I wish that someone would read this essay to Bernanke, Geithner and Blankfein as the biggest loudest rant of them all. It should be played like “Noriega music” until it recreates the insanity which has been brought to us by these “fine gentlemen.”
The War against the Regulatory Cops on the Bank Beat
By William K. Black - New Economic Perspectives (posted by Devin Smith)
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Epidemics of accounting control fraud and the bubbles they hyper-inflate are the Achilles’ heel of econometrics, neo-classical economic theory, and neo-classical praxis. They all become perverse in the control fraud context. Accounting control fraud is a “sure thing” – it is guaranteed to lead to record reported (albeit fictional) income in the near term. This causes econometric studies to report mythical results. Whatever business practices best aid accounting fraud will have the strongest positive correlation with reported income – until the frauds collapse and the true (negative) “sign” of the correlation between accounting fraud and income emerges in the “hard data.” The real sign of the correlation emerges far too late for effective supervisory intervention and policy reforms that could end the criminogenic environment. During the critical years that the fraud epidemic and bubble could be stemmed, econometric studies based on “hard data” will support the worst possible policies. They will suggest that all is well – the frauds are highly profitable. Economists will argue that the agency should encourage the business practices that optimize accounting fraud. When there is an epidemic of accounting control fraud, econometricians will be the last to recognize idiosyncratic and systemic risk. Bank examiners will, as always, produce the earliest warnings of idiosyncratic and systemic risk and failures.
Any regulator who believes that the numbers provided by banks and their non-independent professionals are “hard data” is a regulator who will fail catastrophically. Believing that fiction is fact fits into two of the Fed’s greatest weaknesses – it relies on economists and econometrics to drive supervision and policy. The Federal Reserve economists believe in the perennially falsified economic dogma of markets that automatically exclude fraud.
The LIBOR and HSBC scandals simply confirm that the largest banks in the world will repeatedly violate the law and lie if they believe they can get away with it. The only entity that should consistently have the incentive to tell senior regulators the truth about problem and fraudulent banks are the examiners. Similarly, banks with honest senior leaders should love the independence of examines. Blankfein is right about examiners – they “don’t work for us.” That is why they are uniquely valuable. Examiners routinely speak truth to power. The author has no clue how rare and how valuable that is to an honest bank’s senior managers, to senior regulators, and the nation. The author also has [an] idea how threatening a trait it is to the CEO running a control fraud.
Read the entire essay here
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