Interesting question on many levels. By not writing "every other serious finance economist" implies that both S&P economists and Allan Greenspan are not "serious". Buffet may be serious, but not an economist, a fianacier who holds a low opinion of economics. Another question is what is a finance economists? Are they economists who teach in the finance department of business schools, or who work for financial institutions?
Krugman has an incomplete understanding of stock options. For new companies, stock options are a way to reduce start-up cost by keeping management salaries low and tying performance to compensation. When stock options do not work out, exceutives suffer opportunities cost. Many executives borrow against the option values and are saddled with huge debts personally when their companies collapse. But the real rationale of executive options is rooted in the American star system. Like financing a movie, a company's share value is directly affect by the star quality of its chief. Like a star studded movie, the actual performance is a secondary risk. Often the star billing itself would generate enough pre-opening advanced sales to reduce or neutralize the risk of the venture, making the rest pure gravey. When a company hires a star chief executive, the immediate impact on share value often more than justifies the cost of the new chief's compensation package.
The real problem of corporation accounting has nothing to do with executive options, because options are fairly value determined. The trouble is with the system's profit incentive. When profit can be created by layoffs and creative accounting, layoffs and creative accounting will happen. It is a systemic issue, not personal morals of executives who are warrior aiming at the prize. They are merely thoroughbred trained to race to win. If the prize is public good, executives will achieve it and if it is public destruction, they will also achieve it. The prize in finance capitalism is creative destruction and legalized fraud. And the results are to be expected.
The trouble with US corporate accounting is the inability to evaluate true risks brought about through market deregulation and structurted finance. The rating agencies themselves are part of the problem. The Chairman of Moody was on the board of WorldCom which has the distinction of being the mother of creative accounting, all with impecable Moody ratings on its junk bonds which now trade a few cents on a dollar. The reason accountants and rating agencies wield so much power is because finance capitalism is all "air ball" financing - loans based on pro forma future cashflow rather than hard assets or real current profits. Ratings determines credit access and cost which translates in profits, since the economy now mainly produces mainly profit and all else (real products) are imported, and profit in finance is a function of interswt rate spread which theoretically is a function of risk. Structured finance has increased the opaqeness of risk distribution, forcing a mismatch of credit ratings and market analysis with reality. The greatest fear the SEC has is that at the end of the day, after all the investigations, it will find that all had been done legally even if unethically, as the Enron trial (which deals only with obstruction of justice, not financial fraud) is beginning to show. If no law had been violated, then the system of de-regulated markets is rotton to the core, a fact that will shake the foundation of 2 decades of neo-liberalism. Free market means open season for legalized robbery.
Greenspan has become a stealth Chartalist. He pumps liquidity into the system to support the equity and debt markets since the beginning of 2001 and like a drunken sailor after 9:11, and he credits the floating balloon to "productivity". Of course productivity can rise exponentailly if the economy stops making products and makes only profits with bogus trades, and asset appreciation will entered not as inflation but as growth and wage declines are taken into part of the inflation calculation. But Greenspan frogets that the State Theory of Money does not work unless it produces full employment a high wages to absorb the overcapacity. Without overcapacity, the application of the STM will produce hyperinflation, and without full employment a rising wages, the STM will exacerbate overcapacity toward the creative destruction of wealth.
Henry C.K. Liu
Krugman talks more like a cosmetic embalmer than a faith curer
Cui Zhiyuan wrote:
May 17, 2002 New York Times
America's Poor Standards
By PAUL KRUGMAN
n Tuesday Standard & Poor's, the private bond rating agency, announced that it would do something unprecedented: It will try to impose accounting standards substantially stricter than those required by the federal government. Instead of taking corporate reports at face value, S.&P. will correct the numbers to eliminate what it considers the inappropriate treatment of "one-time" expenses, pension fund earnings and, above all, stock options ? a major part of executive compensation that, according to federal standards, somehow isn't a business expense. S.&P.'s estimate of "core earnings" for the 500 largest companies slashes reported profits by an astonishing 25 percent.
Why does S.&P. ? along with Warren Buffett, Alan Greenspan and just about every serious financial economist ? think that current accounting standards require a drastic overhaul? And if such an overhaul is needed, why doesn't the government do it? Why does S.&P. think that it must do the job itself?
To see the absurdity of the current rules, consider stock options. An executive is given the right to purchase shares of the company's stock, at a fixed price, some time in the future. If the stock rises, he buys at bargain prices. If the stock falls, he doesn't exercise the option. At worst, he loses nothing; at best, he makes a lot of money. Nice work if you can get it.
Yet according to federal accounting standards, such deals don't cost employers anything, as long as the guaranteed price isn't below the market price on the day the option is granted. Of course, this ignores the "heads I win, tails you lose" aspect: executives get a share of investors' gains if things go well, but don't share the losses if things go badly. In fact, companies literally apply a double standard: they deduct the cost of options from taxable income, even while denying that they cost anything in their profit statements.
So how could it possibly make sense not to count options as a cost? Defenders of the current system argue that stock options align the interests of executives with those of investors. Even if that were true, however, it wouldn't justify ignoring the cost ? no more than it would make sense to deny that wages, which provide incentives to workers, are a business expense. Furthermore, it's now clear that stock options, far from reliably inducing executives to serve shareholders, often create perverse incentives. At worst, they handsomely reward managers who run their companies as pump-and-dump schemes; executives atEnron and many other companies got rich thanks to stock prices that soared before they collapsed.
Options are only part of an accounting system in deep trouble. As David Blitzer, S.&P.'s chief investment strategist, recently wrote, "Financial markets are as much a social contract as is democratic government." Yet there is a growing sense that this contract is being broken, undermining the trust that is so essential to the operation of financial markets. Clearly, major reforms are needed. And bear in mind that this isn't a left-right issue; it's about protecting investors ? middle-class and wealthy alike ? from exploitation by self-dealing insiders. So who could possibly be opposed? You'd be surprised.
Harvey Pitt, the accounting-industry lawyer who heads the Securities and Exchange Commission, has clearly been dragging his feet on reform. And his boss, George W. Bush, has declared himself opposed to treating stock options as a business expense. Wouldn't it be nice, just once, to see the Bush administration oppose the interests of a privileged elite?
But the administration is not alone in its foot-dragging. In fact, perhaps the biggest foot-dragger of all is Senator Joseph Lieberman. Way back in 1994 Mr. Lieberman gave crucial aid to lobbyists trying to head off new accounting standards, which would have forced companies to recognize the cost of options; now he is once again defending the status quo, urging his colleagues to go slow.
Some politicians do see the problem; John McCain and Carl Levin have introduced legislation to reform America's accounting standards. But it seems unlikely that government will fix our dysfunctional accounting rules anytime soon.
Mr. Blitzer of S.&P. points out that in previous periods of corporate scandal, "legislators and prosecutors took the lead in tackling public concerns over the market." It is a sad commentary on our leadership that this time he feels that he must do the job himself.