Government accounting standards fall short

by James McCusker

On the Fourth of July we celebrate a lot of things: our independence, our nation, our flag, each other’s company and our good fortune — past, present, and future.

There are other great things on the list, certainly — hot dogs, ice cream, beer and baseball come immediately to mind — but it is a long list. And yet there are two things that never come up as things to celebrate on this holiday: Government and accounting.

Putting them together as “government accounting” doesn’t help. There is still nothing much to celebrate. To paraphrase Groucho Marx, government accounting is to accounting what government thinking is to thought.

Accounting and financial reporting, though, are at the heart of the economic mess we are in today. They are also at the heart of the financial reform legislation that is now emerging from the Congress. As much as the senators and representatives labored over the high principles and higher politics of financial reform, its success or failure will boil down to the words and numbers of financial reports.

Whether these reports are read and understood, of course, is another matter. No one who has ever bought or sold a house could fail to marvel at all the records, reporting requirements and paper shuffling that accompanies the transaction. Yet none of that was any help in slowing down, let alone preventing, the mortgage-based financial bust, or even in sorting it all out later.

Sometimes financial reporting, as boring as it is, can mean the difference between liberty and imprisonment. The U.S. Supreme Court, for example, has sent Enron CEO Jeffrey Skilling’s case back to lower court because part of his criminal conviction was based on a law that was too vaguely worded to be Constitutional.

Given the world-class mess that Enron made under Skilling’s leadership we might wonder why prosecutors chose to base any part of their case on a vague law that had such a clear risk of being successfully challenged. The answer is that they had to because much of what Enron did was reported in their filed, publicly available accounting and financial statements that no one, including regulators, apparently read. It’s pretty hard to prove fraud when the evidence was routinely disclosed in the public record.

One of the things that the Enron case did was to shine light on the company’s dubious practice of creating “off-balance sheet” assets and liabilities. But while private sector practitioners can risk jail time for this, a strikingly similar practice is routine procedure for many governmental bodies.

Governments — federal, state, and local — have, at best, a curious perspective on accounting, especially when it comes to their own transactions and obligations. The Government Accounting Standards Board develops the principles and practices that governments should use in their financial reports, much as the Financial Accounting Standards Board provides the guidebook and rules for the private sector.

The government board has proposed some new rules for how governments should report their pension fund assets and liabilities. There is a lot of tedious detail involved, of course — such things as when to recognize a liability, the role that statistical probabilities should play, and calculation methods — but there are some fundamentals, too.

It isn’t the details or the fundamentals, though, that have caused the government board to move with tortoise-like speed on the new pension fund accounting rules. It is push-back from the governmental entities themselves.

Pensions in the private sector have been forced to play by the rules for decades, partially at the insistence of Congress. And there really isn’t that much difference between a private and a public pension — except for how it is reported. The reason why the government board has been working on this since 2006 and hasn’t finished the job yet has to be that governments have been using footnotes and some questionable accounting methods as tools to dig a financial hole — and they don’t want to reveal how deep it really is.

The government board proposal would make governments use a reasonable interest rate to calculate the adequacy of their current pension fund contributions. Some states and other government entities have been routinely underfunding their pension obligations for years.

Governments have been using some pretty imaginative rates of interest to calculate the future value of their pension fund contributions. Some have assumed rates of return on their money that only habitual lottery players would find credible.

It is shameful that the government board has to pussyfoot around federal, state, and local authorities who are working so diligently to conceal the facts. The truth is that if we use the accounting standards demanded of private pensions, the 50 state government pensions, taken together, would have to admit being underfunded by at least $3 trillion dollars. No wonder we’re not celebrating.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.