Monday, October 12, 2009

Frightening Update

I recently wrote about how frightening the financial situation of the United States was. How could it be that an entity as complex as the United States economy could employ cash based accounting, the same method used by hot dog stands?

After posting that blog I had breakfast with one of my oldest and best friends. I met him early in my engineering career. We branched in graduate school after both of us completed Masters degrees. I went on with mechanical engineering, while he pursued an MBA. We branched again when I abandoned engineering and ran down the software track.

We've managed to stay in contact in spite of the fact that we no longer work together. We'd meet for lunch until the noon hour stopped being considered a sacred "meeting free" time. Then we switched to monthly breakfasts before work. These are coffee-fueled discussions about all our favorite topics - engineering, politics, religion, movies, sports. I can't think of many people in my life with whom I could spend an hour this way. I look forward to them like nothing else.

My friend is a dyed-in-the-wool leftie who's against all things Republican. I tend to be left of center as well, but it's easier for me to slip into "a pox on both your houses" mode when I think that Democrats aren't living up to their ideals. It's a position that's easy to assume these days. Except for the change in tone I don't see much difference between the current administration and the Republican regimes of the last eight years, with two wars in progress and being funded by "off budget" expenditures, the Treasury taken over by Goldman Sachs, the Patriot Act in place, Glass-Steagall rolled back, and Guantanamo in operation.

During our last breakfast I relayed the essence of my distress: Why doesn't the US government use GAAP? I thought myself very clever when I said that cash based accounting made us no better than a hot dog vendor.

My friend drew on the wellspring of knowledge he accumulated during his MBA and shot me down: "Cash-based accounting is the most honest form there is. You look into the till and report on how much cash you see!" He pointed out that GAAP is loaded with loopholes and tricks. Depreciation makes all kinds of shenanigans possible.

My argument was shot down. I was an easy target, because I've never studied accounting.

I'd appreciate it if someone could explain to me where I went wrong. I realize that it won't be possible to relate or absorb such a vast subject in the space of a web comment, but I could use a nudge in the right direction.

Perhaps the real answer is that no accounting system is a guarantee of honesty and transparency. Scandals too numerous to list, such as Baan, Enron, etc., have taught us that outright lying can be done using any accounting system. GAAP won't stop you from booking loans as income, or moving sales back from one quarter to another to make a bad quarter look better, or shipping product to a warehouse you own and treating them as sales, or ignoring an IOU to Social Security and Medicare because you spent the cash accumulated within back in the Vietnam days.

The real problem isn't the way the Congressional Budget Office is tallying the numbers. It's the way we're misled about what the numbers are in the first place.

One reason for the housing boom is people taking on debts beyond their means, assuming that the value of the house would always appreciate at a rate that would make it possible to flip the house at a profit before paying for it became a problem.

I think our current fiscal situation is based on an equally flawed assumption: that the United States will always be the world's pre-eminent economic power, that the rest of the world will never catch up, that our economy will always continue to grow fast enough to make it possible to pay off the obligations we're piling up.

I keep waiting for the Obama administration to start telling us the truth, but it's like waiting for Godot.

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