Friday :: Oct 22, 2010

Open Thread

by Mary

Dan Froomkin had an important interview with William K Black about the invasive fraud that is eating away at the heart of the US economy. One of the links in this piece discussed the control fraud that has been baked into our system since the Savings & Loan crisis.

Control fraud theory was developed in the savings and loan debacle. It explained that the person controlling the S&L (typically the CEO) posed a unique risk because he could use it as a weapon.

The theory synthesized criminology (Wheeler and Rothman 1982), economics (Akerlof 1970), accounting, law, finance, and political science. It explained how a CEO optimized “his” S&L as a weapon to loot creditors and shareholders. The weapon of choice was accounting fraud. The company is the perpetrator and a victim. Control frauds are optimal looters because the CEO has four unique advantages. He uses his ability to hire and fire to suborn internal and external controls and make them allies. Control frauds consistently get “clean” opinions for financial statements that show record profitability when the company is insolvent and unprofitable. CEOs choose top-tier auditors. Their reputation helps deceive creditors and shareholders.

The sad thing is nothing has been done to really change the rules that pervert the incentives CEOs have in cooking the books since the 90s. Once this behavior is baked in, others downstream start to look out for their opportunity. And soon you have the mortgage crisis which ate the world. No wonder things have just gotten worse.

Mary :: 12:00 AM :: Comments (3) :: Digg It!