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.