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Date: Fri, 18 Jan 2002 16:24:00 PST
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Subject: [R-G] There are more Enrons out there; the rot is systemic -
William Greider
The Nation February 4, 2002
Crime in the Suites
There are more Enrons out there; the rot is systemic
by William Greider
The collapse of Enron has swiftly morphed into a go-to-jail financial
scandal, laden with the heavy breathing of political fixers, but Enron makes
visible a more profound scandal--the failure of market orthodoxy itself.
Enron, accompanied by a supporting cast from banking, accounting and
Washington politics, is a virtual piņata of corrupt practices and betrayed
obligations to investors, taxpayers and voters. But these matters ought not
to surprise anyone, because they have been familiar, recurring outrages
during the recent reign of high-flying Wall Street. This time, the
distinctive scale may make it harder to brush them aside. "There are many
more Enrons out there," a well-placed Washington lawyer confided. He knows
because he has represented a couple of them.
The rot in America's financial system is structural and systemic. It
consists of lying, cheating and stealing on a grand scale, but most offenses
seem depersonalized because the transactions are so complex and remote from
ordinary human criminality. The various cops-and-robbers investigations now
under way will provide the story line for coming months, but the heart of
the matter lies deeper than individual venality. In this era of deregulation
and laissez-faire ideology, the essential premise has been that market
forces discipline and punish the errant players more effectively than
government does. To produce greater efficiency and innovation, government
was told to back off, and it largely has. "Transparency" became the exalted
buzzword. The market discipline would be exercised by investors acting on
honest information supplied by the banks and brokerages holding their money,
"independent" corporate directors and outside auditors, and regular
disclosure reports required by the Securities and Exchange Commission and
other regulatory agencies. The Enron story makes a sick joke of all these
safeguards.
But the rot consists of more than greed and ignorance. The evolving new
forms of finance and banking, joined with the permissive culture in
Washington, produced an exotic structural nightmare in which some firms are
regulated and supervised while others are not. They converge, however, with
kereitzu-style back-scratching in the business of lending and investing
other people's money. The results are profoundly conflicted loyalties in
banks and financial firms--who have fiduciary obligations to the citizens
who give them money to invest. Banks and brokerages often cannot tell the
truth to retail customers, depositors or investors without potentially
injuring the corporate clients that provide huge commissions and profits
from investment deals. Sometimes bankers cannot even tell the truth to
themselves because they have put their own capital (or government-insured
deposits) at risk in the deals. These and other deformities will not be
cleaned up overnight (if at all, given the bipartisan political subservience
to Wall Street interests). But Enron ought to be seen as the casebook for
fundamental reform.
The people bilked in Enron's sudden implosion were not only the 12,000
employees whose 401(k) savings disappeared while Enron insiders were smartly
cashing out more than $1 billion of their own shares. The other losers are
working people across America. Enron was effectively owned by them. On June
30, before the CEO abruptly resigned and the stock price began its terminal
decline, 64 percent of Enron's 744 million shares were owned by
institutional investors, mainly pension funds but also mutual funds in which
families have individual accounts. At midyear, the company was valued at
$36.5 billion, having fallen from $70 billion in less than six months. The
share price is now close to zero. Either way you figure it, ordinary
Americans--the beneficial owners of pension funds--lost $25-$50 billion
because they were told lies by the people and firms they trusted to protect
their interests.
This is a shocking but not a new development. Global Crossing went from $60
a share to pennies (as with Enron, the market had said it was worth more
than General Motors). CEO Gary Winnick cashed out early for $600 million,
but the insiders did not share the bad news with other shareholders. Workers
at telephone companies bought by Global Crossing had been compelled to
accept its stock in their retirement plans. (Winnick bought a $60 million
home in Bel Air, said to be the highest-priced single-family dwelling in
America.) Lucent's stock price tanked with similar consequences for
employees and shareholders, while executives sold $12 million in shares back
to the failing company. (After running Lucent into the ground, CEO Richard
McGinn left with an $11.3 million severance package.) There are many Enrons,
as the lawyer said.
The disorder writ large by the Enron story is this regular plundering of
ordinary Americans, who are saving on their own or who have accepted
deferred wages in the form of future retirement benefits. Major pension
funds can and do sue for damages when they are defrauded, but this is
obviously an impotent form of discipline. Labor Department officials have
known the vulnerable spots in pension-fund protection for many years and
regularly sent corrective amendments to Congress--ignored under both
parties. In the financial world, the larceny is effectively
decriminalized--culprits typically settle in cash with fines or settlements,
without admitting guilt but promising not to do it again. If jailtime deters
garden-variety crime, maybe it would be useful therapy for corporate and
financial behavior.
The most important reform that could flow from these disasters is
legislation that gives employees, union and nonunion, a voice and role in
supervising their own pension funds as well as the growing 401(k) plans. In
Enron's case, the employees who were not wiped out were sheet-metal workers
at subsidiaries acquired by Enron whose union locals insisted on keeping
their own separately managed pension funds. Labor-managed pension funds,
with holdings of about $400 billion, are dwarfed by corporate-controlled
funds, in which the future beneficiaries are frequently manipulated to
enhance the company's bottom line. Yet pension funds supervised jointly by
unions and management give better average benefits and broader coverage
(despite a few scandals of their own). If pension boards included people
whose own money is at stake, it could be a powerful enforcer of responsible
behavior.
The corporate transgressions could not have occurred if the supposedly
independent watchdogs in the system had not failed to execute their
obligations. Wendy Gramm, wife of Senator Phil, the leading Congressional
patron of banking's privileges, is an "independent" director of Enron and
supposedly speaks for the broader interests of other stakeholders, from the
employees to outside shareholders. Instead, she sold early too. With notable
exceptions, the "independent" directors on most corporate boards are a
well-known sham--typically handpicked by the CEO and loyal to him, even
while serving on the executive compensation committees that ratify bloated
CEO pay packages. The poster boy for this charade is Michael Eisner of
Disney. As CEO, he must answer to a board of directors that includes the
principal of his kids' elementary school, actor Sidney Poitier, the
architect who designed Eisner's Aspen home and a university president whose
school got a $1 million donation from Eisner. As Robert A.G. Monks and Nell
Minow, leading critics of corporate governance, asked in one of their books:
"Who is watching the watchers?"
Do not count on "independent" auditors, as Arthur Andersen vividly
demonstrated at Enron. While previous scandals did not involve massive
document-shredding, Andersen's behavior is actually typical among the Big
Five accounting firms that monopolize commercial/financial auditing
worldwide. Andersen already faces SEC investigation for its role in
"Chainsaw Al" Dunlap's butchery of Sunbeam and has paid $110 million to
settle Sunbeam investors' damage suits. A decade ago Andersen fronted for
Charles Keating's notorious Lincoln Savings & Loan, which bilked the elderly
and then collapsed at taxpayer expense--despite a prestigious seal of
approval from Alan Greenspan (Keating went to prison; Greenspan became
Federal Reserve Chairman). But why pick on Arthur Andersen? Ernst & Young
paid out even more for "recklessly misrepresenting" the profit claims of
Cendant Corporation--$335 million to the New York and California
public-employee pension funds. Cendant itself has paid out $2.8 billion to
injured investors, but hopes to recover some money by suing Ernst & Young.
PriceWaterhouseCoopers handled the books at Lucent, accused of inflating
profits by $679 million in 2000 and prompting yet another SEC investigation.
The corruption of customary auditing--and the fact that an
industry-sponsored board sets the arcane accounting tricks for determining
whether profits are real or fictitious--is driven partly by the Big Five's
dual role as consultants and auditors. First they help a company set its
business strategy, then they examine the books to see if management is
telling the truth. This egregious conflict of interest should have been
prohibited long ago, but the scandal has reached a ripeness that now calls
for a more radical solution--the creation of public auditors, hired by
government, paid by insurance fees levied on industry and completely
insulated from private interests or politics. Actually, this isn't a very
radical idea, since the government already exercises the same close scrutiny
and supervision over commercial banks. Because that banking sector lost its
primary role in lending during the past two decades, the same public
auditing and supervisory protections should be extended to cover the
unregulated money-market firms and funds that have displaced the bankers.
Enron is unregulated, though it functioned like a giant financial house. So
is GE Capital, a money pool much larger than all but a few commercial banks.
Mutual funds and hedge funds are essentially free of government scrutiny. So
are the exotic financial derivatives that Enron sold and that led to
shocking breakdowns like the bankruptcy of Orange County, California.
The government failed too, mainly by going limp in its due diligence but
also by withdrawing responsibility through legislative deregulation. The one
brave exception was Arthur Levitt, Clinton's SEC commissioner, who gamely
raised some of these questions, but without much effect because he was
hammered by the industry and its Congressional cheerleaders. Corrupt
accountants and investment bankers now have a friendlier commissioner at the
SEC--lawyer Harvey Pitt, whose firm has represented Arthur Andersen, each of
the Big Five and Ivan Boesky, whose fraud case was settled for $100 million.
Pitt blames Arthur Levitt's inquiries for upsetting the accounting
industry's self-regulation. Given his connections, Pitt should not just
recuse himself from the Enron case--a crisis of legitimacy for the SEC--he
should be compelled to resign. Similarly sympathetic cops are scattered
throughout the regulatory agencies. At the Federal Reserve, a new governor,
Mark Olson, headed "regulatory consulting" in Ernst & Young's Washington
office. Another new Fed governor, Memphis banker Susan Bies, has been an
active opponent of strengthening derivatives regulation.
But the heart of the scandal resides in New York, not Washington. The major
houses of Wall Street play a double game with their customers--doing
investment deals with companies in their private offices while their stock
analysts are out front whipping up enthusiasm for the same companies'
stocks. Think of Goldman Sachs still advising a "buy" on Enron shares last
fall, even as the company abruptly revealed a $1.2 billion erasure in
shareholder equity. Goldman earned $69 million from Enron underwriting in
recent years, the leader among the $323 million Enron paid Wall Street
firms. Think of the young Henry Blodget, now famous as Merrill Lynch's
never-say-sell tout for the same Nasdaq clients whose fees helped fuel
Blodget's $5-million-a-year income (Merrill has begun settling investor
lawsuits in cash). Think of Mary Meeker at Morgan Stanley Dean Witter,
dubbed the "Queen of the Net" for pumping up Internet firms while Morgan
Stanley was taking in $480 million in fees on Internet IPOs. The conflict is
not exactly new but has reached staggering dimensions. The brokers whose
stock tips you can trust are the ones who don't offer any.
The larger and far more dangerous conflict of interest lies in the
convergence of government-insured commercial banks and the investment banks,
because this marriage has the potential not only to burn investors but to
shake the financial system and entire economy. If the newly created and
top-heavy mega-banks get in trouble, their friends in power may arrange
another cozy government bailout for those it deems "too big to fail." The
banking convergence, slyly under way for years, was formally legalized in
the 1999 repeal of Glass-Steagall, the New Deal law that separated the two
sectors to eliminate the very kind of self-dealing that the Enron case
suggests may be threatening again. We don't yet know how much damage has
been done to the banking system, but its losses seem to grow with each new
revelation. JP Morgan Chase and Citigroup provided billions to Enron while
also stage-managing its huge investment deals around the world and arranging
a fire-sale buyout by Dynergy that failed (Morgan also played financial
backstop for Enron's various kinds of trading transactions). Instead of
backing off and demanding more prudent management, these two banks lent
additional billions during Enron's final days, perhaps trying to save their
own positions (we don't yet know). Instead of warning other banks of the
rising dangers, Chase and Citi led the happy talk. Both have syndicated many
billions in bank loans to other commercial banks--a rich fee-generating
business that allows them to pass the risks on to others (federal regulators
report that the volume of "adversely classified" syndicated loans has risen
to 8 percent, tripling the problem loans since 1998).
These facts may help explain why former Treasury Secretary Robert Rubin, now
of Citigroup, called an old friend at Treasury and suggested federal
intervention. Rubin's bank has a large and growing hole in its own loan
portfolio. Could Treasury please pressure the credit-rating agencies, Rubin
asked, not to downgrade Enron? Though he styles himself as a high-minded
public servant, Rubin was trying to save his own ass. Indeed, he called the
very Treasury official who, as an officer of the New York Federal Reserve
back in 1998, had engineered the cozy bailout of Long Term Capital
Management--the failing hedge fund that Citigroup, Merrill and other major
financial houses had financed. Gentlemanly solicitude for big boys who get
in trouble connects Washington with Wall Street and spans both political
parties.
In this new world of laissez-faire, when things go blooey, the government
itself is exposed to risk alongside hapless investors--if the commercial
banks are lending federally insured deposits along with their own investment
plays or are exercising what amounts to an equity position in the failed
management. This is allegedly forbidden by "firewalls" within the
mega-banks, but when a banker gets in deep enough trouble, he may be tempted
to use the creative accounting needed to slip around firewalls. "A bank that
has equity shares in a company that goes south can no longer make neutral,
objective judgments about when to cut off credit," said Tom Schlesinger,
executive director of the Financial Markets Center. "The rationale for
repealing Glass-Steagall was that it would create more diversified banks and
therefore more stability. What I see in these mega-banks is not
diversification but more concentration of risk, which puts the taxpayers on
the hook. It also creates a financial sector much less responsive to the
real needs of the economy."
The fallacies of our era are on the table now, visible for all to see, but
the follies are unlikely to be challenged promptly--not without great
political agitation. The other obvious deformity exposed by Enron is the
insidious corruption of democracy by political money. The routine buying of
politicians, federal regulators and laws does not constitute a go-to-jail
scandal since it all appears to be legal. But we do have a strong new brief
for enacting campaign finance reform that is real. The market ideology has
produced the best government that money can buy. The looting is unlikely to
end so long as democracy is for sale.
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