The Great Debate

from David Cay Johnston:

A history of audit failures

The author is a Reuters columnist. The opinions expressed are his own.

The admission by Olympus Corp that it falsified financial reports for more than a decade should not shock anyone. The shock is that, for years, auditors failed to detect such massive fraud.

The failures of auditors to uncover cooked books, which run the gamut from Adelphia to Waste Management Inc, are a cancer on the accounting industry.

The failures go back years. How about Al Dunlap's manufactured numbers at Sunbeam in 1998? Or teenage con man Barry Minkow's ZZZZ Best, which turned out to be a Ponzi scheme and collapsed in 1987? Or Equity Funding, with its computer program to fabricate life insurance policies, in 1973? Or the National Student Marketing "pooling of interests" fraud in 1970, which gave birth to the Financial Accounting Standards Board? Or the 1938 McKesson & Robbins scandal, which gave us the first American audit standards? Or Ivar Kreuger's 20 percent dividends Ponzi scheme in 1932?

That is but a sampling of big frauds that auditors somehow failed to detect, sometimes over many years during which they were supposedly scrutinizing books and looking for verification of revenue and assets.

Olympus's major businesses include building endoscopes, which let surgeons peer inside the body. How ironic that Olympus's financial lies festered unseen for more than a decade.

Everyone’s housing market profits were fictitious

By Maureen Tkacik
The opinions expressed are her own.

Also read part one of this series, How Ed DeMarco finally cried fraud.

A big clue something had become dysfunctional at Fannie Mae and Freddie Mac came in the first week of 2011, when the government mortgage market makers announced the terms of a settlement agreement they’d reached with Bank of America, and were immediately pilloried for extending the bank another “backdoor bailout” by the likes of Maxine Waters and the American Enterprise Institute.

By the end of January an internal investigation had convened, all other settlement negotiations had been suspended, and Edward J. DeMarco, the acting Fannie/Freddie overseer pending the confirmation of his replacement, found himself suddenly faced with the challenge of replacing himself as congressional Republicans vowed to stonewall Obama’s pick. Part one of this series traced DeMarco’s unlikely conversion in 2011 from coddler of banks to unyielding litigator of bank fraud. It’s a rare shift in Washington, where “corruption” is a process that’s practically synonymous with “aging.” What’s often forgotten when bureaucrats fail as spectacularly as they have at Fannie and Freddie is the critical roles played by cluelessness, incuriosity, faulty reasoning and fraudulent economic logic as well.

Consider what the inspector general learned about the corporate procedures for pursuing “putback” claims in place at Freddie Mac. While purchase contracts entitle the GSEs to force banks to buy back any delinquent loan in which it finds evidence of fraud, Freddie restricted examiners to screening only mortgages which had defaulted within two years of origination, a tiny sliver of total foreclosures comprising less than one-tenth of defaults from the years 2004 to 2007—the vintage of the Countrywide loans. When one of DeMarco’s deputies noticed this apparent oversight and began warning executives that “Freddie could passively be absorbing billions of dollars of losses” merely by refusing to glance at 90% of their files, the enterprise … chose to absorb the losses, repeatedly resorting to a boilerplate argument justifying the two-year policy holding that: