Evil Agency—And It Ain’t the CIA

Most people probably haven't heard of one of the most powerful and destructive agencies in Washington: the Public Company Accounting Oversight Board (PCAOB). It was created by the 2002 Sarbanes-Oxley Act, with the task of setting and policing the auditing standards for publicly held companies. The PCAOB not only conducts investigations of accounting firms but also interprets key sections of Sarbanes-Oxley, particularly the notorious Section 404, which covers a company's internal controls. The agency also has the power to tax--dubbed an "accounting support fee"--to fund its operations. The PCAOB has five members. Not surprisingly, with their power to tax, these members pay themselves handsomely. PCAOB Chairman Mark Olson took home about $654,000 last year, and his four colleagues each raked in nearly $532,000. This far exceeds what the U.S. President makes ($400,000), as well as the $500,000 cap the Obama Administration has set for CEOs whose companies receive federal bailout money.

The PCAOB has morphed into an accounting version of Nurse Ratched from One Flew Over the Cuckoo's Nest, demanding costly but useless procedures, including such minutiae as which workers in a company can have office keys and telling companies how often they should change computer access codes. While drenching itself in such trivia, the PCAOB was out to lunch on the biggest economic/ accounting issue of our time: the subprime mortgage disaster.

The whole point of Sarbanes-Oxley was to prevent fraud. In that regard it has failed miserably. Three years after Sarbanes-Oxley was enacted a major commodities firm, Refco, collapsed amid brazen accounting fraud. A Brookings-American Enterprise Institute study has found that Sarbox has cost the U.S. economy more than $1 trillion in direct and indirect costs.

PCAOB was a vigorous champion of that weapon of mass destruction, mark-to-market accounting. Even now it is waging a rear-guard action to undo the easing that the FASB promulgated in April.

Relief may be on the horizon. In a move that astonished observers the Supreme Court announced last month that it would hear a case brought by the Competitive Enterprise Institute and the Free Enterprise Fund challenging the constitutionality of the PCAOB. The challenge sounds arcane, but it could be one of those landmark cases that occasionally crop up and bolster the sanctity of the rule of law, which undergirds the U.S.' political and free-enterprise system.

The challenge is based on the appointments clause of the Constitution, which requires that "Officers of the United States" be appointed by the President or by the head of an agency. The officials of the PCAOB--despite their enormous powers, including civil and criminal investigations of accounting firms--are appointed by the SEC commissioners acting collectively. As CEI General Counsel Sam Kazman puts it: "The framers of the Constitution believed that if government officers were appointed by collective bodies rather than by individuals, then responsibility for their actions would largely vanish." The PCAOB is not accountable to the President or to the SEC chairman.

This is a case worth watching. If constitutional prohibitions are treated as relics, if commercial contracts can be brazenly upended to serve short-term political ends and if property rights can be trampled on for political purposes, then the U.S. will indeed sink into an Argentina-like morass in the years to come. But such a disaster would have mortal--not just economic--consequences. Without a strong, purposeful U.S., the world would be a far more violent and tyrannical and less prosperous place. One need only look at the 1930s to see what can unfold when the U.S. is weak and withdrawn.

The latest business loans numbers show that bank loans to businesses are still falling. AS I have written in recent posts, large banks have systematically shut down their lending to small businesses over the past 2 months, an unintended consequence of the hugely profitable government bailout programs. Basically, today if you can't sell it to the government don't bother making the loan.

Banks have loaned approximately -$100 billion to U.S. companies since last fall. Tough to make payroll when you have to pay more to the bank than you get from the bank.

The latest weekly figures, show that banks have reduced loans to businesses by $15.8 billion–roughly -$4,000,000,000 per week–in the past month alone. That does not mean there is less borrowing; it means there is negative borrowing. Banks have forced their business customers to actually pay down their loan balances by $4 billion per week. The only way to do that in a small business is to lay off a worker or sell some inventory or other assets at a deep discount.

Essentially all business loans are small business loans–big public companies get their working capital in the commercial paper market. This is a major reason why employment continues to fall.

This is not the end of the world. I wrote a few days ago, in a piece called Time to Think About the Next Story-Inflation, Rising Rates, Commodity Prices, Weak Dollar, that the tsunami of bank reserves released by the Fed over the past six months is hugely profitable for banks and will eventually force a reopening of the credit markets. This chart is just to remind you that it is going to take longer to show up in jobs numbers than it has in bank stock prices.

The big question around Google's new push into e-books is how, if at all, it will change Amazon's fortunes. Jefferies & Company analyst Yousseff Squali argues that Amazon will likely remain the e-books leader, but that the move by Google (NSDQ: GOOG) may force Amazon to provide publishers with better financial terms and offer aggressive discounts on the Kindle. Squali didn't provide specifics on what those new terms might be, but he did analyze the competitive challenges the two will face as they grow their e-books businesses.

—Search is a key advantage for Google: Squali said Google could use its dominant search engine as a distribution channel that could trigger impulse buys. Google could, for example, easily publish its own sponsored search or paid click listings alongside searches for e-books or relative products. 

—Google's profit margins will likely be higher: By offering an e-books sales-and-delivery service rather than selling an e-reader, Squali believes Google could get higher profit margins from its e-books business than Amazon (NSDQ: AMZN). (Amazon, of course, has manufacturing, distribution and support costs related to the Kindle.) If Squali's prediction that Amazon will have to drop its price for the Kindle is right, margins would be even lower since the costs of making and distributing the Kindle likely wouldn't change.

—Several factors will determine the winner: Squali sees three primary factors in deciding who will be the ultimate winner in the e-book battle: 1) whether users gravitate to reading e-books online or on devices; 2) whether users will be satisfied with reading books that are stored on Google's servers or "own" them on their hard drives; and 3) which company wins the pricing war.