Corporate finance executives, along with the rest of the world, have in recent days been caught mumbling a big question: What just happened?
While the immediate answers sounded hyperbolic — perhaps appropriately so — a longer-term answer raises difficult questions for corporate finance executives wondering how to reforecast 2008 budgets while looking ahead to other, more daunting, regulatory changes on the horizon.
The Wall Street Journal, for example, described the federal government's orchestration of Bear Stearns's fire sale to JPMorgan Chase as the culmination of “Ten Days That Changed Capitalism.” In the news coverage that followed, Ed Yardeni was quoted almost as frequently as U.S. Treasury Secretary Henry Paulson and U.S. Federal Reserve Chairman Ben Bernanke. Yardeni, the president of his own investment strategy research firm, was cited in numerous articles in columns for his catchy summation of Paulson and Bernanke's collaboration: “The Government of Last Resort is working with the Lender of Last Resort to shore up the housing and credit markets to avoid Great Depression II.”
While most financial services experts agree that this intervention qualifies as historic, the majority of CFOs, controllers, and other corporate finance executives face more pressing challenges than digesting Wall Street's woes. Namely, they need to respond to the economic upheaval and monitor potentially momentous regulatory changes — including one that does not figure among the changes outlined in the Treasury Department's recently released “Blueprint for a Stronger Regulatory Structure.”
SUBPRIME IMPACT
As pundits and politicians parse the collapse — or bailout, depending on your bent — of Bear Stearns, finance executives are readjusting their planning, forecasts, and budgets in light of a macroeconomic environment that's beginning to resemble the 1970s more (right now, anyway) than the 1930s.
“The average CFO or controller will probably see the greatest impact in terms of their budget — what they set for their 2008 budget last fall probably looks optimistic right now,” notes Lynn Turner, former U.S. Securities and Exchange Commission (SEC) chief accountant. “They will have to spend during the next few months in readjusting their budget and trying to figure out where this takes them. I think that this is probably the biggest issue for all of them. What do 2008 and 2009 look like?”
These questions have arisen because the economic climate in the U.S., and possibly in much of the rest of the world, looks more than a little like it did for the 1972-1973 market crash. That downturn, which included the bankruptcy of a large and highly visible company (Penn Central), lingered for years.
In the short term, the U.S. economy may enjoy a brief goosing when many taxpayers receive their $600 checks from the IRS. However, many growth obstacles also loom, including the dollar's devaluation, soaring oil prices, inflation, and the possibility of the European markets succumbing to economic pressure (and a real estate bubble of their own in several areas).
Figuring out what 2008 and 2009 look like from a revenue and expense perspective poses a steep challenge for corporate finance. “Reforecasting everything is a very, very difficult job for CFOs and controllers,” Turner says. “They have cost increases coming through that they probably can't pass through entirely. They have inflationary costs coming at them. And, finally, the terrain ahead very much remains an unknown.”
BLUEPRINT PROS AND CONS
The fate of the blueprint for regulatory reform also remains unknown, although most handicappers are laying long odds that the most substantial recommendations in the 218-page document develop into full-blown legislative and/or regulatory changes.
Reactions to the blueprint, many of which break down along political lines, range from “dead in the water” to “a needed, thoughtful, and comprehensive plan to modernize and streamline the financial regulatory structure.”
The U.S. Chamber of Commerce applauded the blueprint. New York Times business columnists Nelson Schwartz and Floyd Norris noted that much of the regulatory oversight proposed in the blueprint “would have a light touch, enabling the government to do little beyond collecting information, except in a time of crisis.”
The timing of the blueprint's release is unfortunate for two reasons. First, some confused the lengthy proposal, which appeared a week after Bear Stearns's collapse, as a direct response to the subprime crisis. While the blueprint does seek to remake the U.S. regulatory structure in light of the complexities that helped to foment the subprime credit crisis, it came out of a debate last year on ways to make U.S. companies, burdened by regulatory compliance requirements, more competitive globally. Second, there appears little likelihood of the blueprint's more substantive recommendations being seriously considered, much less enacted, prior to the November presidential elections.
U.S. Rep. Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, described the blueprint as “a very constructive step forward in this important debate” and also stated that this debate “cannot be concluded before the election.” Frank's constructive initial response appeared refreshingly free of political machinations. And his description of the blueprint as potential facilitator of a necessary debate was difficult to refute.
“The blueprint's initial stated objective is to align the regulatory regime more directly with the way products and services are being offered in the market and structured in the market,” notes Scott Mitchell, chairman and CEO of the Open Compliance & Ethics Group (OCEG). “I don't think that anybody could disagree with that.” Whether or not the current blueprint represents the best way of executing this objective is another question, Mitchell says — but not one that most finance executives outside the financial services industry need to concern themselves with right now.
BIGGER THAN ANY BLUEPRINT
“If you are a CFO or a controller, I'm not so sure that the blueprint is something you should focus on,” Mitchell says. “The blueprint should be of interest to you as a financial services professional because it affects the way our financial markets will be supervised and regulated. But for other finance executives who return to the office on Monday, it won't affect them one iota.”
Mitchell and others suggest that CFOs and controllers monitor other regulatory developments, including the SEC's coming decision on International Financial Reporting Standards (IFRS) and the use of extensible business reporting language (XBRL) in financial reporting.
This summer, the SEC is slated to decide whether and how publicly listed U.S. companies should follow IFRS (commonly pronounced as “iffers”). The smart money is betting that the SEC will opt for U.S. companies to switch over to IFRS at some point in the future — a specific date in 2012 or 2013, for example.
If U.S. companies were required to adopt IFRS at some point in the future, University of Tennessee professor and Public Company Accounting Oversight Board (PCAOB) Standing Advisory Group (SAG) member Joseph Carcello says, this change “could be the most far-reaching change in financial reporting in our lifetime.” It would, Carcello adds, “make 404 look like a day at the beach.”
As they currently stand, IFRS would give companies more leeway in their financial reporting; opponents of a shift from GAAP to IFRS say that this means that more companies could use that leeway to manage earnings more aggressively.
Finance departments would be affected by this shift in another, potentially expensive area: talent. If U.S. companies are required to move to IFRS at a future date, “people are going to need training because very few people, if any, in the U.S. are trained on IFRS,” says Turner. “The Big Four accounting firms will tell their clients that they are happy to help, for a fee. This will be a tremendous amount of revenue for the Big Four, following on SOX 404.”
And it will be yet another tremendous adjustment for corporate finance departments. In other words, the impact of what just happened may pale in comparison to the implications of what happens next.
See Business Finance's interview with Lynn Turner [1] for more of his thoughts on the subprime crisis's impact on corporate finance departments and other regulatory matters.