Following close behind the Enron scandal, we now have the bankruptcy of another major US corporation, Worldcom, which has triggered huge stock exchange falls, not only in the US but also on all other major western exchanges, including the UK’s.
We learn from this latest collapse that yet again tricky accounting inflated the company’s profits; yet again apparent high profits inflated the company’s share price; yet again those in the know were able to enrich themselves by paying themselves huge salaries and bonuses and profiting from their lavish share options. It is always, however, only a matter of time before the true state of affairs becomes known, at which time there is a stampede to sell the shares in which the slowest to sell take the greatest losses.
For years the prices of stocks and shares have been well above what can be justified by the level of the companies’ earnings. The high price has been maintained by an excess of investor demand – the excess demand arising from the absence of more lucrative alternative investment opportunities – and supercharged by the 1997 economic collapse in the Far East which herded investors into American and European stocks instead. The investors have known the stock was overpriced but since the markets had been rising steadily they were happy to sit back and reap their speculative profits – hopeful that when the downturn came (and everybody knew it would) they could sell quickly and still come out winning overall.
Not only did investors know their stocks were overpriced and therefore not worth as much as their market price would indicate, they also knew that in the US at least it was commonplace to use tricky accounting practices to make a company profitability look much more than it really was. Mark Beale of New Star Asset Management is quoted by Steve Johnson in the Financial Times of 6 July 2002 as saying:
“People have known for years that the US is playing fast and loose with its numbers, but for years investors have turned a blind eye to it” (‘Investment: There may yet be more bad news’).
Among the tricks used are:
1.Treating routine expenses of trading, which are normally deducted in full from the year’s earnings to determine the year’s profit, as though they were capital expenditure (i.e., expenditure on assets that will last over several years of trading and whose cost can therefore be spread over several years rather than being deducted in one lump from the earning of the year in purchase). If expenditure is on assets that are not kept beyond a year (e.g., materials from which a company’s products are manufactured), then the whole of it should be deducted from the year’s earnings when calculating profit. To call such expenditure capital expenditure is to add more to the deductions which will have to be made against the earnings of a later period, bringing about eventually a sudden steep decline in the company’s declared profits – unleashing an investor stampede.
2.Another trick for artificially boosting profits is raiding the company’s pension fund. The fund is itself held in overpriced stocks which, for the last five years, have been rising. If those high prices could be maintained indefinitely (which everybody knows they cannot), the pension funds would have far more money than they need to pay out to their pensioners. The companies (who invariably control their own staff pension funds) therefore help themselves to this ‘surplus’. When the stocks go down – as invariably they do – the pension funds are left short of what they need to pay their obligations. Cheating pensioners in this way, however, is perfectly legal in capitalist society. When pensioners find themselves bereft of the pensions for which they have been contributing all their working lives, they must realise it is not simply a question of the vagaries of the market. It is also a question of shameless looting to line the pockets of the rich.
Among those who have made themselves rich through the looting of corporate assets we now find President George W Bush and his Vice President Dick Cheney. Paul Krugman sets out the story of one of Bush’s scams in the Guardian of 9 July:
“In 1986 one would have considered Mr Bush a failed businessman. He had run through millions of dollars of other people’s money, with nothing to show for it but a company losing money and heavily burdened with debt. But he was rescued from failure when Harken Energy bought his company at an astonishingly high price. There is no question that Harken was basically paying for Mr Bush’s connections”.
Bush became a director of Harken but “Despite these connections, Harken did badly. But for a time it concealed its failure – sustaining its stock price, as it turned out, just long enough for Mr Bush to sell out most of his stake at a large profit – with an accounting trick identical to one of the main ploys used by Enron a decade later. (Yes, Andersen was the accountant).
“The ploy works as follows: corporate insiders create a front organisation that seems independent but is really under their control. This front buys some of the firm’s assets at unrealistically high prices, creating a phantom profit that inflates the stock price, allowing the executives to cash in their stock.
“A group of insiders, using money borrowed from Harken itself, paid an exorbitant price for a Harken subsidiary, Harken Petroleum. That created a $10 million phantom profit”. This phantom profit boosted the price of the Harken shares thus enabling Bush to sell his shares for $849,000 just before the company reported a $23.2 million quarterly loss, which sent the Harken share price plummeting downwards.
“White House aides have played down the significance of this manoeuvre, saying $10 million isn’t much… But for Harken’s stock price – and hence for Mr Bush’s personal wealth – this accounting trickery made all the difference.”
Dick Cheney’s efforts have been on a more grandiose scale than his President’s. While Cheney was chief executive of Halliburton between 1995 and 2000, it entered income of some $100 million from its pipeline construction work without there being any likelihood that they would actually be paid. (Andersen were also the auditors for Halliburton).
And of course the links of various members of the Bush team to Enron have become a matter of notoriety. Thomas White, top White House military chief, former Enron vice-president, sold $12 million in Enron shares between June and November 2001 (but claims to have been privy to no inside information!). Robert Zoellick, US trade representative, was on Enron’s advisory council. Lawrence Lindsay, top economic adviser to President Bush, was formerly a paid consultant of Enron’s.
Enron was also one of Bush’s biggest backers, first for governor of Texas and then for President – donating more than $800,000 to his campaigns. Worldcom also donated $41,000 to Bush’s presidential campaign in 2000. The various energy companies which backed Bush were rewarded when the Bush administration adopted an energy policy that provided them with $33 billion in tax breaks (see David Teather, the Guardian, 9 July 2002, ‘Corporate Corruption’).
Currently Bush is going round making speeches about the need to tighten up on tricky accounting practices, as he frantically tries to hold back the rush of investors away from US stocks as they take fright that recent revelations of corporate fraud will drive down share prices – themselves driving down those prices by taking flight. Not surprisingly there is considerable cynicism over these Bush promises:
“Not to put too fine a point on it … the notion of Mr Bush and Mr Cheney leading a crusade against corporate misbehaviour has for many people about the same credibility as the Empress Messalina taking vows of chastity” (The Independent, 10 July 2002, ‘Speaking loudly, while carrying a very small stick’).
Anthony Hilton in the Evening Standard of 3 July suggests:
“Of course, if President Bush wants to be really bold he could copy what his predecessors did 70 years ago when the SEC [Securities Exchange Commission] was created in the wake of the 1929 stock market crash. The authorities appointed Joe Kennedy, father of President John Kennedy, as its first head on the basis there were few bigger crooks on Wall Street so he would know how to catch them.”
As it is, Bush has had his arm twisted to increase the SEC’s budget from $438 million to $776 million, which may help the SEC to find a few teeth. Last year “funding and personnel resources at the agency were so thin that it could only review 16% of annual corporate filings … or about half its stated goal” (Peter Spiegel and Adrian Michaels, Financial Times, 27 June 2002, ‘SEC chairman hits back at critics’).
Capitalism is the cause
Just as the 1997 financial collapse in the Far East was variously blamed on croneyism, corruption and overborrowing, the current plummeting of the western stock exchanges and the disastrous consequences this is likely to entail are being blamed on tricky accounting. The satirical magazine Private Eye has produced an amusing cover page conveying just such a ‘lesson’. It shows Osama bin Laden rejecting terrorism in favour of becoming an accounant.
Nevertheless, while undoubtedly capitalism attracts a host of parasites who gorge themselves on its decaying carcass, like the Bushes and Cheneys of this world, corruption and fraud are not the cause of capitalism’s crises. The cause of these is overproduction brought about by the relative poverty into which capitalism inevitably drives the masses of people who cannot therefore buy its products. It is for lack of sales that companies cook their books, and it is the lack of sales that cause the disaster rather than the cooking of the books, which merely delays its onset. The 1997 financial crisis plunged millions of corporate and individual consumers in the Far East into poverty. This could not but adversely affect western corporations trying to sell goods and services to them. The present crisis is likely to wipe out the pensions of millions of people in the US and Europe – again with dire consequences for effective world demand for goods and services.
Stock exchange regulation and auditing practice can be tinkered with but have absolutely no effect on the underlying cause of the crashes endemic to capitalism. Only the ending of capitalism itself can bring capitalist crises to an end.