Earlier this year big institutional investors were blithely telling themselves that Enron was just an exception. After all, it was a case of outright fraud. How often does that happen? And sure, every company cooks the books a little. But we expect it of them and make allowances for it. No problemo!
But we warned our institutional clients that Enron was just the tip of the iceberg, and that corporate corruption issues were not going to go away anytime soon. Then Global Crossing came along, and for a while that was another exception. Then Tyco was another. Then Qwest. Then Xerox. Then Merck. Then WorldCom.
Now the exception is when a day goes by that some company doesn’t blow up in some kind of scandal, great or small (and right now, every scandal seems great whether it is or not). Corporate corruption has become a media circus, planted front and center in the public consciousness. It has taken the place of terrorism as the thing that America loves to obsess about. The cover of this month’s Playboy even features a pictorial on “The Girls of Enron.”
Pretty soon we’re going to run out of real scandals. And what we’ll find is that the problem going forward isn’t so much corruption itself. That will pass. The problem will be all the stupid, puritanical, misguided, expensive, bass-ackwards things that our political class does in the heat of the moment when it seems that the world was ending and we have to “do something.” We’ll have to live with those somethings for a long time. At this point, I’m a lot more scared of that than of the next scandal.
Just as a matter of pure dollars and sense, the obsession with making financial reports completely transparent will benefit the Internal Revenue Service at lot more than it will benefit shareholders. At Enron, “special purpose entities” and “related party transactions” were described very vaguely in the notes to the consolidated financial statements in order to conceal debt, trading losses, and massive payments to executives. But at most other companies, those same things, described just as vaguely, are entirely legal structures for saving money on corporate taxes — and that means saving money for the benefit of shareholders. Making those descriptions more detailed would be like walking into an IRS office with a sign saying “audit me” taped to your forehead. Make no mistake about it: financial statements will be a lot more detailed in the future, and corporate taxes are going to be a lot higher.
How many billions of dollars of shareholder wealth is it worth paying to the IRS in increased taxes in order to explain every detail of every entity and transaction? Most shareholders don’t even read financial reports anyway — they don’t have any idea how to. And when, in the future, financial reports become even longer and more detailed than they are now, no one is going to read them — except IRS agents, that is.
But far worse, we now risk making it so that pretty soon no one will dare to be a public company CEO or CFO. The risks will simply be too great. Now the Securities and Exchange Commission is ordering executives to personally certify, under oath (which means under penalty of perjury) that every detail of every financial filing for their incomprehensibly vast and complex companies is squeaky clean. And Wednesday the Senate unanimously passed a bill criminalizing accounting fraud, with long jail sentences.
Say it quickly and it all sounds so reasonable — after all, we have to “do something!” But the reality is that many areas of accounting for complex companies are entirely subjective and judgmental and always will be, and no one can really say exactly where misjudgment shades into fraud. With today’s public hysteria about corporate corruption, do you want to be the CEO or CFO who finds out in front of a jury?
Are the big bucks big enough to make potential CEOs and CFOs take the risk? I’m not sure — at this point making money itself is tantamount to fraud and corruption. Today, with so many investors licking their wounds from so many trillions of dollars of losses, having any money left at all must mean you’re a crook.
That even applies to the President of the United States. After President Bush’s speech on corporate corruption, CNN’s Lou Dobbs clucked dismissively that Bush himself had “sold stock that later went down” — referring to his sale of shares in Harken Energy, of which he was a director in the 1980s — as though such a sale were inherently criminal. The SEC exonerated Bush of any wrongdoing a decade ago. But today, is “survivor’s guilt” a crime?
Dobbs, of course, isn’t the only one taking shots at President Bush for his involvement with Harken Energy. With mid-term elections just months away, and with Bush still popular for masterminding the war on terrorism, what else can Senate Majority Leader Tom Daschle and the Democrats do but try to sling corporate-corruption mud and make Bush and his team look weak for not cracking down on corporate crooks?
Never mind that most of the scandals that are just now coming to light took place under the Clinton administration. And never mind that while the Bush administration may have had ties to Enron, the Democrats are hip deep in Global Crossing and ImClone. It all just adds to the pressure for Bush and the Republicans to “do something,” to be seen as even more devout fighters of corporate corruption than the Democrats.
The economy is recovering. On average, stocks are now more attractively valued than at any time since early 1996, at least outside the technology and telecom sectors. And corporate earnings are surging back from recession — despite increasing conservatism in the way those earnings are being reported, by and large.
Those are the reasons I’m bullish now, for the first time in over two years. And yet I’m talking to my institutional clients about taking only small pilot positions in equities. Not because I’m afraid of more major accounting scandals, but because I’m afraid of what will happen when we “do something.” Watch carefully what happens in Washington over the next couple weeks. We’ll be just fine, and we’ll look back on this period as a great buying opportunity — provided that the political class doesn’t destroy all the capitalists in order to save capitalism.
