“Has Finance Been Fixed? Ten Years After Lehman”

You might have seen the headline in the Economist with the above title. And so, almost everybody is talking about the Global Financial Crisis (GFC) again and what we have learned (or haven’t learned) since.

While financial crises are part of the human story or economic cycle (the IMF states that there have been 124 of them between 1970 and 2007), with the current level of technological tools or human know-how (both Natural Intelligence (NI) and Artificial Intelligence (AI)), we can prevent them or at least, reduce their frequency.

It seems that we continue to miss the point of what needs to be learned or fixed. The Economist’s article and many others just point out symptoms that occur from the malaise. We need to have strong auditing firms who can report the real state of the enterprise (especially when management fails in its mandate) to a solid board of directors who know what they are doing and can act. However, an outstanding in-house financial team is sine qua non.

In an article I wrote and shared with the SEC (excerpts appeared in the August 1999 Edition of the CFO Magazine) – basis for things like the formation of the Public Company Accounting Oversight Board, you would find that some of what went wrong in the GFC were known before hand, except enough action was not taken a priori.

If you went back to the Enron fiasco, as documented in the “Conspiracy of Fools” by Kurt Eichenwald, you would find out that a strong audit team, could have been able to prevent the Enron meltdown, long before it started!

Again, the same is true with Lehman. If Lehman auditors had understood right away the economic ramifications of the accounting treatment of the distressed liquidity instruments (Repo 105 – which was no more than a “Bill and Hold” of sorts in the classical auditing parlance), a timely solution could have been found if the board of directors had acted expeditiously.

With regards to auditors, you might have heard of the travails that the likes of KPMG are going through. I think we need to enhance their independence and they need to ensure that their auditors are well trained (or perhaps well educated, especially in the various exotic financial products). Greed will always be with us.  So, if we are to avert another crisis, we need strong accounting firms and solid board of directors. These are structural issues which fail in all financial crises. Financial education was flagged from the crisis as one of the areas for improvement -- more needs to be done in that regard. We also need to improve board governance.

To create value or preserve value, CFOs need to be aware of these dynamics and act accordingly. Goldman Sachs’ then CFO worked timely with his team to ensure that the firm’s balance sheet was not negatively exposed to the toxic mortgage assets. The audit firms and board of directors can serve as back-stops, if the CFOs and their teams fail to provide the needed financial acumen for value creation or preservation.