Accounting and The Rise and Fall of Firms and Nations
James Grant, presenter of the Henry Hazlitt Memorial Lecture at this year’s AERC, reviews The Reckoning. Success and failure of institutions and states raise and fall with the integrity of their balance sheets. As Grant observes, “successful societies—while they last—are those that properly cast their figures. They confront their liabilities as well as their assets. In their enterprise and politics, accountability is the watchword …”
Amazon summarizes the arguments of the book thusly:
Basic accounting tools such as auditing and double-entry bookkeeping form the basis of modern capitalism and the nation-state. Yet our appreciation for accounting and its formative role throughout history remains minimal at best—and we remain ignorant at our peril. The 2008 financial crisis is only the most recent example of how poor or risky practices can shake, and even bring down, entire societies.
Readers of The West Grew Rich: The Economic Transformation Of The Industrial World, a excellent book that I used as a foundation source when in taught economic history would not be surprised at this assessment of the importance of double entry bookkeeping. The authors, in addition to pointing out correctly that the living standard norm world-wide, pre-industrial revolution, was poverty provide an excellent list of “institutions favorable to commerce”. Included among these essential institutions was double entry bookkeeping.
Mr. Solis work puts heavy emphasis on this institution. Grant summarizes, “Mr. Soll’s story largely concerns the technique of double-entry bookkeeping, with its elegantly counterbalanced assets and liabilities. It is a system that almost forces managerial attention not only on profit and loss but also on debt, net worth and solvency. As Mr. Soll hustles through history, he stops to ask whether a particular society employs the double-entry method or not.” Successful institutions rely on sound accounting.
Grant next asks a very penetrating question:
His grand thesis is another matter. Is good accounting a cause of the wealth of nations or is it an effect of the virtues—individual liberty and the rule of law, to name two—that foster financial and political truth-telling? Does careful reckoning implant these essential moral qualities or do honest people count straight and true whatever the state of their knowledge about generally accepted accounting principles?
Deirdre Nansen McCloskey’s The Bourgeois Virtues: Ethics for an Age of Commerce would tilt the answer in Grant’s direction.
Grant ends the review with penetrating commentary relevant to meaningful discussion banking reform.
Mr. Soll, though a keen proponent of accountability, misses a bet when he fails to mention the convention of “double liability.” In America before the coming of the Federal Deposit Insurance Corp., the stockholders of a bank were responsible for the solvency of the institution in which they owned a fractional interest. In the event of impairment or insolvency, they—not the taxpayers—were required to stump up the funds with which to pay the creditors.
The 21st-century reader will rub his eyes. Were most banks not limited-liability corporations? They were. And is the liability of the stockholder of such a corporation not, well, limited? Indeed it was and is. Banks were the exception. Between the Civil War and the Depression, the stockholders of a failed bank got a capital call from the receiver. They were liable for an amount up to and including the par value of their shares.
They got the dividends in good times. They owned the problem in bad times. In short, they were accountable.