Much of the problems we experienced in the last five years in the US banking sector can be attributed to government changing the accounting rules back in the Clinton administration.
Phil Purcell, former CEO of Dean Witter and then Morgan Stanley after the merger, says that before the accounting change, financial firms could reserve for potential losses during the good times and draw on those reserves during down periods. They lost the ability to do that in the 1990s while Arthur Levitt was chairman of the CEO. Levitt felt the banks were “managing earnings”, sand-bagging results when times were good and cushioning them when things were less robust.
He changed the rules so that banks had to report profits as they accrued and the same for losses. So the system went from being counter-cyclical to cyclical, with drastic results.
Think of the global deleveraging we have seen from the banks over the past five years. If they had been able to draw on reserves built up during the boom , we may not had as nearly deep a bust.
Sort of undermines the “greedy banker” stereotype, slightly.
