Bring Transparency to Off-Balance Sheet Accounting
Abusive off-balance sheet accounting was a major cause of the financial crisis. These abuses triggered a daisy chain of dysfunctional decision-making by removing transparency from investors, markets, and regulators. Off-balance sheet accounting facilitating the spread of the bad loans, securitizations, and derivative transactions that brought the financial system to the brink of collapse.
As in the 1920s, the balance sheets of major corporations recently failed to provide a clear picture of the financial health of those entities. Banks in particular have become predisposed to narrow the size of their balance sheets, because investors and regulators use the balance sheet as an anchor in their assessment of risk. Banks use financial engineering to make it appear that they are better capitalized and less risky than they really are. Most people and businesses include all of their assets and liabilities on their balance sheets. But large financial institutions do not.
Frank Partnoy is the George E. Barnett Professor of Law and Finance and is the director of the Center on Coporate and Securities Law at the University of San Diego. He worked as a derivatives structurer at Morgan Stanley and CS First Boston during the mid-1990s and wrote F.I.A.S.C.O.: Blook in the Water on Wall Street, a best-selling book about his experiences there. His other books include Infectious Greed: How Deceit and Risk Corrupted the Financial Markets and The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall Street Scandals.
Lynn Turner has the unique perspective of having been the Chief Accountant of the Securities and Exchange Commission, a member of boards of public companies, a trustee of a mutual fund and a public pension fund, a professor of accounting, a partner in one of the major international auditing firms, the managing director of a research firm and a chief financial officers and an executive in industry. In 2007, Treasury Secretary Paulson appointed him to the Treasury Committee on the Auditing Profession. He currently serves as a senior advisor to LECG, an international forensics and economic consulting firm.
The views expressed in this paper are those of the authors and do not necessarily reflect the positions of the Roosevelt Institute, its officers, or its directors.