A couple of months ago From the Stool dealt with the stench arising from the Enron bankruptcy, and the despicable behavior of their senior executives. At that time it looked like Arthur Anderson was an accomplice – there now is no doubt. While the president and both houses of Congress feigned outrage and called for corporate reforms nothing much happened, further eroding individual investors’ confidence. Our economy continued to improve, the Dow Jones was back over 10,000 and George W. was extolling the stimulative effect of his massive tax cut.
It has only been in the past few weeks that we learned Martha Stewart apparently mimicked Boesky, WorldCom capitalized $3.9 billion of expense, presaging bankruptcy, Tyco’s Kozlowski just doesn’t believe in paying sales tax, the euro overtook the dollar, and in less than two years we have converted a huge budget surplus (the basis for the tax cut) into a $195 billion deficit. People have lost confidence in the integrity of U.S. business and its leaders and are therefore questioning whether to hold or fold. Those folding have recently taken the lead over those holding.
Our financial markets have responded in a manner reminiscent of the Great Depression and absent a miracle it looks like 2002 will be the third consecutive year of the bear. George W. now blames his budget woes on the absence of capital gains tax collection, an interesting hypothesis for a guy who campaigned on eliminating them.
Our press and media have reacted to each new revelation of impropriety like sharks to chum. Emotion, lack of faith, trust and confidence often provoke reactions more severe than the actual circumstances merit. The horrendous attacks of September 11 should not have nearly toppled the world economy. The U.S. is no less the mightiest nation militarily and economically. The global reaction, however, to the destruction of the World Trade Center by nineteen individual psychopaths created irrational doubts about our ability to maintain our way of life. As we are the model that most other nations emulate, the effect was devastating.
The energy industry, particularly gas and oil, has always been a smarmy one. Perhaps the reckless willingness to bet the farm on highly speculative data encourages a breed of cowboy who, when successful, believes he can do no wrong. The old time oil barons thought they could rule the world, and nearly did. Ken Lay and his Enron cronies possess the same arrogance based on the fact that our survival depends on energy, and on Enron’s ability to buy influence as one of the largest suppliers. There is hopefully no substance to the recent allegations of accounting irregularities surrounding Vice President Cheney’s tenure as the Halliburton CEO, and nothing unsavory regarding George W’s stock sales while a director of Harken Energy. Revelations to the contrary, however, shouldn’t surprise anyone, and while in and of themselves are largely meaningless, have the potential to further shatter what little is left of investor confidence.
We learned last week that the Adelphia founding family, held up as community pillars, loaned themselves for personal use virtually all of the stockholders equity, making the $400 million loan to Bernie Ebbers, WorldCom founder, look like reasonable corporate largesse. In both cases, criminal investigations are under way but little, if any, relief is expected for the investors in these now bankrupt corporations.
If we can’t believe a Fortune 500 CEO when he or she reports earnings, or accept the objectivity of a “buy” recommendation from a Merrill Lynch analyst, or believe that the outside directors on audit committees will perform their fiduciary responsibility to the shareholders, then the strength of the U.S. equity markets and our ability to lead the world may well be in jeopardy.
This should not be the case. The “irrational exuberance” investors felt in the seven plus years of the Clinton bull market fueled corporate excess that appeared to do little harm with the S&P compounding at a 25% annual rate. Most institutional money managers in their late twenties and thirties had never held a job, made a payroll, negotiated a contract, and never experienced a down year. Youthful and inexperienced analysts established sales and earnings growth rates for publicly held companies that were not sustainable. PE ratios, particularly in the tech sector, defied logic. Ideas absent any economic model were being sold for ten times revenue even when there wasn’t any. An honest, hard working CEO could see his company lose half its market value if he missed consensus expectations by a single penny even if he produced record results. Against this backdrop, it’s not hard to understand management pressure on public accounting firms to find ways to cover up bad news and manage earnings.
When the dot.com bubble burst, the NASDAQ lost 3,500 points. A mild recession caused a major revision in expectations for corporate earnings, setting the stage for the post September 11 market meltdown. While we had struggled to regain a solid footing as the economy improved and our faith in homeland security recovered, these isolated examples of corruption are causing many to give up on American business at the wrong time for the wrong reasons. The strength of our financial markets is essential to the strength of our economy and profoundly affects the economic health of the rest of the world.
Most CEOs are honest. Most boards of directors are incorruptible. Interest rates are at a forty-year low. We are experiencing real GDP growth. The remaining public accounting firms will not repeat Andersen’s mistakes. The government and SEC will not allow it. Our housing industry is booming. By any standard, our unemployment rate is still low. While our dollar has weakened, it remained significantly overvalued for too long; and if one were to bet on a currency for the long pull, few would back the euro, the yen, or any other for that matter, vis-à-vis the dollar. There are few solutions possible to major international problems, like the Middle East, without strong U.S. leadership. We lead the world in technology and our industries are the most productive on earth. We are every nation’s largest customer, generating a third of the world’s GDP and producing nearly half of the world’s food.
Unfortunately, it takes a longer time to make a friend than to lose one. There is nothing newsworthy about the thousands of business executives whose primary concern is the well-being of their employees, communities and shareholders. If a corporation cannot generate consistent earnings and reasonable sales growth over time, it should be punished, but not when it does well.
The U.S. financial markets should not collapse, however, because there are a handful of Ken Lays still abusing their public trust and a few fanatics willing to kill themselves blowing up a bridge. The entire telecom industry represents less than 1% of U.S. GDP. It will again become a major growth sector.
We should not imitate the lemmings who lose whole populations when a few start to run. There have been few times in the past century when there has been more to gain by supporting those institutions whose results warrant that support. If the folders continue for much longer to outnumber the holders, the future looks bleak and the bad guys will have won. I’m betting that it won’t happen. Hope that I’m not alone.