Apples & oranges: recordkeeping principles for transforming business practices.

• Author: Montana, John C.
• Position: Cover story

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Despite having voluminous, detailed transaction records, regulators did not have a clear picture of the financial industry's health before its recent collapse and the economy's subsequent downward spiral. President Barack Obama and key cabinet members have stressed transparency and accountability, two key elements of the Generally Accepted Recordkeeping Principles[SM], for preventing similar crises from occurring.

It's obvious the financial services industry is heavily regulated. Those regulations require records--lots and lots of them. And indeed, organizations in the industry have produced those records, with every transaction, every account balance, and every movement dutifully recorded and maintained, often for extended periods of time. This detailed transactional recordkeeping is intended to enable regulators to determine whether organizations are conforming to the regulations governing them and their transactions.

Yet, despite its detailed recordkeeping, the financial industry is at the root of the current economic breakdown. Several cases demonstrate a number of flaws in the regulatory system, including Bernie Madoff swindling investors out of $50 billion, AIG's $3 trillion dollars in credit default swaps, and the prevalence of risky mortgage derivatives that are behind the housing collapse. (See sidebar on page 28 for details.)

The Failure of the Old Paradigm

What went wrong in each of these cases? Conceptually, the answer is simple: Voluminous records don't necessarily equal accurate--or particularly useful--records.

The Madoff case is illustrative of this. Madoff and his firm produced massive quantities of impressively detailed and internally consistent--but entirely fabricated--records over a period of many years. An audit of those records without reference to any external sources would apparently not have revealed any inconsistency because the numbers added up. Yet, other records existed that would have provided a different story. Simple graphing of his claimed results revealed an impossibly consistent track record.

And, according to the Chicago Tribune, publicly available market information, if looked at in conjunction with Madoff's records, would have revealed he could not possibly have been making the kind of trades he claimed in the volumes he claimed. (See www.swamppolitics.com/news/ politics/blog/2009/02/madoff_case_whistleblower_on_c. html.) There were other clues as well, but authorities never compared the information side-by-side, so the necessary connections were never made.

In one form or another, the AIG and mortgage derivative cases share characteristics that result in similar outcomes: Notwithstanding a great many records in many places, the result was not the clarity and certainty those records were supposed to ensure, but opacity, confusion, and staggeringly large financial losses.

Given that, at this point, investors and other innocent parties have suffered many billions of dollars in losses, and several trillions of dollars in public money in the United States alone have either been spent or pledged to repair the damage from this situation, it's now self-evident something must change. For many reasons, the situation that has arisen must not happen again.

The New Mantra: Transparency and Accountability

Public comments by government officials capture both the essence of the problem and the outlines of the coming solutions. On numerous occasions, President Obama has...