Conservative Donnybrook

I dropped into a local watering hole with a buddy last night and the conversation, as it regularly does, turned to the financial crisis. He made a suggestion that I thought was pretty brilliant. Why not eliminate accrual accounting? For those without an accounting class under their belt, there are two types of accounting methods that businesses use to account for income: cash basis and accrual basis. Cash basis is the most intuitive to understand. If I contract to paint another person’s house next spring, I report the income when I have completed the job and the homeowner sends me a check. Once I have the cash in hand, it gets reported on my balance sheet. Accrual basis, on the other hand, would allow me to report that income on this year’s balance sheet on the theory that once the contract is signed, it is an asset with value equal to the receivables I anticipate.

In large part, it seems this is what has been occurring with the banks. They have written a number of mortgages and reported the income from them on their balance sheets. The fat balance sheets look attractive to investors and so investment monies pour in. Nonetheless, as we have now learned, many of those loans were not worth the paper they were written on because the homeowners were never able to pay them back. The financial institution benefited by the inflow of income from investors in the short term, putting the onus of the inevitable loss on those investors. If the banks had been required to report income on a cash basis, they could not have reported income on bad loans. Loans which were in default, therefore, would have been conspicuous on the balance sheets for their absence – indeed, they would have shown a loss. Investors would have been better informed of the true nature of the company’s financial situation and may have demanded a resolution to this problem well before it got to the point where the institutions were in collapse. Indeed, there may have never been the need for a bailout had investors been aware of the state of the companies’ loans allowing them to demand stricter lending criteria from the institutions early on.

Another idea this buddy proposed when the first round of bailouts was announced was the requirement that the banks actually loan all the bailout money to consumers. It seems simple, but Congress made no such requirements in all the “oversight” they placed on the banks. As a result, we have seen, the banks used the money to purchase other banks and the credit crisis was largely unresolved. Now that Obama is pushing for the other half of the TARP money to be released, I seriously hope it will be under the proviso that the banks can only use the money for loans to consumers. If Congress were to do that, it might even alleviate some of the problems that GM and Chrysler are facing by making money available to people who want to purchase one of their vehicles.

I saw a news story last night where it was being reported that President Obama promised up to four million new jobs as a result of his proposed $825 billion stimulus package. I’m no economist, but I do have a calculator. It seems to me that the government would be paying more than $206, 000 for each of those jobs. Assuming that Obama would want those jobs to last for four years – at least through the end of his first term – the government could simply hire four million people and pay them $51,000 a year or nearly $25 an hour for that money. Being all indirect and creating a package seems a little screwball to me when the exact same money could be used directly to hire the folks that Obama wants to employ. In fact the cost of the stimulus would have the added benefit of being spread over four years and would have the virtue of doing exactly that which was promised by employing four million new employees. He just needs to figure out what these people should do for $25 an hour.