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Another day, another Wall Street scandal. The regularity
and frequency with which "bad news" is coming out of the
corporate world in the US, involving some of the giants
of international business, is almost laughable. Each
week, at least one major company is being forced to
reveal that it has been involved in financial
irregularities, often of breathtaking extent.
Some companies "forget" to record their losses, or
record them as loans to specially created subsidiaries.
Other companies "just happen" to slip in normal expenses
as "capital expenses", thereby removing them from the
profit-and-loss account. In some instances, important
flows of finance are simply not recorded at all, and
just disappear from the balance sheets. Other accounting
discrepancies include understatement of interest
payments, fictitious investments, and simply taking cash
out of employees’ pensions and social security funds.
In most of these cases, the numbers involved are not
small, usually amounting to several billion dollars. And
the indications are that these malpractices are not just
once-off mistakes, but have been going for some years –
suggesting that auditors have been negligent or even
complicit. Quite often, there is even no mention of
these practices in the companies’ books, making it
difficult to trace what exactly has been going on.
The biggest and most public scam of recent times was
that concerning the energy trading multinational giant
Enron, which was earlier seen as the most effective
symbol of the swashbuckling new globalised capitalism of
the 1990s. But now it turns out that the case of Enron –
huge and dramatic as it was – is just the tip of the
iceberg in terms of shady and ultimately unsustainable
business practices in the international corporate world.
Consider just some of the scams that are now plaguing
the already overworked Securities and Exchange
Commission (SEC), the
US
government agency that is supposed to regulate all this.
The company Adelphia is facing an SEC probe into $3.1bn
in off-balance sheet loans, some of which were used to
cover the assets of the founder of the company and his
family. Global Crossing is under investigation for its
accounting treatment of long-term
wholesale capacity contracts, which artificially
inflated profits. Lucent Technologies and Peregrine
Systems have been found to be "adjusting" fiscal
revenues and are being forced to restate incomes and
profits for the past few years. The largest retailing
company in the
US, K-Mart, has had to lower its recorded profits after
admitting to incorrect accounting methods.
Enron, as is well known, admitted
to improperly inflating earnings and hiding debt through
a complex web of off-balance sheet business
partnerships. The company’s subsequent bankruptcy
created a ripple effect across the corporate and
financial world even in developing countries. Other
energy trading companies are not pristine either. Duke
Energy has admitted to
"round-trip" or "wash" trades, in which two or more
traders buy and sell energy among themselves for the
same price and at the same time, which added at least $1
billion to its revenues over three years. Dynegy, the
company that earlier offered to rescue Enron just before
its collapse, is being investigated for using
partnerships in deals to inflate its cash flow.
And
then there is the insider trading, along with instances
of top management seeking to save the value of their own
assets of reward themselves before the imminent collapse
of the company. The founder and other top managers of
Computer Associates awarded themselves more than a
billion dollars in shares (which they then sold) only
days before issuing a profit warning which sent the
share price down. The founder and CEO of Imclone Systems
was found to be selling large numbers of shares held by
his family and friends just before the cancer drug which
was its sole product was denied approval by the US FDA.
The chairman and other executives of Tyco International
spent vast amounts on luxury housing for themselves and
other perks, just before declaring losses.
The
list goes on and on. The most recent examples are of the
telecom giant WorldCom and the multinational Xerox, both
of which represent in some ways the essence of current
global capitalism.
WorldCom, like Enron, was a potent symbol of aggressive
capitalism in the past decade. Like Enron, it is a
company of recent origin, founded
by
the flamboyant entrepreneur Bernie Ebbers, who was
perhaps the most aggressive acquirer during the US
mergers and acquisitions boom of the 1990s. WorldCom's
stock market success even surpassed that of Enron.
Before the
US
stock market started to sag in 2001, WorldCom’s asset
value had soared to $180bn - nearly three times that of
Enron at its peak.
WorldCom has now admitted that
$3.8 billion of operating costs were treated as capital
spending, forcing it to restate results for 2001 and the
first quarter of 2002. Since the company is already
facing losses, it is likely that it will soon file for
bankruptcy and default on its $35 billion debt.
Just a few days later, Xerox admitted that it would have
to reclassify more than $2 billion of its revenues.
Under pressure from the SEC, it has subsequently
announced that the extent of overstatement of revenues
for a five-year period was even greater, at more than
$6.4 billion. Once again the auditors at Xerox, as usual
one of the international "Big Five", had apparently not
noticed the discrepancies for all these years.
Obviously, the story is not going to end here, and many
more such cases will probably emerge in the near future.
What exactly is going on? What explains this sudden
flurry of unsavoury revelations and the apparent
collapse of even minimal corporate accounting norms that
these cases are bringing to light?
Forget, for a moment, the issues of morality, corporate
ethics, and all that. Forget even the interests of the
unfortunate shareholders of all these companies, which
include not just get-rich-quick financiers but also
workers’ pension fund managers and other presumably
worthy groups. The real question is what all this tells
us about the current phase of international capitalism,
and what implications there are for the near future.
The
first point to note is that such scams are not new or
unexpected; in fact they are part of capitalism’s normal
functioning. Only the most naïve of interpretations of
the history of capitalism would leave out the crucial
role played by fraud, deceit and skullduggery in the
accumulation of capital and its subsequent use. And the
notion that the "new" capitalism is somehow more open,
accountable and democratic, is a false illusion purveyed
by the media which also have major stakes in the system.
The
second point is that such scams typically emerge at the
end of a boom, or when it is beginning to peter out. It
is not that the scams cause the financial or economic
collapse; rather, they are symptoms of the turning
point, when companies find that profit expectations are
not being met, and try to prevent or delay the
anticipated downturn with whatever means they possess,
including fraud. Thus, while many of the financial
malpractices have been going on for several years, they
have been exposed only recently, as the economic
slowdown and the stock market bear trend have fed into
each other. This is characteristic of the "revulsion"
phase of the financial cycle.
The
third point has to do with the specific nature of
US capitalism, which is "capital-market-based" rather
than "bank-based". After the financial crises in Japan
and South Korea, bank-based systems (especially in Asia)
came in for a lot of criticism internationally, for
being opaque and prone to "crony" behaviour and
clientelism. The current spate of scandals in the US
shows that capital-market-based systems can be even more
problematic. Not only do they allow (and even encourage)
creative accounting, they are prone to the worst forms
of "insider" excesses.
More
to the point, they may even force managements to
misstate actual results, since so much of the stock
market value depends on this, and the stock value in
turn typically determines not just assets but even
management’s own remuneration. Those investigating
WorldCom have found that
the
important sums involved in recent wrongly classified
transactions — which reduced reported operating expenses
over the last five quarters — were exactly those needed
for WorldCom to meet its profit margin goals, and so
keep its shareholders satisfied.
This does not mean that it is only the US corporate
world which is in trouble. It is likely, as some
European analysts have suggested, that because Western
European accounting norms are stricter such cases of
fraud will be less common and the European bourse may
even benefit from the current revulsion away from US
stocks. Indeed, the recent downward drift of the dollar
– which has required co-ordinated central bank
intervention to slow down – is one indication of this.
But European corporations are by no means immune, as may
become clear quite soon. First, the same macroeconomic
forces of slowdown and reduced investor confidence are
likely to affect European companies just as they have
already hit Japanese and US corporations. Second, across
the world the pattern has been to take on more and more
elements of the "US model", even in bank-based systems
such as in France and Germany, and so such financial
scandals are more likely there now than in the past.
It is clear the SEC-type regulation is inadequate to
monitor and regulate markets which are so open to fraud
because of the severe information problems they suffer
from. It is also clear that during a slowdown, more and
more cases of explicit and implicit fraud are likely,
and they in turn can add to the more bearish investor
sentiment which in turn would worsen the slowdown.
All these instances – and the new ones that are almost
inevitably going to emerge from the woodwork quite soon
– add up to a really big financial mess, and certainly
do portend a major crisis of confidence for corporate
US. Unfortunately, however, they still do not signify
the end of capitalism as we currently know it. In fact,
they do not even mean that the corporate world will
necessarily become much cleaner and more "ethical" as a
result. But if they do bring about a much more serious
public reconsideration of the system as a whole, then
they are probably to be welcomed. |
