A recent reading of the December Esquire magazine grabbed my attention. The main investigative article – by Stephen Armstrong - in the edition looked at the role of the “NatWest 3” and Enron as it may – or may not – relate to the current market volatility. The article starts with the idea that the three may have been responsible for the Credit Crunch.
Don’t misunderstand this, the NatWest 3 did not do this alone. They were simply at the forefront of the market in borrowing money in an off-balance sheet way that was located in an offshore jurisdiction. As their ideas caught hold, more and more firms copied their methods and hid their debts as footnotes in their accounts. Enron – as we know – went further and faster than was prudent and it all collapsed.
But with this accounting magic, many other firms have manipulated their balance sheets and - therefore by definition – their stock price. The consequences are here for all to see. Banks and insurance companies are in chaos, many on the verge of bankruptcy or facing massive losses. Whilst these loans may have been “off the books”, it was still a loan. If it needs instant repayment – as many have been – then someone, somewhere needs to take notice.
Footnote or not, these are real debts.
The upshot of much of this was that a company was able to invest money profitably and book those profits, but at the same time use leverage (borrowing) to enhance the returns. Profits were booked and loans were hidden. If you are thinking that this might not be prudent behaviour from a banker, then you might well be right.
However, there were a few things that caught my eye about this article. The first was that Esquire had a couple of quotes from one of the ‘Three”, David Bermingham, who is currently incarcerated in the Unites States. The second was the nature of his quotes. Firstly, he says that these types of accounting steps are not illegal. In fact, many governments use them in their own accounting practices.
In 2006, Bermingham was quoted as saying, “The British government has more off-balance-sheet debt by a factor of 20 than Enron ever did; the new Channel Tunnel Rail Link, all the private finance initiative stuff - you name it. Gordon Brown has been the single greatest off-balance-sheet financier in the history of this country. That doesn’t make it illegal. There’s nothing illegal about what Enron were doing in terms of off-balance-sheet financig. It’s been given a very dirty context because Enron went so spectacularly bust. But the thing that it does do is to obscure to a degree the full picture.”
Wow! Did you realise that Gordon Brown was the king of this style of accounting? No? Me neither. I bet the UK public isn’t aware either. In terms of the large amounts of money currently being discussed with relation to bank bailouts, tax cuts and ‘stimulus’, this could be a frightening further twist in the story of his record as Chancellor and Prime Minister.