03.07.2002

Bad apples, rotten system

"Crook Street" and "WorldCon" were the banner headlines in New York's mass circulation tabloids last week. The wise guys on Wall Street had bitten the bullet and pulled out of WorldCom's plummeting stock some months ago. But millions of small investors on Main Street USA - many of them from the more prosperous layers of the working class - were devastated as they tried to come to terms with the country's latest financial scandal. Billions of dollars of capital - not just in the shares and bonds of WorldCom Inc itself, but right across the market - were destroyed in a few hours. The contagion spread across the globe, with London's FTSE 100 index shedding around £24 billion in the immediate aftermath. The dollar, already heading downwards in recent months, became a one-way bet and was hit by wave after wave of short selling, to find itself hovering around parity with the once derided euro. In the meantime, markets have steadied somewhat, but they nervously await the next revelation of corporate fraud on a scale hitherto unimaginable, fraud that places a huge question mark over the whole of corporate America, the heartland of global capitalism. Xerox, a component of the Dow Jones index and not exactly the raciest of stocks, came clean to the Securities and Exchange Commission about its inflated earnings statements and took a $10 million fine as punishment. Rumours abound that other DJ stocks, such as General Motors and General Electric - core holdings in the portfolios of every fund manager across the world - have also been cooking their books. Enron (energy trader), Adelphia (cable operator) and Tyco International (industrial conglomerate) - all of them guilty of gross misfeasance and mismanagement - were bad enough already, but WorldCom dwarfed them all in the sheer audacity of its creative accounting. The atmosphere of disillusionment, betrayal and even a touch of outright panic were palpable. The official reaction to this phenomenon was predictable: it was merely the 'bad apples' or the 'black sheep' who were responsible for destroying trust in what is supposedly an otherwise perfectly regulated, transparent and stable market. At all costs, capital has to avoid the recognition that WorldCom et al represent the tip of an iceberg - a generalised systemic failure. Hence, The Times assures us that US investors are a "hardy bunch" who have "plenty of historical experience of capitalism that "¦ has sometimes lived on the edge of the frontier". However, "good capitalism quickly drives out bad capitalism, scandal is followed by reform" and "the US economy can recover at speed from the embarrassment "¦ wounds will be licked and entrepreneurs will quickly move on" (June 27). Just as predictable, though we have yet to hear it, will be the reaction from certain sections of the left, for whom this current crisis, in their catastrophist dreams, will (yet again) betoken the beginning of the end. To be sure, the demise of WorldCom looks likely to be a watershed event. When Enron went belly up, the White House was in an acutely embarrassing position. Enron's boss, Kenneth Lay (known as 'Ken the boy' to his long-standing Texan friend, George W Bush), was not just a household name on the corporate scene, but also a big donor to the Republicans. Dubya's buddy, it turned out, was a crook. Thousands of jobs, livelihoods and pensions went down the tubes overnight, but when all the shredding of documents and spinning of lies was complete, we were left with the message that Enron's Byzantine financial scams were ultimately attributable to the flawed genius of a brilliant entrepreneur. Had Enron and the other scandals not happened, we would now be being treated to the same sort of spin. After all, Bernie Ebbers, the founder and presiding genius of WorldCom, was a quintessentially American wheeler-dealer. Where else but in the USA could you find a man who was both a Baptist Sunday school teacher and a reckless sybarite, a man who started out as a milkman and owed his limited academic achievements to a basketball scholarship, yet whose folksy, straight-talking and incessantly brilliant deal-making supposedly bewitched the entire financial community? Given the scale and widespread nature of the crimes that are now coming to light, such simplistic ad hominem denunciations of individual malefactors are obviously not sustainable. Bush, hoping that the Enron story is now yesterday's news, tells us that the WorldCom case is "outrageous". The Justice Department launches a federal criminal investigation and the SEC demands that the 1,000 largest companies in the US must certify their accounts. Errant bosses might, we are told, end up in a federal penitentiary. The point of all this frenetic activity is to shore up what is clearly a sick financial system in which all the parties - the companies themselves, and a small incestuous army of investment bankers, analysts, brokers, consultants and accountants - are involved in a tacit conspiracy to rig stock prices, using every form of manipulation available to them. Keeping the price of stock high and talking it higher is the name of the game, because this is the only way to attract the fresh finance capital essential to keep the enterprise afloat. It also brings rich rewards beyond the dreams of avarice in the form of bonuses measured in millions of dollars. WorldCom will come to be seen as a paradigm of the wild excesses that characterised the US stock market in the mid to late 1990s. Though the company was founded in 1983 - long before the so-called dot-com revolution - its meteoric rise could only have taken place in a situation where all measures of real value were thrown out of the window, as the speculative internet bubble lured even the most sober investors into an unprecedented spree. Devil take the hindmost. Seventy acquisitions in four years, paid for not in cash ('never pay cash' was one of Ebbers' oft quoted aphorisms), but in the paper money of WorldCom's ever growing stock market valuation. At its peak ($62 a share) WorldCom had a market capitalisation of nigh on $200 billion, which gave this single company a paper value far exceeding the GDP of many countries, including, for example, the entire economy of Greece. Unlike the classic dot-com companies (immense hype, but no foreseeable profits) that went to the wall, once the bubble was pricked, WorldCom had and has real assets, carrying a reported 85% of all internet traffic between Europe and the US. The only slight problem was that this status was built on a veritable mountain of debt. It was the failure of WorldCom's audacious $129 billion bid for Sprint in October 1999 - blocked the following year by regulators on grounds of competition - that signalled a deal too far. Thereafter, despite the best efforts of friendly analysts and other interested parties, WorldCom's stock began a slow but inexorable decline. The crunch came earlier this year. Not content with the immense personal fortune in share options that he had accrued from WorldCom's star status, Ebber had been betting heavily on the dot-com boom. When the bubble was pricked, he needed cash - desperately - to cover his losses, and his ever obliging chief financial officer, Scot Sullivan, the real architect of WorldCom's phenomenal performance, and now public enemy number one, was happy to oblige in the form of a personal loan estimated at some $400 million. When news of this largesse leaked out and the market took fright, the SEC belatedly decided to launch an enquiry into WorldCom. A routine audit of the books showed that some $3.8 billion of operational costs had been booked as capital expenditure over the last five quarters in order to enhance the bottom line. WorldCom's accountants were Andersen - who just happened to be the firm responsible for auditing Enron. Back then, despite their shredders being in permanent overdrive, they were banged to rights. This time, their excuse is that Sullivan covered up essential information that would have enabled them to detect and report the scam. Even the Financial Times finds this plea to be "astounding". Booking day-to-day operational costs as capex, effectively designating them as depreciable (but actually nonexistent capital assets) is the sort of routine fiddling that any trainee accountant would spot a mile off. So much for the detail, but how should we assess the financial, economic and political fallout from the WorldCom affair? Does it, for example, portend some kind of general crisis for the capitalist system as such? One's first instinct is to say decidedly not. In the last decade alone markets have weathered much more serious events - true, billions in capital have been destroyed and perhaps millions of jobs have been sacrificed on a global basis, but the system itself has survived these shocks. Why? In great part because of a global capital surplus, with huge sums of money looking for a home and much of it finding a haven in US equity and bond markets, where historical returns have been consistently satisfactory. On the other hand, it would be foolish to ignore the sheer psychological impact of recent events on investors who are thinking of buying US assets. Confidence has already been badly shaken. If more skeletons emerge from the closet and it turns out that the barrel itself, rather than a few apples, is rotten, then the worldwide consequences would be immense. A significant flight of capital from US bond markets and an ongoing investors' 'strike' would basically bankrupt the administration, which is sitting on trade and budgetary deficits that are frankly unsustainable. We forget sometimes that the world's mightiest and richest country is actually living on tick. Imagine what would happen if the USA defaulted on even one small tranche of its debt repayments: as always, it would be the working class that would have to pay the price in terms of social provision, but the political dislocation resulting from such an event would be incalculable. Even leaving aside such nightmare scenarios, you could argue that the ideological basis of US hegemony in the post-Soviet era has already been severely damaged. No alternative? To this? Ironically, it is not in the US, but here at home that the impact of WorldCom could first cause serious difficulties for the market. Blair assures us that such a thing could never happen here. Maybe he was out of the country on one of his globe-trotting 'save the world' missions when the Marconi scandal happened and nobody bothered to tell him about it? If the FTSE 100 index falls by another couple of hundred points, then the major insurance companies will perforce become distressed sellers of shares. See what that will do to the stock market. Maurice Bernal