Summer, 2002

From the Editor

Turning Crises Into Opportunity

Enron and Tyco have been prominent in the headlines, but Adelphia, Xerox, AOLTimeWarner, WorldCom and a panoply of other famous names in American business have also drawn attention. Arthur Anderson is attacked for allowing accounting irregularities and Merrill Lynch for calling analysts what they really are: high-powered salespeople.

To one who trades with American business, it must seem almost inconceivable as icon after icon seems to get knocked off pedestal after pedestal, not just because business is bad, but because of write-offs of tens of billions of dollars, accounting irregularities, fraud and more.

These are not trivial or academic issues. Indeed, in many ways the political breakdown on American economic policy issues has always been counterintuitive. For example, the typical working man or woman in America is much more passionate that the inheritance tax should be abolished than are members of the economic elite.

To understand why a laborer who is not affected by such a tax would oppose it and a member of the economic elite would support it, you really have to understand America and Americans. In the broad picture, that laborer does not identify himself as a laborer; he probably considers himself middle class — almost all Americans do — and sees his current situation as temporary.

Our laborer may know that Jack Welch, the recently retired CEO of General Electric, is the son of a train conductor or that President Ronald Reagan grew up in modest circumstances while his father struggled to hold down a job as a shoe salesman. Put another way, when the issue at hand is how inheritances should be treated, an American laborer views the issue not through the prism of a presumption that he and his children are caught in a caste, but in light of the presumption that his children and grandchildren have unlimited opportunities.

As one travels around the world, one of the interesting differences between Americans and citizens of other nationalities is that working class Americans are often very involved in the stock market. With IRA and 401k retirement accounts, money market funds, market-indexed insurance policies and a literal alphabet soup of savings vehicles, the fluctuations of interest rates, stock market indices and other financial information is common cocktail party chatter among virtually all income groups.

Which is why the collapse of Enron particularly, as well the general problems of the accounting profession and Wall Street houses, poses a real threat to the American economy. It is not that a particular company can’t go out of business. While Americans can accept betting on the wrong horse, they count on the fact that the race is being judged fairly.

The controversies over American business threaten to undermine the confidence in our institutions, which is the key currency of a capitalist economy. In Enron, the issue was hiding losses and liabilities in off-balance-sheet entities. This, in effect, meant that investors were working without crucial information.

In the case of WorldCom, it turns out that the company’s founder and long-time CEO got hit with a big margin call. Instead of simply letting him suffer the losses for borrowing against the value of his stock, the company’s Board of Directors lent him money and thus put hundreds of millions of dollars of shareholders’ money at risk. This type of behavior led to the impression that many executives are treating public companies like their private piggy banks... and that many boards are letting them get away with it.

The Arthur Anderson case is important, not because the government alleges the accounting firm destroyed documents to avoid prosecution. It is important because it leaves the impression that auditors, which the public relies on to give a Seal of Approval on financial statements, actually will bend over backwards to approve almost anything management wants — lest they lose business.

The Merrill Lynch case, in which analysts were found to be skeptical internally but wildly optimistic in public pronouncements, has certainly made many Americans even more skeptical of Wall Street.

All in all it adds up to a genuine crisis of American capitalism. But the aftermath is also showing the enormous strength and recuperative power of the American capitalist system. Although the government huffs and puffs and Congress holds hearings, precious little has changed in a legal sense.

Everything is changing throughout the economy, however. All the sudden, companies are tardy with their earnings reports as accountants apply greater rigor to their audits. Charles Schwab, a discount broker, announces a new system for rating stocks and points out that it doesn’t do investment banking so there is no conflict of interest. All the sudden every company finds its shareholders demanding more independent directors and that they have more power.

It is all happening in the shadow of the headlines. But like seeds sprouting under ground, it is a miracle at work that we just can’t see. In the end, it means the new growth of a cleaner, more analytical capitalism; a financial system is regenerating itself and will power America, and the world, for the 21st century.  EXP