The Accounting Trick Behind Thirty Years of Scandal

The Accounting Trick Behind Thirty Years of Scandal | Business | TIME.com

America has been afflicted with one financial scandal after another over the past generation – culminating in the 2008 financial panic, the effects of which we are still suffering under. It has widely been assumed that each of these scandals have had disparate causes, but in their new paper Bratton and Levitin argue that three of the most notorious scandals of the past generation — Michael Milken’s junk-bond-related securities fraud in the 1980s, the Enron scandal of the early 2000s, and the subprime mortgage meltdown of 2007-08 — are all linked by their use of an esoteric accounting mechanism called a “special purpose entity,” or SPE. When used dishonestly, SPEs are nothing more than financial sleight of hand, the clever shifting around of assets to trick regulators and investors into seeing something that isn’t there.

With weakened I-O regulation the Iv-B economy becomes more deceptive, here it grows exponentially with secret cracks into special purpose vehicles. Because of compeititon those that don't do this fall behind and can be taken over, so honest accounting is driven out of the system.

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So what exactly are SPEs? Broadly speaking, they are legal entities that are separate from the firms that have created them. They can hold assets and owe debt, but as Bratton and Levitin write, “they never fully coalesce as independent organizations that take actions in pursuit of business goals.” They are companies running on autopilot that serve one purpose: removing assets and liabilities from the parent company’s balance sheet.

Companies can use SPEs for legitimate purposes. For example, an oil company might want to finance an expensive and risky exploration project without putting the whole firm at risk of its failure. So they’ll set up an SPE with limited resources, put only those resources at risk in pursuance of the new project, and fully disclose the arrangement to potential investors. But as Bratton and Levitin’s paper shows, special purpose entities can be — and frequently are — a recipes for disaster.