.

Recall the dramatic downdraft we had in January. This is coincident with a little known fact.

Quarterly earnings reports are not audited. Annual statements, typically issued in January, are.

AUDITED reports, especially after the Enron scandal, are far more probative of a company's ACTUAL financial health. This story deals with the difference between an AUDITED and an UNAUDITED view of a company's balance sheet.

Under current case law, accounting firms are FULLY LIABLE for ALL of the losses not properly represented on AUDITED statements. This means that just one poorly performed audit of a corporate behemoth can wipe out any of the large accounting firms. Again, recall Enron and Arthur Andersen. This case law has not changed.

As yet another sign of their central role in intensifying this crisis, the SEC (NOT the FED) is likely to argue in court against this case law. However, it is by no means clear they will prevail.

Think of Arthur Andersen's extinction at the hands of Paul Volcker and the courts. They were thought to be "too big to fail". Their very public dismemberment chastened EVERYONE working for a large accountng firm.

Because ONLY annual reports are audited, this accounts for why there were so many huge earnings "surprises" in January. Last January, corporate Treasurers were shocked by the intensity and pugnaciousness of the auditing firms, said firms determined not to go the way of their dear friends at Arthur Andersen by failing to include enormous risks posed by asinine derivatives accounting practices in their comprehensive audits.

The story above is but one example why in this current environment quarterly earnings reports are virtually worthless and the ONLY rational accounting treatment occurs from the AUDITED reports, issued every January.

Matt Dubuque

By: Timothy

Timothy — Sun, 07 Sep 2008 10:14:00 +0000

“while not necessarily in violation of accounting rules” will go down in history with the Showa Emperor’s famous admission at the end of WW2 “The situation has developed not entirely to Japan’s advantage” as a world class understatement. I would be really surprised if this does not end up costing at least the high end estimates floating around at present. The can-opener has been deployed now count the worms

By: Anonymous

Anonymous — Sun, 07 Sep 2008 06:25:00 +0000

“We have no plans to insert money into either of those two institutions,” Mr. Paulson said in an interview on NBC’s “Meet the Press” broadcast Sunday from Beijing.

By: Anonymous

Anonymous — Sun, 07 Sep 2008 06:19:00 +0000

Why do you expect a post-mortem? There hasn’t been even talk of a post-mortem of the Bear Stearns fiasco bailout.

By: Independent Accountant

Independent Accountant — Sun, 07 Sep 2008 06:09:00 +0000

Dave:
To answer your question about the CPAs, not being more forceful with F&F, having seen the S&L crisis first hand: because Uncle Sam didn't want those deferred tax assets written down, that's why. Allan Sloan at Fortune had a recent article explaining what's going on, i.e., delay and pray. Why did the Big 87654 firms fail to find the S&L industry was insolvent in about 1983? Because it does what Uncle Sam wants it to do: conceal financial difficulties in large financial firms.
Doc Holliday:
As for the PCAOB, it is a hopeless fraud. I've blogged extensively on the PCAOB.

By: Dave

Dave — Sun, 07 Sep 2008 04:52:00 +0000

This looks a bit more like an accounting “accident” as opposed to accounting fraud. I may not be adding anything to the discussion, but when a firm has losses it generates net operating loss carryforwards which are grossed down to deferred tax assets, or taxes that will not need to be paid in the future. This is a legitimate asset… so long as the company earns enough profit to benefit from it. The problem is that most firms have to put up a “valuation allowance” against the gross deferred tax asset (which yields the NET deferred tax asset) until they prove to their auditors (lots of subjectivity here) that they’ll be able to earn enough pre-tax income to use up the deferred tax asset. My issue is not that either firm did anything illegal, but rather why did their auditors allow them to have such a small (or completely absent) valuation allowance given that they hadn’t been earning any money? While deferred tax asset valuation allowances aren’t an exact science, it doesn’t take a rocket surgeon to see that Fannie and Freddie’s profitability was in doubt. Consequently, these firms should have had to keep a full valuation allowance against their gross deferred tax assets until they could show a couple of years of profitability that justified a positive value. And given the recent losses, a full valuation allowance should have been in effect. That’s not so much Fannie or Freddie’s fault – they’re going to lobby for as much GAAP value as they can get. But why did the auditors give in under the circumstances? Bizarre.

By: mxq

mxq — Sun, 07 Sep 2008 04:41:00 +0000

“….such credits have no value unless the companies generate profits. They have failed to do so over the last four quarters and seem increasingly unlikely to the next year.”

The exact same reason that GM has ended up with a book value of -$102 per share.

The verdict: Syron, Mudd and Raines…4 years re-education through labor. No trial.

By: doc holiday

doc holiday — Sun, 07 Sep 2008 04:00:00 +0000

I’m just amazed at this whole conspiracy to defraud, i.e, where were the regulators, the ratings agencies, the accounting firms, the auditors, The SEC, The FED, OFHEO, the FASB and the highly effective: http://www.pcaobus.org/ ??

— I just don’t buy this: http://www.urbandictionary.com/define.php?term=sack%20of%20shit

Beneath contempt. Worthless. The term is usually used to describe a contemptably dishonest person.

Also see: In Dante Alighieri’s Inferno, the lowest circles of Hell are reserved for traitors; Judas, who betrayed Jesus, suffers the worst torments of all. His treachery is in fact so notorious that his name has long been synonymous with traitor, a fate he shares with Benedict Arnold, Marcus Junius Brutus, and Vidkun Quisling. E.g: Don’t be a Paulson or Bernanke you little snark!

By: Stuart

Stuart — Sun, 07 Sep 2008 03:59:00 +0000

I haven’t seen this anywhere, apologies if it was already discussed. What’s the consensus/thoughts on what this does to Treasuries and the dollar?

By: Yves Smith

Yves Smith — Sun, 07 Sep 2008 03:52:00 +0000

Yes, but they aren’t on a supposed short leash as a result of accounting fraud a mere five years ago.