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Matthew Hoy currently works as a metro page designer at the San Diego Union-Tribune.

The opinions presented here do not represent those of the Union-Tribune and are solely those of the author.

If you have any opinions or comments, please e-mail the author at: hoystory -at- cox -dot- net.

Dec. 7, 2001
Christian Coalition Challenged
Hoystory interviews al Qaeda
Fisking Fritz
Politicizing Prescription Drugs

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Tuesday, May 21, 2002
The New York Times' Paul "Line 47" Krugman continues last week's attack on the accounting industry. Make no mistake, the accounting industry needs a good spanking, but I'm skeptical that a former Enron hack is the one to deliver the chastisement.

["I] would suggest to you that the single most important innovation shaping [America's] capital market was the idea of generally accepted accounting principles." So declared Lawrence Summers, then deputy secretary of the Treasury, in a 1998 speech. Mr. Summers urged troubled Asian economies, then in the middle of a disastrous financial crisis, to emulate American-style "transparency and disclosure."

Now America has its own problems with corporate accounting, exemplified by Enron. So will we follow our own advice? Will we provide investors with the facts they need to make informed decisions? Probably not. And that's bad news, because Enron's case, though extreme, was by no means unique.

We really don't know whether or not Enron's accounting methods were or were not unique. Other companies may have used similar partnerships to hide debts, but if they have, they have not done so to the degree that it has caused the company to fail -- yet. Krugman wants his readers to believe that many companies are doing what Enron was discovered to have done. Time will tell, but I'll put up a dozen of Rubio's Fish Tacos against some of those New York City hot dogs that no other American company has done what Enron did to the degree that it lands them in bankruptcy court. [Bet may only be accepted by Paul Krugman.]

Krugman also poses the question about whether the government, through regulation, will provide investors with "the facts they need to make informed decisions." And then says that it won't. Well, the government may, and it may not. But the facts will get out. The transparency of the American capital market will win out.

In last week's column, Krugman pointed out that Standard & Poor's will impose accounting standards that are stricter than those required by the federal government. Private industry will step up, whether or not Congress or the president do anything. I doubt that Krugman missed the parade of companies dumping Arthur Andersen as their auditor. Doesn't that say something about what these companies expect from their auditor? American companies, unwilling to be the "next Enron," are going to demand tougher accounting, as are investors. Standard & Poor's won't be the only private bond rating company to demand tougher standards -- Moody's and others will follow. Wall Street cannot afford another Enron.

For corporate America as a whole, 1997 was a watershed year. According to government statistics, overall corporate profits grew rapidly between 1992 and 1997, but then stalled; after-tax profits in the third quarter of 2000 were barely higher than they were three years earlier. But the operating earnings of the S.&P. 500 - that is, the profits companies reported to investors - grew 46 percent over those three years.

There are technical reasons that these measures of profits need not grow at exactly the same rate, but they have historically tracked each other fairly well. So why did they suddenly diverge? Surely the main reason was that after 1997 companies made increasingly aggressive use of accounting gimmicks to create the illusion of profit growth.

I don't doubt that this happened. The companies that did this are going to pay now. Their stock prices are dropping, or will drop -- I can guarantee it. If the accounting gimmicks were illegal and allowed CEOs and other insiders to profit, the FCI Lompoc is going to be expanding.

Of course, what does this say about the "Clinton Economy?" If what Krugman says is completely accurate, the seeds for the current economic doldrums were planted in 1997, not late 2000.

The truth is that the only ones to blame are the greedy company executives and their partners in crime in the accounting firms.

You see, corporate leaders were desperate to keep their stock prices rising, in an environment where anything short of 20 percent profit growth was considered failure. And why were they desperate? In a word: options. The bull market, combined with ever-more-generous options packages, led to an explosion of executive compensation. In 1980 chief executives at large companies, according to Business Week's estimates, earned 45 times as much as non-supervisory workers. By 1995, however, the ratio had risen to 160; by 1997, it had reached 305. C.E.O.'s wanted to keep the good times rolling, and they did: by 2000, though profits hadn't really increased, they were paid 458 times as much as ordinary workers.

The point here isn't that top executives are overpaid, though they surely are; it's that the way they are paid rewards them for creating the illusion of success, never mind the reality.

I agree that these CEOs are way overpaid. The increasing disparity between the richest Americans and the middle class is troubling, to say the least. But whose responsibility is it to make sure that CEO salaries are kept to some level of sanity? That would be the boards of directors, and, by extension, the stockholders. Vote with your dollars. If a company whose stock you won is paying its CEO an inordinate sum of money, put your money elsewhere.

Still, that's exactly the kind of thing that accounting standards are supposed to prevent. What allowed our corporate emperors to hide their nakedness was a combination of poorly crafted standards, which I wrote about last week, and compliant auditors. Major accounting firms were all too happy to be deceived by corporate smoke and mirrors, as long as they got lucrative consulting contracts.

And, with the demise of Enron, that sort of thing is very likely to end. What are corporate investors going to think about companies now when they see that the same company that is supposed to be auditing the books also is being paid millions in consulting contracts?

Also, Krugman blames the Enron/Arthur Andersen debacle on "poorly crafted standards." While this may be true, there was also fraud involved. Last I checked fraud was illegal. Arthur Andersen is in federal court facing obstruction of justice charges. Enron higher-ups will be going to jail. Skilling, definitely. Lay, probably. Saying that the accounting standards don't work because they didn't prevent Enron's illegal acts is like saying that murder statutes don't work because Ted Bundy managed to kill dozens of people.

Time for reform? Not according to some people. Today the Senate Banking Committee is scheduled to take up a bill drafted by Paul Sarbanes, the committee's chairman, that would take some modest steps toward accounting and auditing reform. The bill has been endorsed by some of the most respected names in finance ? people like Paul Volcker, the great former Fed chairman, and John Bogle, the famed investor. But Senator Phil Gramm, throwing his weight behind an all-out lobbying effort by the accounting industry, has made it clear that he will try to kill the bill.

Let me do the math. 50 Democrats. 49 Republicans. 1 Independent. 60 needed for cloture. Phil Gramm = 1 vote.

Given the current political environment, I doubt that Gramm will be able to get a bunch of friends to vote with him. While the accounting firms may not want to have a wall placed between their auditing and consulting businesses -- it's going to happen. Either because Congress requires it, or because investors demand it.

I'd like to be nonpartisan here ? really I would. And there are indeed Democrats who have gotten large contributions from accounting firms. But the current effort to prevent any meaningful accounting reform is explicitly a Republican initiative, one directed from the very top: The New York Times reports that Mr. Gramm is "working closely with the Bush administration" in his efforts to block the Sarbanes bill.

Let me repeat what I said last time: Honesty in corporate accounting isn't a left-right issue; it's about protecting all investors from exploitation by insiders. By blocking reform of a broken system, the Bush administration is favoring the interests of a tiny corporate oligarchy over those of everyone else.

Oh...my side! Nonpartisan? Oh, that hurts!

Yes, Democrats have gotten big money from the Big Five (maybe it should be Big 4.1, seeing how things are going for Arthur Andersen), not as much Republicans, but a tidy sum nonetheless. Reading Krugman, you'd think that Gramm is the biggest beneficiary of the Big Five's largesse. You'd be wrong. It's New York's own Sen. Chuck Schumer who received more than $340,000 since 1989. Gramm is actually in third place, behind Rep. Billy Tauzin (R-La.).

What's this say about the cynical world of campaign finance reform? Well, it says Republicans stay bought.

Seriously, according to Krugman, Sarbanes bill is perfect as it stands. Contains no flaws and should simply pass both houses of Congress by voice vote. Why don't we just elect Sarbanes, with Krugman's consent, emperor? Debate and compromise is part of how democratic institutions work. Changes will be made, whether the accounting industry wants them or not, and whether or not Congress passes new laws.

With Enron, liberals are adapting the script they typically use for gun violence. Whenever there is another tragic, evil, fatal shooting, they call for new gun laws -- ignoring the fact that the shooter typically already violated numerous laws that were already on the books.

Enron's bigwigs, I guarantee you, broke existing laws. Laws don't stop thieves before they take your money, they allow you to toss them behind bars after they've stolen your money. If someone is determined to do evil, a law won't stop them.

One final thought: This isn't just a question of treating American investors fairly. Like the Asian nations before their crisis, the United States relies heavily on inflows of foreign capital, inflows that depend on international faith in the integrity of U.S. markets. The Bush administration may believe that investors have nowhere else to go, that the money will keep coming even if we don't reform. That's what Suharto thought, too.

Well, at least Krugman isn't comparing Bush to Osama bin Laden or Hitler. He may just be improving.

1:52 AM

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