Morning:
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Back in March, Cable & Wireless had a pension deficit in its main UK scheme of £32 million but in the half-year figures published yesterday this had ballooned to £305 million.
Just think if every other FTSE 100 company were to report a similar hit in the next few weeks as they publish their figures, we could be looking at an increase in deficits in six months of £30 billion. That's almost enough to bail out a bank.
But how can this be? Back in March half the world thought the other half was coming to an end and markets were at their lowest for a generation. Since then they have risen not far short of 50%.
So how can a fund which was then pretty close to break-even, appear to have gone south by an amount which is almost twice the pre-tax profit the entire group earned in the period?
Well the technical answer is that the interest rate yield on AA-rated corporate bonds — which accountants use to calculate the future liabilities of the pension fund — has fallen in the period from 6.7% to 5.4%.
What this means in English is that if you calculate that, for the next 20 years or so, you will get a lower rate of interest on the money you have in the fund than you calculated you would get when you last did the sum six months ago, then clearly you will need more money in the fund in order to deliver the same amount of interest income at that point in the future when the fund has to pay out.
The so-called deficit is nothing more than an estimate of how short you are likely to be unless you do something about it. It follows that the lower the rate of interest you assume, the more money you will need.
But of course when the accountants devised this system they assumed that interest rates would be stable and reflect market prices.
It never entered their heads that there would come a time when the entire resources of much of the western central banking system would be deployed to manipulate the rate lower — which is what is happening with quantitative easing. The whole point of the Bank of England's efforts for the past six months has been to get interest rates artificially low as part of its efforts to revive the economy.
So even if you accept the theoretical basis for the pension-fund calculation — and there are many reasons, which we won't go into here, why you shouldn't — once you start discounting using a fake interest rate then the whole exercise becomes a complete nonsense.
Accountants say that they aim to produce accounts which are true and fair. But not when they have a load of fiction at their heart they don't.
This matters because people have to take the rubbish seriously — even when they know it is rubbish — so extreme is the box-ticking compliance culture in which we now live.
Cable & Wireless has been contemplating splitting itself in half, basically into home and overseas. But after looking at the Cable & Wireless figures yesterday one of the most respected analysts in the sector, Nick Delfas of Morgan Stanley, questioned whether the pension fund trustees could agree to such a move given the apparent state of the fund.
Trustees have a duty to monitor the financial health of a sponsoring company and demand more money or security if the financial prospects of the parent change for the worse and make it less likely that the sponsor will be able to make good the deficit. If they don't do this then they are liable to have the pensions regulator on their backs. A demerger would certainly change the game so there is a very real possibility that management would be prevented from doing it, even if it believes it to be in the best interests of the company, because of a pension deficit which everyone knows is based on a fraudulent calculation.
You couldn't make it up. The economist John Maynard Keynes once observed that it was better to be vaguely right than precisely wrong. These days though it is quite the reverse.
Today's accountants not only give investors, companies and users of accounts, information which is precisely wrong but the system then tries to force boards to act on it.
This blind adherence to the script displays that same tendency which blew up the banking system which is to believe that financial models remove the need for intelligent thought. Models have their uses but one always has to remember two things.
The first is “rubbish in, rubbish out”. In other words if you put in false data you will get wrong answers. Second, some models are flawed. Traders excused their losses during the crash by saying that events predicted to happen once every 10,000 years were happening three times a night. But they could not see the obvious explanation: the model was wrong.
The real issue though is that there ought to be some way to re-establish sanity and usefulness as the twin principles of accounts and accounting while the documents still retain some credibility. But the pressures all seem to be the other way: the bigger and more detailed they become, the less they appear fit for purpose.
