Posts Tagged ‘accounting’
“Risk comes from not knowing what you’re doing”*…
In a follow-on (in a fashion) to an (R)D earlier this month on financialization and gambling, Liz Hoffman on the striking changes underway in the financial sector…
Wall Street is starting to look a bit like a stage drama where nobody is playing the part that casting assigned.
To build a giant Louisiana data center, Meta raised $29 billion in equity from Blue Owl (a firm known for private credit) and private credit from PIMCO (a firm known for public bonds). Google has piles of cash and a red-hot stock, but is instead bringing its pristine credit rating to the deal table, backstopping crypto miners. The $7 billion that KKR and Apollo are putting into Keurig Dr Pepper is “equity” in the sense that it will help KDP reduce its debt load. But it isn’t coming from their traditional PE funds.
You think companies are built with equity and debt? That’s cute, today’s masters of the universe will chuckle while patting your head.
What used to be called simply “investing” or “lending” has been replaced by “capital solutions” — hybrid equity, kickers, and cash flows tailored to match the returns promised to investors on the other side. Growing pots of money now resemble liquid sand, moldable into whatever shape will fit the money hole in front of it. This shift has been obscured by narratives, overcooked in my view, about a battle between private credit and banks: “There’s one system,” Goldman Sachs President John Waldron told me a few weeks ago, and it’s changing quickly.
Goldman reorganized itself along these lines earlier this year… Apollo, one of the original private-equity firms, is now 80% credit… and firms from Chicago buyout shops to Middle Eastern sovereign wealth funds have launched “capital solutions” arms. Lawyers are jumping in downstream.
Prioritizing what companies actually need over whatever widgets Wall Street happens to sell is good customer service. Personal wealth management got a lot better when firms started asking “how much do you need to retire?” instead of “would you like to buy this structured note?”
And the rise of insurance money in investing has created patient capital that in many cases fits those money holes better than blunter instruments. Much of KKR and Apollo’s Keurig investment will end up in their insurance arms, backed by long-term contracts with the coffee-pod maker, people familiar with the matter said.
But flexible capital will almost certainly overflex, and not everyone with “go-anywhere” money should go anywhere. I suspect that before this cycle is over, we’ll see a few instances that leave everyone asking, “why did they own that?”… Sometimes “capital solutions” just code for investing in distressed companies, which is nothing if not a capital problem in search of a solution, trade publication Private Debt Investor wrote…
“What Wall Street’s obsession with ‘capital solutions’ tells us,” from @semafor.com.
[Image above: source]
* Warren Buffett
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As we go back to basics, we might note that it’s International Accounting Day– a celebration of the field on this date each year that commemorates the publication of Luca Pacioli’s seminal work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita, in 1494, which introduced the double-entry bookkeeping system—a foundational element of modern accounting.
“If someone separated the art of counting and measuring and weighing from all the other arts, what was left of each (of the others) would be, so to speak, insignificant”*…
Mathematics, Bo Malmberg and Hannes Malmberg argue, was the cornerstone of the Industrial Revolution. A new paradigm of measurement and calculation, more than scientific discovery, built industry, modernity, and the world we inhabit today…
In school, you might have heard that the Industrial Revolution was preceded by the Scientific Revolution, when Newton uncovered the mechanical laws underlying motion and Galileo learned the true shape of the cosmos. Armed with this newfound knowledge and the scientific method, the inventors of the Industrial Revolution created machines – from watches to steam engines – that would change everything.
But was science really the key? Most of the significant inventions of the Industrial Revolution were not undergirded by a deep scientific understanding, and their inventors were not scientists.
The standard chronology ignores many of the important events of the previous 500 years. Widespread trade expanded throughout Europe. Artists began using linear perspective and mathematicians learned to use derivatives. Financiers started joint stock corporations and ships navigated the open seas. Fiscally powerful states were conducting warfare on a global scale.
There is an intellectual thread that runs through all of these advances: measurement and calculation. Geometric calculations led to breakthroughs in painting, astronomy, cartography, surveying, and physics. The introduction of mathematics in human affairs led to advancements in accounting, finance, fiscal affairs, demography, and economics – a kind of social mathematics. All reflect an underlying ‘calculating paradigm’ – the idea that measurement, calculation, and mathematics can be successfully applied to virtually every domain. This paradigm spread across Europe through education, which we can observe by the proliferation of mathematics textbooks and schools. It was this paradigm, more than science itself, that drove progress. It was this mathematical revolution that created modernity…
The fascinating story: “How mathematics built the modern world,” from @bomalmb and @HannesMalmberg1 in @WorksInProgMag.
* Plato
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As we muse on measurement, we might recall that it was on this date in 1790, early in the French Revolution, that the French Assembly, acting on the urging of Bishop Charles Maurice de Talleyrand, moved to create a new system of weights and measures based on natural units– what we now know as the metric system.
“Never call an accountant a credit to his profession; a good accountant is a debit to his profession.”*…
The estimable Henry Farrell on accountancy as a lens on the hidden systems of the world…
When reading Cory Doctorow’s latest novel, The Bezzle [which your correspondent highly recommends], I kept on thinking about another recent book, Bruce Schneier’s A Hacker’s Mind: How the Powerful Bend Society’s Rules and How to Bend Them Back [ditto]. Cory’s book is fiction, and Bruce’s non-fiction, but they are clearly examples of the same broad genre (the ‘pre-apocalyptic systems thriller’?). Both are about hackers, but tell us to pay attention to other things than computers and traditional information systems. We need to go beneath the glossy surfaces of cyberpunk and look closely at the messy, complex systems of power beneath them. And these systems – like those described in the very early cyberpunk of William Gibson and others – are all about money and power.
What Bruce says:
In my story, hacking isn’t just something bored teenagers or rival governments do to computer systems … It isn’t countercultural misbehavior by the less powerful. A hacker is more likely to be working for a hedge fund, finding a loophole in financial regulations that lets her siphon extra profits out of the system. He’s more likely in a corporate office. Or an elected official. Hacking is integral to the job of every government lobbyist. It’s how social media systems keep us on our platform.
Bruce’s prime example of hacking is Peter Thiel using a Roth IRA to stash his Paypal shares and turn them into $5 billion, tax free.
This underscores his four key points. First, hacking isn’t just about computers. It’s about finding the loopholes; figuring out how to make complex system of rules do things that they aren’t supposed to. Second, it isn’t countercultural. Most of the hacking you might care about is done by boring seeming people in boring seeming clothes (I’m reminded of Sam Anthony’s anecdote about how the costume designer of the film Hackers visited with people at a 2600 conference for background research, but decided that they “were a bunch of boring nerds and went and took pictures of club kids on St. Marks instead”). Third, hacking tends to reinforce power symmetries rather than undermine them. The rich have far more resources to figure out how to gimmick the rules. Fourth, we should mostly identify ourselves not with the hackers but the hacked. Because that is who, in fact, we mostly are….
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… Still, there are things you can do to fight back. One of the major themes of The Bezzle is that prison is now a profit model. Tyler Cowen, the economist, used to talk a lot about “markets in everything.” I occasionally responded by pointing to “captive markets in everything.” And there isn’t any market that is more literally captive than prisoners. As for-profit corporations (and venal authorities) came to realize this, they started to systematically remake the rules and hack the gaps in the regulatory system to squeeze prisoners and their relatives for as much money as possible, charging extortionate amounts for mail, for phone calls, for books that could only be accessed through proprietary electronic tablets.
That’s changing, in part thanks to ingenious counter hacking. The Appeal published a piece last week on how Securus, “the nation’s largest prison and jail telecom corporation,” had to effectively default on nearly a billion dollars of debt. Part of the reason for the company’s travails is that activists have figured out how to use the system against it…
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… In other sectors, where companies doing sketchy things have publicly traded shares, activists have started getting motions passed at shareholder meetings, to challenge their policies. However, the companies have begun in turn to sue, using the legal system in unconventional ways to try to prevent these unconventional tactics. Again, as both Bruce and Cory suggest, the preponderance of hacking muscle is owned by the powerful, not those challenging them.
Even so, the more that ordinary people understand the complexities of the system, the more that they will be able to push back. Perhaps the most magnificent example of this is Max Schrems, an Austrian law student who successfully bollocksed-up the entire system of EU-US data transfers by spotting loopholes and incoherencies and weaponizing them in EU courts. Cory’s Martin Hench books seem to me to purpose-designed to inspire a thousand Max Schrems – people who are probably past their teenage years, have some grounding in the relevant professions, and really want to see things change.
And in this, the books return to some of the original ambitions of ‘cyberpunk,’ a somewhat ungainly and contested term that has come to emphasize the literary movement’s countercultural cool over its actual intentions…
One word that never appears in Neuromancer, and for good reason: “Internet.” When it was written, the Internet was just one among many information networks, and there was no reason to suspect that it would defeat and devour its rivals, subordinating them to its own logic. Before cyberspace and the Internet became entangled, Gibson’s term was a synecdoche for a much broader set of phenomena. What cyberspace actually referred to back then was more ‘capitalism’ than ‘computerized information.’
So, in a very important sense, The Bezzle returns to the original mission statement – understanding how the hacker mythos is entwined with capitalism. To actually understand hacking, we need to understand the complex systems of finance and how they work. If you really want to penetrate the system, you need to really grasp what money is and what it does. That, I think, is what Cory is trying to tell us. And so too Bruce. The nexus between accountancy and hacking is not a literary trick or artifice. It is an important fact about the world, which both fiction and non-fiction writers need to pay attention to…
Eminently worth reading in full: “Today’s hackers wear green eyeshades, not mirrorshades,” from @henryfarrell in his invaluable newsletter Programmable Mutter.
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As we ponder power, we might recall that on this date in 1927, a “counter-hacker” in a different domain, Mae West, was sentenced to jail for obscenity.
Her first starring role on Broadway was in a 1926 play entitled Sex, which she wrote, produced, and directed. Although conservative critics panned the show, ticket sales were strong. The production did not go over well with city officials, who had received complaints from some religious groups, and the theater was raided and West arrested along with the cast. She was taken to the Jefferson Market Court House (now Jefferson Market Library), where she was prosecuted on morals charges, and on April 19, 1927, was sentenced to 10 days for “corrupting the morals of youth.” Though West could have paid a fine and been let off, she chose the jail sentence for the publicity it would garner. While incarcerated on Welfare Island (now known as Roosevelt Island), she dined with the warden and his wife; she told reporters that she had worn her silk panties while serving time, in lieu of the “burlap” the other girls had to wear. West got great mileage from this jail stint. She served eight days with two days off for “good behavior”.
Wikipedia
“Things gained through fraud are never secure”*…
… Still, the damage done to the defrauded is too often too real. A unsettling report from the front lines of financial accounting…
The level of corporate earnings manipulation is similar to that of past pre-recessionary periods, according to research by professors at the University of Missouri and Indiana University.
Their finding is based on the M-Score, a screening model that catches fraud in corporate earnings reports. Messod Daniel Beneish, a professor at the Indiana University Kelley School of Business, created the M-Score in the 1990s. The “M” stands for manipulation, and the measure is also sometimes referred to as the Beneish M-Score.
Based on known examples of past financial misreporting, the M-Score combines eight ratios on a company’s balance sheet to assess its fraud risk. A higher M-Score means a company is more likely to be manipulating its earnings.
“It allows us to assess fraud risk in real time,” said Matt Glendening, an accounting professor at the University of Missouri. “The advantage of using a measure such as the M-Score is that if you use actual instances of accounting fraud, not all cases are caught, especially the less severe cases. And also, there is a delay between the misreporting period and the time at which the fraud is actually revealed.”
One notable M-Score success came in 1998, when a group of Cornell students used the M-Score to flag Enron as having an elevated fraud risk. This was three years before the public learned that the company was inflating its profits, resulting in what was then the largest corporate bankruptcy in history and several executives going to jail.
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Corporate earnings are traditionally manipulated either by overstating revenues or understating expenses. How companies do this varies, but it could include recognizing sales revenues early or understating inventory.
“There are all sorts of capital market pressures on firms to maintain stock price, maintain earnings growth,” Glendening said. “There could also be some compensation incentives at play.”
In 2019, Beneish expanded the M-Score, creating a new measure that goes beyond individual companies to the economy as a whole. With the help of Glendening and two other co-authors, Beneish created the aggregate M-Score, which now compiles the M-Scores of 2,004 companies to measure the likelihood of earnings manipulation across the economy. Earlier in 2023, the aggregate M-Score was at its highest level in 40 years.
“Accounting manipulation matters for the economy at large,” Glendening said. Companies use other business’ earnings data to inform hiring, purchasing, and production decisions. “What we are finding is that the level of aggregate misreporting is very similar to what we’ve observed in pre-recessionary periods.”
Ask not for whom the bell tolls: “This little-known accounting measure is ringing an economic warning bell,” from Kai Ryssdal (@kairyssdal) and Andie Corban on @Marketplace.
See also: “Corporate Fraud” (source of the image above)
* Sophocles
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As we look more closely, we might recall that it was on this date in 1974 that the House Judiciary Committee voted to recommend that America’s 37th president, Richard M. Nixon, be impeached and removed from office for a variety of offenses that arose from the Watergate Affair. Several days later (August 5), as the full house discussed the trial, the “Smoking Gun” tape was released, demonstrating that Nixon was in fact involved in the cover-up. His political capital destroyed, Nixon resigned– in a nationwide television address– on August 8, effective the next day.
“Things gained through unjust fraud are never secure”*…
Mischief is cyclical—it is bred in good times and uncovered in bad times…
The bad news just keeps coming. Ten months after America’s stock market peaked, its big technology companies have suffered another rout. Hopes that the Federal Reserve might change course have been dashed; interest rates are set to rise by more than previously thought. The bond market is screaming recession. Could things get any worse? The answer is yes. Stock market booms of the sort that crested in January tend to engender fraud. Bad times like those that lie ahead reveal it.
“There is an inverse relationship between interest rates and dishonesty,” says Carson Block, a short-seller. Quite so. A decade of ultra-low borrowing costs has encouraged companies to load up on cheap debt. And debt can hide a lot of misdeeds. They are uncovered when credit dries up. The global financial crisis of 2007-09 exposed fraud and negligence in mortgage lending. The stockmarket bust of the early 2000s unmasked the deceptions of the dotcom bonanza and the book-cooking at Enron, Worldcom and Global Crossing. Those with longer memories in Britain will recall the Polly Peck and Maxwell scandals at the end of the go-go 1980s.
The next downturn seems likely to uncover a similar wave of corporate fraud…
The archetypal sin revealed by recession is accounting fraud. The big scandals play out like tragic dramas: when the plot twist arrives, it seems both surprising and inevitable. No simple formula exists to sort the number-fiddlers from the rest. But the field can be narrowed by searching within the “fraud triangle” of financial pressure, opportunity and rationalization…
As Warren Buffett has noted, “you don’t find out who’s been swimming naked until the tide goes out.” Read on for more from @TheEconomist, “A sleuth’s guide to the coming wave of corporate fraud” (a gift article: no paywall).
* Sophocles
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As we contemplate criminality, we might recall that it was on this date in 1997 that MCI and Worldcom announced what was then the largest merger in history, valued at $37 Billion, creating the second largest telecom company in the U.S. (after ATT).
Worldcom, the acquirer, completed the deal in 1998, then continued to grow via acquisition. MCI Worldcom (as then it was) filed for bankruptcy in 2002 (the Dot Com Bust) after an accounting scandal (as referenced above), in which several executives, including CEO Bernard Ebbers, were convicted of a scheme to inflate the company’s assets… which were ultimately acquired by Verizon.
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