UNITED STATES: A few bad apples or a rotten system?

Issue 

BY EVA CHENG

Even before news of the latest corporate scams exploded in late June, the London-based Economist on May 18 published a 20-page defence of capitalism. The article began with the claim that "the capitalist system has proved surprisingly robust in the face of recent crises" and concluded that "capitalism, like democracy, may not be perfect, but it beats the alternative. And making it as good as possible will advance the future prosperity of all."

After the scandals involving more big corporations such as WorldCom, Xerox, Halliburton and Harken erupted, the July 1 London Financial Times also went into damage control, proclaiming: "US capitalism down, not out". The FT blamed the trouble on the "excess, turbulence and short-termism" of "Anglo-Saxon transactional capitalism", contrasting it to more "patient" capitalists, as represented by the "German model".

The June 28 British Guardian also assured its readers that "this is no crisis of capitalism... It is an implosion of the current US formula". Similar attempts to salvage corporate capitalism's dwindling credibility have filled the big business media.

However, the Guardian and the FT carefully ignored the wave of corporate scams that rocked Europe in the last two decades, which have involved big corporations such as Polly Peck and Bank of Credit and Commerce (Britain), Ferruzzi Finanziaria (Italy), Credit Lyonnais (France), Lernout and Hauspie (Belgium), the World Online (the Netherlands), Infomatec AG (Germany) and British media tycoon Robert Maxwell.

Some of the fraudulent tactics pulled by these European crooks — Lernout and Hauspie overstated its revenue and Informatec inflated its sales — were old tricks which are being recycled today by their US counterparts.

In the US, the apologists tried to focus the blame on a handful of corporate crooks. US President George Bush, for example, assured a news conference on July 8 that "by far the vast majority of CEOs in America are good, honourable, honest people who have nothing to hide". Just a few "have created the stains that we must deal with", he added. He repeated that line in a widely broadcast speech the following day.

Deep trouble

Big business is in deep trouble and its apologists know it. Harald Malmgren, an economist who has served four US presidents, was reported in the July 5 Australian Financial Review as warning that the scandals are "developing a widespread crisis of confidence". How can there not be such a crisis as more top US firms now come under criminal investigation?

The dirty deeds of Enron and Arthur Andersen, and now WorldCom, were only the most high profile cases. Before Enron, corporations investigated for shonky accounting included Cendant (formerly CUC), Waste Management, Livent, Rite-Aid, Microstrategy, Oxford Health, Informix, McKesson HBOC and Boston Scientific.

The more prominent irregularities uncovered since the Enron collapse include Global Crossing, Tyco International, Merrill Lynch, Dynegy, ImClone Systems, Adelphia Communications, Computer Associates, Peregrine Systems, Qwest Communications, Xerox, WorldCom, Merck, Halliburton (while US vice-president Dick Cheney was its chief executive) and Harken Energy (during the early 1990s when Bush junior was a director). The list goes on.

The US$1.4 billion fraud at Waste Management, discovered in 1998, led to the biggest restatement of results in US history. However, that was eclipsed by Enron last December, and again on June 26 with the US$3.8 billion fraud by WorldCom and the US$6 billion debacle at Xerox on June 28. WorldCom, Tyco, Qwest, Enron and Computer Associates collectively inflicted a loss of US$460 billion in paper value on the stock market.

Bush's "bad apple" theory doesn't measure up to the picture revealed by the USA's own watchdog, the Securities and Exchange Commission (SEC). Last year, it reported that investigations relating to "financial statement improprieties" in recent years had pushed its caseload to an unprecedented 260.

Moreover, the number of companies being ordered by the SEC to "restate" their financial results soared from an average of 49 per year between 1990-97 to 150 per year in 1999 and 2000. Few have doubts these figures only captured a fraction of the US corporate crooks. But they were a gauge of a growing problem, which became more pronounced when capitalist profits lapsed into a depressive phase.

The most common restatements, according to the SEC, relate to "revenue recognition". The decision on what constitutes a firm's revenue and what constitutes business expenses (capital or operating, for example) can have a pivotal impact on a company's reported earnings.

As profit growth is increasingly hard to achieve due to capitalism's inherent problem of overproduction, more and more US capitalists and managers resort to fiddling the books to produce more desirable results.

Profit figures have a direct bearing on a corporation's share price, the personal fortune of the executives who run the firm and the availability and costs of credit which is crucial to the survival of most capitalist businesses. If the executives don't fiddle the books to match the performance of their competitors, they may not be able to stay in the game. This is a key driving force behind the current wave of corporate crime.

'Acceptable' manoeuvres

However, there are many manoeuvres that are "acceptable" until one gets caught. For instance, while operating expenses will be reflected fully on the immediate profit and loss account, the impact of capital expenditure will be spread out. What goes to which of the two accounts is not always clear-cut, but the grey area will be minimised if honest accounting principles are observed. The same applies to many other accounting decisions. One of the external auditors' main jobs is to check that honest decisions are being made.

But driven by the compulsion to maximise reported profits, corporate managers have stretched the grey area. Big auditing firms, desperate to keep clients, have increasingly turned a blind eye to such scams.

It's not hard to understand why many auditors avoid asking too many questions when, for example, WorldCom paid Arthur Andersen US$4 billion last year to audit its books and US$12 billion for other consulting work.

Not counting profit-linked stock option incentives for senior executives as company expenses is another significant and common way to "improve the bottom line". "Borrow" sales from future periods and "adjustments to bad-debt reserves" are also common tricks to fudge the books.

Serial acquisitions open a wide field for the massaging of accounts, a trick that WorldCom knows well. Since 1995, the company acquired more than 75 companies in less than five years and generated a US$30 billion long-term debt. The higher the share price, the stronger is a company's ability to borrow, at the lowest costs. That's why keeping the share price buoyant is crucial in the capitalist game.

Recently, even General Electric, the world's biggest company, has been put on the suspect list. William Gross, manager of the US$55 billion Pimco Total Return bond fund, challenged the basis of GE's almost continuous profit growth of 15% per year for more than two decades, far outpacing its competitors. GE's "impressive" records were made easier by its acquisition of more than 500 companies in the last five years, Gross pointed out.

Arthur Andersen's role in the Enron scam only reflects the more extreme end of the fraud spectrum. Elaborate fiddling and other "aggressive accounting" measures occur every day on a grand scale throughout the capitalist system and are mostly "perfectly legal".

Many capitalist apologists now pretend that these acts are exceptional, one-off, committed only by individual crooks and have nothing to do with the capitalist system itself. In reality, these fraudulent acts are an integral part of the capitalist system.

Embezzlement

Even liberal economist John Kenneth Galbraith acknowledged in his 1954 book, The Great Crash 1929, that US business was soaked in a permanent pool of undiscovered embezzlement. In "good" times, when money is plentiful, Galbraith said, the embezzlement grows but the rate of discovery falls. The opposite occurs in depressions.

Under immense public pressure, the usually corporate-friendly SEC has been forced to be seen to respond. In early July, it issued an order to the chief executives of the top 1000 US-listed companies, instructing them to personally verify their company accounts. It is widely tipped that the move will spark a new wave of "financial restatements" in the coming months.

Harald Malmgren even predicted it could be the cause of six big new cases of a scale on par with WorldCom — which led to the loss of US$150 billion in shareholder "wealth" — and "many dozens of mid-sized ones".

Also lost as a result of the recent scandals were the jobs of tens of thousands of workers and billions of dollars of retirement savings of many ordinary workers. The retirement schemes of more and more US companies have coerced workers to take a stake in the stock market.

The recent scandals only give a glimpse of the true nature of a system based on corporate profits, driven by the greed of a small minority. The Economist is wrong. Capitalism isn't the best that we've got. A system that gears to meet the needs of the people — a socialist system — is the much decent and viable alternative.

From Green Left Weekly, July 17, 2002.
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