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The Joy of Regulation
Sep. 16th, 2005 10:01 amOne thing my job entails is looking at government and administrative regulations that make requirements on businesses (particularly the business I work for.) For me, this is primarily the Payment Card Industry Data Security Standard, which isn't a government regulation at all but rather a regulation Visa and MasterCard are imposing on any firm that accepts them in large numbers.
However, this results in me keeping up with the news on other regulatory compliance issues, too, since I regularly talk to external auditors. And let's just say that this has not increased my faith in the government to create useful regulations (not that I had any to begin with.)
Sarbanes-Oxley was a massive law passed to prevent corporate accounting fraud of the kind that brought down Enron, WorldCom, and Tyco. In addition to the much-talked-about accountability requirements (CEOs being personally responsible for the validity of the company's financial statements), it included rigid accounting requirements on practically everything.
The problem is that the government didn't bother to take reality into account when developing these. The cost of compliance has been in the tens or hundreds of billions of dollars as everyone restructures all their corporate accounting to meet the new decree. But sometimes it mandates doing stupid things.
For example: banks are aware there is a credit cycle. When interest rates are low and the economy is booming, they lower their lending standards and give out a lot of loans. They also store up a large bad-debt reserve. When interest rates go up or the economy slows down, loans start going bad, so the banks raise their lending standards, give out fewer loans, and then use the money in the bad-debt reserve to remain solvent during the downturn.
Sarbanes-Oxley prohibits planning. You can't keep a bad debt reserve unless you can individually identify which loans are going to go bad and earmark funds only for those. Of course, if the banks knew which loans were going to go bad they wouldn't have made them to begin with.
The idea is that a loan-loss reserve "hides" bad loans from investors, since they don't show up on the income statement. But Sarbanes-Oxley doesn't take into account that banks don't just do this to make themselves look better -- they do it because to do otherwise risks rendering them insolvent. If bad loans outstrip the reserve, they start eating into operating funds; too much of this and the bank's credit rating is impacted, rendering it unable to borrow money to cover the bad loans, leading to a sort of government-induced banking death spiral.
Most banks will probably find a way to work around this. But the whole idea of Sarbanes-Oxley was to stop "creative accounting" and working around regulations. Instead we just get mandated creative accounting and working around regulations... and we get to pay billions for it.
However, this results in me keeping up with the news on other regulatory compliance issues, too, since I regularly talk to external auditors. And let's just say that this has not increased my faith in the government to create useful regulations (not that I had any to begin with.)
Sarbanes-Oxley was a massive law passed to prevent corporate accounting fraud of the kind that brought down Enron, WorldCom, and Tyco. In addition to the much-talked-about accountability requirements (CEOs being personally responsible for the validity of the company's financial statements), it included rigid accounting requirements on practically everything.
The problem is that the government didn't bother to take reality into account when developing these. The cost of compliance has been in the tens or hundreds of billions of dollars as everyone restructures all their corporate accounting to meet the new decree. But sometimes it mandates doing stupid things.
For example: banks are aware there is a credit cycle. When interest rates are low and the economy is booming, they lower their lending standards and give out a lot of loans. They also store up a large bad-debt reserve. When interest rates go up or the economy slows down, loans start going bad, so the banks raise their lending standards, give out fewer loans, and then use the money in the bad-debt reserve to remain solvent during the downturn.
Sarbanes-Oxley prohibits planning. You can't keep a bad debt reserve unless you can individually identify which loans are going to go bad and earmark funds only for those. Of course, if the banks knew which loans were going to go bad they wouldn't have made them to begin with.
The idea is that a loan-loss reserve "hides" bad loans from investors, since they don't show up on the income statement. But Sarbanes-Oxley doesn't take into account that banks don't just do this to make themselves look better -- they do it because to do otherwise risks rendering them insolvent. If bad loans outstrip the reserve, they start eating into operating funds; too much of this and the bank's credit rating is impacted, rendering it unable to borrow money to cover the bad loans, leading to a sort of government-induced banking death spiral.
Most banks will probably find a way to work around this. But the whole idea of Sarbanes-Oxley was to stop "creative accounting" and working around regulations. Instead we just get mandated creative accounting and working around regulations... and we get to pay billions for it.
