January 13, 2004
How Much of a Ponzi Scheme Was Enron, Anyway?

A correspondent writes: One piece of the puzzle I don't understand . . . Richard Kinder is President and COO of Enron from 1990 to 1996. He leaves and takes over Kinder Morgan, which is a pipeline company. Then, it would appear, he successfully executes a strategy of building up from solid pipeline assets. In other words, it (tentatively) looks like the guy who is really running Enron leaves in '96 and proceeds to successfully execute the strategy Enron avowed. It makes me suspect there really was a there there at Enron, but that Kenneth Lay allowed silly lieutenants like Skilling, Fastow, White, et cetera to start doing silly things--like overpaying for foreign assets and building up big trading infrastructures to trade in immature markets....

Posted by DeLong at 12:24 AM

December 28, 2003
Enron and Former Army Secretary Tom White

There was some discussion over the past several years about the qualifications of former Enron executive Thomas White to be Bush's Secretary of the Army. Rumsfeld fired him at the start of May 2003. Reading Bethany McLean and Peter Elkind (2003), The Smartest Guys in the Room: The Amazing Rise and Fall of ENRON (New York: Penguin: 1591840082) makes it clear that Tom White's appointment--and his survival for more than two years--was even more astonishing than I had previously imagined. From the summer of 1997 until the winter of 2001 Tom White was the number two executive at Enron Energy Services [EES], and here's what McLean and Elkind have to say about EES: p. 175 ff: ...In March 1997, two months after becoming president, Skilling... broke out retail as a separate business, named it Enron Energy Services, and designated Lou Pai as its chairman and CEO.... A few months later Tom White, the retired general who had managed the construction of Teesside, was named Pai's number two.... But how was this new team going to turn things around? Enron had lost $35 million on the retail [power sales] business in 1996. The following year... a hiring binge... advertising costs, EES...

Posted by DeLong at 08:28 PM

Notes: Thoughts on ENRON

ENRON seems to have consisted of a guy (Kenneth Lay) who believed that deregulation would produce huge profit opportunities (but weren't sure what they were), a guy (Jeff Skilling) who understood that deregulation would produce huge profit opportunities to a firm that could become the best at trading natural-gas contracts in newly-deregulated energy markets (but had no clue what to do next--other than to piss away billions upon billions of $$$$$ trying to enter markets that nobody inside ENRON understood), a guy (Andrew Fastow) whom Lay and Skilling let steal $100 million because he was very good at both legal and illegal large-scale financial fraud, a host of investors and analysts who paid no attention to the large wedges between ENRON's unimpressive cash-flow and its impressive reported earnings, and a host of other enablers. I had thought that ENRON's problem was that it started by trying to hide losses for one quarter until the business got a good bounce, played double-or-nothing in this business for a couple of years, and wound up in real trouble as a result. But it looks considerably worse than that. It looks like a game of "let's see how long we can fool the...

Posted by DeLong at 02:16 PM

December 23, 2003
Where Did the Money Go?

Yes. But where did the $11 billion go? Who has it now? Italian Officials Say They Suspect $11 Billion Ruse at Parmalat: Parmalat, the Italian dairy and food giant, engaged in a tangled scheme involving dozens of offshore front companies to invent assets to offset perhaps as much as $11 billion in liabilities over more than a decade, Italian investigators said on Tuesday.... The crisis at Parmalat, carrying echoes of the byzantine partnerships that contributed to the collapse of Enron in the United States, dwarfs all other European accounting scandals in recent years and raises questions about the ability of European regulators to oversee global companies that are increasingly financially sophisticated... Now that last sentence is simply wrong. It's not the European regulators who have failed, it's--once again--the auditors: Grant Thornton, and maybe Deloitte and Touche. For example: ...In March, Parmalat sent Grant Thornton documents on Bank of America letterheads confirming the accounts. Bank of America subsequently declared the letters forgeries. People close to the investigation said the documents, including a letter supposedly written on March 6 and signed by Agnes Belgrave, a Bank of America employee in New York, had been forged using scanners, probably by Parmalat finance officers,...

Posted by DeLong at 09:08 PM

December 19, 2003
Where Did the Money Go?

This is one of the most bald-faced financial frauds I have ever seen: FT.com Home US: ...Parmalat on Friday said Bank of America had rejected the validity of a document stating that Bonlat, the Italian dairy group's Cayman-based subsidiary, held euro 3.95bn ($4.89bn) in cash and securities in a BoA account. BoA told Grant Thornton, Bonlat's auditor, that a document dated March 6, 2003, claiming euro 3.95bn in cash and securities as of December 31, 2002, was not authentic, Parmalat said. Grant Thornton had used the document to certify Bonlat's 2002 balance sheet. Last week, Maurizio Bianchi, a Grant Thornton partner, said in an interview with Il Sole 24 Ore, an Italian financial newspaper, that the auditing firm had "received by letter confirmation of (the liquidity). And, naturally, of the existence of the securities in the portfolio of the company for which we are the auditors, including bonds emitted by Parmalat and bought back." Mr Bianchi was not available to comment on Friday on whether the letter of confirmation had been obtained from Parmalat or directly from BoA. Last week, Standard & Poor's said it appears to have been repeatedly misled by Parmalat. The rating agency slashed Parmalat's debt by...

Posted by DeLong at 09:38 AM

November 18, 2003
Mutual Funds

Charles Dodgson links to a very nice Paul Krugman column on the current mutual fund scandals: Through the Looking Glass: Paul Krugman today is shrill on the subject of the mutual fund scandals, lucidly explaining them in his usual lucid, cogent shriek. But the SEC is on the case. They're dealing with the problem. Consider what they've already achieved in their settlement with the Putnam mutual funds company: The settlement with the S.E.C. did not outline what penalties or fines would be paid by Putnam. Restitution will be determined later. As is customary, Putnam neither admitted nor denied the accusations. So what did the commission extract from Putnam in the quickie deal? An independent board of directors, something the company previously claimed to have; compliance controls, which the company was already supposed to have; and employee trading restrictions, which Putnam should have had all along. They sure are tough negotiators down there at the S.E.C. Fund companies that have turned up abusive trading practices in their own shops will surely cheer this settlement and line up to receive their own version. Which, of course, helps to deal with the problem, by giving the fund companies something that they can point...

Posted by DeLong at 07:54 AM

November 13, 2003
Corporate Control

Peter Temin is surprised that there hasn't been more of a response to the various forms of high corporate fraud uncovered in the past several years: WSJ.com - Capital: MIT economic historian Peter Temin is underwhelmed by the response to business wrongdoing. "In the 1930s," he says, "there were a lot of accusations about bad behavior on the part of banks and investing companies." That led to major changes, some later deemed unnecessary, such as the Glass-Steagall ban on the mixing of banking and investing. "Subsequent work has tended to exonerate businesspeople and blame the transformation of the end of a bubble into the Great Depression on the administration and the Federal Reserve." This episode is the opposite: "There was clearly malfeasance in the private economy, but there has been surprisingly little outrage relative to the problem." The SEC and Mr. Spitzer, he says, are merely "growling around the edges and getting a few sacrificial lambs." On one point, the three professors agree: Evidence that mutual-fund managers and sophisticated investors were in cahoots to take money from ordinary mutual-fund investors is alarming, and demands significant change....

Posted by DeLong at 08:31 AM

October 10, 2003

The Enron investigation creeps forward: Ex-Enron Accountant To Settle (washingtonpost.com): A former senior accountant at Enron Corp. has agreed to pay a $500,000 fine to settle government charges that he and other executives fraudulently manipulated the Houston company's earnings, shifting energy-trading profits in California and other states to hide more than $1 billion in losses in 2000 and 2001. The Securities and Exchange Commission said yesterday that Wesley H. Colwell, who had been the chief accounting officer of Enron North America, the company's energy-trading arm, is cooperating with the Justice Department's criminal investigation of Enron's December 2001 bankruptcy filing. Colwell was a close friend and colleague of Enron's top accountant, Richard A. Causey, and will become a pivotal witness in future cases if he has evidence that top executives knew about earnings manipulation, according to lawyers involved in the case. The SEC's complaint said that the trading profits were used to help hide $1 billion in losses at its retail energy unit in the first six months of 2001 -- a period when Enron's declining stock price threatened a financial crisis at the onset of Jeffrey K. Skilling's tenure as chief executive......

Posted by DeLong at 09:04 AM

September 17, 2003

Stories like this leave me frustrated: why was it so important for Enron to boost this quarter's earnings by $12 million? I can understand why Richard Cheney and the rest of the Halliburton crowd would change their accounting procedures and conceal the change in order to boost earnings by $100 million: $100 million can have a significant impact. But $12 million? In the context of a company as large as Enron? Why? FT.com Home US: Three former senior Merrill Lynch bankers were indicted on Wednesday for allegedly facilitating a Nigerian barge deal that let Enron inflate its income by $12m. Daniel Bayly, former head of global investment banking, James Brown, former head of strategic asset lease and finance, and Robert Furst, the bank's then-relationship manager for Enron - are charged with conspiring to commit wire fraud and falsify records. The indictment also alleges they lied to Congress and the SEC about the transaction.... The indictment alleges that Merrill Lynch temporarily bought Nigerian power barges from Enron in 1999. The transaction should not have been considered a true sale under accounting rules because Enron had allegedly promised to buy the barges back at a higher price. The justice department previously indicted...

Posted by DeLong at 08:05 PM

July 29, 2003
Charles Dodgson Says, "I Told You So"

Yes, Virginia, there was fraud at Enron: Through the Looking Glass: Oh, and while I'm taking care of old business, remember my former bête noir, who made a big splash in the blogsphere by claiming that there couldn't possibly be major fraud at Enron? One piece of "evidence" which he trotted out again and again was that: For the "fraud" hypothesis to be correct, hundreds -- if not thousands -- of employees and professionals at many levels of society had to be in the conspiracy and had to keep quiet for years, notwithstanding the constant threat of exposure to the Securities and Exchange Commission, Citibank and JP Morgan -- the latter two of which had extensive contractual rights to audit and investigate Enron. And of course major banks would never get involved in anything untoward. Cut to today's news: After more than a year of criminal and regulatory investigations, the nation's two largest banks agreed yesterday to pay almost $300 million in fines and penalties to settle accusations that they aided Enron in misrepresenting its true financial condition for years before the company collapsed. The settlements, with J. P. Morgan Chase and Citigroup, are the broadest to date reached with...

Posted by DeLong at 10:58 AM

July 28, 2003
Locking the Barn Door

Will this do any good? Will this make Wall Street less willing to play along the next time an Enron appears? I don't know... WSJ.com - JP Morgan, Citigroup to Pay $255 Million in Enron Case: NEW YORK -- JP Morgan Chase and Citigroup agreed Monday to pay a total of $255 million for their roles in Enron's manipulation of its financial statements. Morgan will pay $135 million and Citigroup will pay $120 million as part of the settlement, the Securities and Exchange Commission said. The SEC said most of the money would go to victims of Enron's massive corporate fraud -- the first in a string of scandals that have tainted corporate America since 2001. The government had accused Morgan and Citigroup of helping Enron design complex transactions that allowed it to underreport its debt. "If you know or have reason to know that you are helping a company mislead its investors, you are in violation of federal securities laws," SEC enforcement chief Stephen Cutler said in a statement. In December, Citigroup and J.P. Morgan Chase officials told an investigative panel of the Senate Governmental Affairs Committee that they believed they were engaging in lawful deals with Enron. Citigroup's...

Posted by DeLong at 10:22 AM

June 26, 2003
Executive Compensation

A small positive step, but a positive step: WSJ.com - SEC Is Set to Require Clearance By Holders of Stock Compensation: WASHINGTON -- The Securities and Exchange Commission is expected to approve a rule Friday requiring companies listed on U.S. markets to win shareholder approval of all stock-compensation plans, according to people familiar with the matter. The long-awaited move will essentially prevent companies from awarding lucrative stock-option packages to executives, directors and others without explicit shareholder approval. Brokers holding shares for their clients will also be barred from voting on equity-compensation plans unless the owner has given voting instructions. The SEC will direct the New York Stock Exchange, the Nasdaq Stock Market and other major markets to include the rule as part of their listing standards, beginning Monday. Listing standards require issuers to follow certain rules or face being bumped from trading on that market. While the NYSE and Nasdaq set their own requirements for listing shares, they must be approved by the SEC. Investor advocates have pushed for greater shareholder control over equity awards as a way to oversee management and ensure that the stock isn't diluted by generous grants of stock or options....

Posted by DeLong at 09:53 PM

June 09, 2003
Well, This Wasn't Expected!

Huge government-sponsored corporation widely thought to be too big to fail fires its president: FT.com Home US: ...Freddie Mac, which provides finance for mortgages and is number 32 in the Fortune 500 list of the largest US companies, said it had fired Mr Glenn "because of serious questions as to the timeliness and completeness of his co-operation and candour" in the review of its earnings......

Posted by DeLong at 10:09 PM

April 18, 2003

From the latest large-scale corporate accounting scandal: HealthSouth: New York Times: ...The 11-minute excerpt, which was played last week in a hearing in federal court in Birmingham, Ala., was secretly recorded by William T. Owens, a former HealthSouth chief financial officer. Mr. Owens has admitted to participating in the fraud and is cooperating with regulators. As part of an undercover operation conducted by the F.B.I., Mr. Owens wore a recording device, which he used to tape a conversation with Richard M. Scrushy, HealthSouth's chairman and chief executive, on March 18, the day before the Securities and Exchange Commission accused HealthSouth and Mr. Scrushy of inflating the company's profits. Mr. Scrushy has since been fired by HealthSouth, but his lawyers have said he had no knowledge of any wrongdoing. Nine former executives have admitted to participating in the fraud. No criminal charges have been brought against Mr. Scrushy. On the tape, parts of which are not intelligible, Mr. Owens recounts a conversation with his wife: "She said, `I'm afraid if you keeping signing these phony financial statements' ? and that was her term ? she says, `I've been reading about Enron and I've been reading about WorldCom.' She said, `I'm afraid...

Posted by DeLong at 09:03 AM

A Big Step Forward on Corporate Reform

Finally, an excellent choice to try to repair the damage done by the corporate fraud and accounting scandals. William McDonough is a class act. Accounting in America Sorting out the wreckage Apr 17th 2003 | NEW YORK From The Economist print editionAmerica's accountants learn the identity of their new overseer BIT by bit, America's financial markets are being patched together again. On April 15th William Donaldson, chairman of the Securities and Exchange Commission (SEC), nominated William McDonough, the retiring head of the Federal Reserve Bank of New York, as the first head of the new Public Company Accounting Oversight Board. Moments later, it was reported that the troubled NASDAQ stockmarket would appoint another banker, Furlong Baldwin, as its chairman and an executive of a financial-technology firm, Robert Greifeld, as chief executive. These appointments should bring stability to areas blighted by chaos. In Mr Baldwin the NASDAQ, a metaphor first for fast-growing technology companies and then for corporate collapse, has chosen a man whose career at Mercantile Bancshares, a Maryland bank, was nothing if not conservative. With Mr McDonough, regulators hope to fill a job that has so far been stillborn. The attempt by Mr Donaldson's predecessor, Harvey Pitt, to appoint...

Posted by DeLong at 08:42 AM

March 20, 2003
The Costs of Failing to Put Corporate Reform on the Front Burner

Federal Reserve Bank of New York President William McDonough says that in his judgment the failure to take much more thorough and aggressive action to repair trust in corporate governance and corporate accounts has been and is being very damaging to the American economy. I fear that he is correct. Forbes.com: War risk not the only drag on US economy-McDonough: Federal Reserve Bank of New York President William McDonough, citing the damage done to investor and lender confidence by corporate scandals. In a speech to the New York State Bankers Association on Thursday, McDonough said investors continue to doubt the quality of internal governance and external oversight as well as the reliability of the information corporations provide. That contrasts to the Fed's Federal Open Market Committee statement after its policy meeting on Tuesday when it argued that geopolitical uncertainty was the main factor holding back the economy and once that uncertainty lifts, the recovery should pick up. McDonough is currently a voting member of the FOMC but is slated to retire in July. The Fed's next policy meeting is on May 6. McDonough said the rash of serious governance problems was one of the surprises that followed the bursting of...

Posted by DeLong at 10:57 AM

March 18, 2003
Accounting for Options

The Economist makes fun of the Silicon Valley executives' campaign to try to stop FASB from requiring that they account sensibly for options granted: Economist.com | Expensing share options: ...ONLY desperate, last-minute lobbying saved America's technology firms last summer from having to count as an expense the billions of dollars-worth of share options that they dish out to their staff each year. This time, the tech industry is better prepared. Even before the Financial Accounting Standards Board (FASB) announced on March 12th that it was opening a formal inquiry into mandating the expensing of stock options, a coalition of tech lobbyists was carpet-bombing the press with propaganda. Wisely, the techies have also shifted their defence. The expensing debate has required delicate handling by Silicon Valley. On the one hand, tech firms oppose the notion that options are an expense at all: accounting for their cost by the usual method (the Black-Scholes options-pricing model) would cut tech firms' reported profits by 70%, on some estimates. On the other, tech firms must guard against the notion that their profits?such as they are?are an accounting fiction. This creates a countervailing urge to argue that the market is already counting in the costs of...

Posted by DeLong at 10:14 AM

September 09, 2002
Alan Murray on IPO Underpricing

Alan Murray wrestles with the problem of IPO--Initial Public Offering--underpricing. On the one hand, why should the rest of us care if entrepreneurs wish to sell 10 percent of their companies at a half-off discount to the friends and clients of their investment bankers when their firms go public? Entrepreneurs are giving a rather large present to those on the IPO list, but if they did not wish to do so they could always use Hambrecht and Quist and run a true auction to sell off the initial tranche of shares. And they get benefits--a bunch of people who will have made money by investing in their stock, and who are likely to hold onto it and talk it up. Murray comes down on the side of the--highly plausible--theory that IPO underpricing is a way that investment banks get their going-public client corporations to bribe those from whom they want to be thrown other prices of investment banking business. WSJ.com - Article ...When the price of a stock jumps to $20 from $10 in the first day of trading, reaping instant profits for the lucky few who have been allocated shares, the investment bankers celebrate a "hot" offering. They ought...

Posted by DeLong at 09:18 PM

September 03, 2002
Really Scary

It's hard to know if this is a fair picture of what went on--and of how ignorant the typical large-corporation board member is. But if it is a fair picture, it's really scary. Back to School, but This One Is for Top Corporate Officials September 3, 2002 By ANDREW ROSS SORKIN HICAGO The class was not faring well. On its accounting exam the average score was 32 percent. The teacher was particularly exasperated that so many students had missed a multiple-choice question on the meaning of retained earnings. "Don't tell me that you're on the audit committee and can't tell me what retained earnings are," Roman L. Weil, an accounting professor at the University of Chicago Graduate School of Business, said to the class. These were no first-year M.B.A. students. They were top executives and board members of some of the nation's largest corporations, at a novel post- Enron boot camp. About 80 officers and directors from companies including Pfizer, McDonald's, Motorola and Dow Chemical sat through three days of lectures to understand how to do their jobs at a time when far more people are watching them....

Posted by DeLong at 01:54 PM

August 21, 2002
Lance Knobel Links to a Map of Corporate Scandals

Lance Knobel links to a map of corporate scandals: Davos Newbies Home...

Posted by DeLong at 08:49 AM

August 12, 2002
What Are the Lessons From Japan's Current Crisis?

Robert Feldman of Morgan Stanley powerfully argues that the center-of-gravity of economists' positions draws the wrong lessons from Japan of a decade ago for the U.S. today. The center-of-gravity is that what Japan's decade-long crisis teaches us is that monetary and fiscal policy need to be very aggressive in the aftermath of a bubble if depression or stagnation is to be avoided. Feldman thinks that is wrong. Feldman thinks that the key lesson is that the collapse of a bubble produces substantial microeconomic problems--structural imbalances--that cannot be fought with macro policy. As applied to the U.S. today, Feldman's argument is that the Federal Reserve can push nominal interest rates on Treasury Bills down to zero, but that still will not revive corporate investment as long as savers are skeptical of the accounting numbers reported by corporations and interest-rate spreads grow. At some level, he's clearly right. The question is how right. How much of an impact will the corporate governance crisis have on the wedge between the terms on which the federal government can obtain capital and the terms on which private businesses can obtain capital? That's the big--and still unknown--question. Morgan Stanley So what are the real lessons of...

Posted by DeLong at 05:14 AM

July 29, 2002
Five Wall Street Journal Reporters Look at Accounting Reform

Unfortunately, they reach no conclusions: everything's up for grads, and whether things turn out well or ill, better or worse, depends on the details of implementation. WSJ.com - Article Just how much change is triggered, and how effective it is, won't be known at least until the Securities and Exchange Commission works out rules implementing the law and appoints the newly created five-member oversight board with powers to investigate and punish. "Congress enacted some structural girders and then left it to the SEC to fill in all the remaining framework," says John Coffee, a law professor at Columbia University who worked with Senate staffers in drafting parts of the law. The biggest unresolved detail, he says: whether the oversight board appointees will be "people of stature and independence or flunkies and fellow travelers of the accounting industry."......

Posted by DeLong at 01:04 PM

July 25, 2002
Details of Financial Reform

I don't know which is more interesting--the remarkable turnaround of Republican politicians who only last week were denouncing Sarbanes's Senate accounting reform bill, or the fact that the success or failure of the reform is now in the hands of people appointed to federal office by people who only last week were denouncing the bill. The Washington Post gives the current state of play... washingtonpost.com: Watchdogs' Vigilance Key to Bill's Success Rep. Michael G. Oxley (R-Ohio), chairman of the House Financial Services Committee, was saying only last week that the Senate-passed corporate governance bill was bad legislation that needed to be changed significantly. Yesterday, he acquiesced almost completely. Treasury Secretary Paul H. O'Neill warned two weeks ago that the Senate bill would let corporate crooks slide through enforcement cracks by giving "the power to enforce securities law to an unaccountable private body." President Bush faced criticism for standing largely on the sidelines as Congress pushed the bill forward. But after the final form of the bill emerged, the president sought his share of credit. "Today was a day of action and a day of accomplishment in Washington, D.C.," Bush told reporters after meeting with Democratic lawmakers. That is what a...

Posted by DeLong at 04:48 PM

Senator Sarbanes Talks About What Is in His Bill

Senator Sarbanes talks about what is in his "PUBLIC COMPANY ACCOUNTING REFORM AND INVESTOR PROTECTION ACT OF 2002." The bill coming out of the conference committee is almost identical to this Senate version. Public Company Accounting Reform-Investor Protection Act PUBLIC COMPANY ACCOUNTING REFORM AND INVESTOR PROTECTION ACT OF 2002 (Senate Version) Mr. SARBANES. I thank the Chair. Mr. President, today the Senate turns its attention to S. 2673, the Public Company Accounting Reform and Investor Protection Act of 2002, which was reported from the Senate Committee on Banking, Housing, and Urban Affairs on June 18 on a strong 17-to-4 vote. A unanimous consent agreement was entered into with respect to this legislation prior to the Fourth of July recess, which provided that at 2 p.m. today, Monday, July 8, the Senate would proceed, for debate only, to the consideration of this legislation. I hope to take a fair amount of time to set out the process through which the committee worked and to discuss the provisions of this legislation.... Title I of the bill creates a strong independent board to oversee the auditors of public companies. Title II strengthens auditor independence from corporate management by limiting the scope of consulting services...

Posted by DeLong at 11:18 AM

July 24, 2002
Warren Buffett on Options Accounting and the Senate

Warren Buffett reminds us that it was Senate pressure on Arthur Levitt that has kept options from being accounted a cost for the past eight years. Who Really Cooks the Books? ...The Senate itself is the major reason corporations have been able to duck option expensing. On May 3, 1994, the Senate, led by Senator Joseph Lieberman, pushed the Financial Accounting Standards Board and Arthur Levitt, then chairman of the S.E.C., into backing down from mandating that options be expensed. Mr. Levitt has said that he regrets this retreat more than any other move he made during his tenure as chairman. Unfortunately, current S.E.C. leadership seems uninterested in correcting this matter. I don't believe in Congress setting accounting rules. But the Senate opened the floodgates in 1994 to an anything-goes reporting system, and it should close them now......

Posted by DeLong at 02:51 PM

July 23, 2002
Fallout From Fraud Investigations: Freezing Restructuring

WorldCom has $30 billion in debt, $100 billion in assets, and is bankrupt--with courts controlling its affairs and its equity valued as close to zero as possible for such a large company. How can this be? First, the $100 billion asset value is a book value--a sum of what the physical capital assets of WorldCom cost to build, plus whatever premiums WorldCom paid over and above asset cost book value to acquire businesses in the past. That it cost $100 billion to build and assemble WorldCom says little about the economic value of its assets, especially in these days when slower than expected demand growth and better than expected software have created huge overcapacity in telecommunications. Second, every potential purchaser is now keenly aware that they may be buying a lawsuit if they buy a chunk of WorldCom. The fact that our legal system is not transparent with respect to what legal liabilities are attached to what assets is a powerful source of uncertainty--and of reluctance to buy WorldCom's assets. BW Online | July 23, 2002 | WorldCom: Take My Assets, Please What a garage sale. WorldCom's filing for Chapter 11 bankruptcy protection on July 21 in New York basically...

Posted by DeLong at 06:40 PM

July 22, 2002
The Economist Joins the Chorus: Options Make Executives Long Volatility

Quite a while ago my brother Chris pointed out to me that stock options do not align the interests of executives with those of shareholders. Options, he said, make the top executives want as much volatility in the company's stock price as possible. Now this point is becoming the conventional wisdom. I think this is healthy. Economist.com ...The theory is that the huge amounts of stock options dished out to executives in the 1990s encouraged them to behave badly. Unlike stock itself, a stock option has no downside: the owner might gain a lot of money if his company's share price rises, but he loses only the cost of the option if the share price falls (and nothing at all if the option is given to him). That might have encouraged excessive risk-taking at the top--a willingness, as Ira Kay of Watson Wyatt, a pay consultancy, puts it, to "roll the dice". Combined with the freedom to sell the company's stock once the option is exercised, stock options might also have encouraged short-term business strategies, or even fraud. By fiddling with their accounts, company bosses could hope to drive up the share price, cash in their options, and set sail...

Posted by DeLong at 10:35 AM

July 20, 2002
Joshua Micah Marshall Says Go Read Chris Caldwell

Joshua Micah Marshall says go read Chris Caldwell's New York Press column, and then go read it again... Talking Points Memo: by Joshua Micah Marshall I didn't want to do any posts this weekend. But this article by Chris Caldwell in the New York Press merits an exception. It's simply devastating and the most apt statement of the White House's predicament I've yet read. Every word of it practically is worth reading and reading again. There's always an element of unmerited, guilty pleasure you feel when you hear someone on the other side making your side's case for you. But it's equally true that sometimes a political point can only be made clearly by someone who has to say it with an element of regret, whose words are free of the dross of wishful-thinking and mindless overstatement......

Posted by DeLong at 10:04 PM

July 19, 2002
Why Congress Moved on Financial Market Reform

Why Congress Moved on Financial Market Reform From the National Journal--the sports page for professional lobbyists. Its analyses of the substance of public policy are often wanting. Its analyses of the shape of political alliances and the interest groups pressing on the government are unsurpassed. National Journal: To The Rescue? (07/19/2002) ...In the 1990s, an extraordinary run-up in the stock market increased the incentives for corporate executives to cheat and dulled investors' incentives to notice. The private-sector watchdogs -- accountants and analysts -- found that it paid more to please corporate clients than to safeguard investors, while the public-sector watchdogs found themselves systematically starved for resources. But as long as investors received 15 percent-a-year appreciation in stock values, no one begrudged executives their multimillion-dollar stock-option awards or pressed too hard for explanations about where all this growth came from... At the beginning of June, the reform movement in Congress seemed moribund.... Paul S. Sarbanes, D-Md., couldn't seem to muster sufficient votes in his own committee to pass a package of auditing reforms.... Having patiently built a persuasive case for reform through a series of hearings, Sarbanes quietly and painstakingly began negotiating for the critical swing votes on his committee. To...

Posted by DeLong at 11:31 AM

July 18, 2002
The Economist's View on Needed Financial Reforms

It leans a little too much on the "moral reform" side, as the passage I quote is followed by claims that the true fix is "...beyond the reach of regulators and legislators." I disagree: I think people look out for their own interests properly and behave honestly only when they have the right incentives to do so, and providing them with the right incentives is the business of regulators and legislators. But, then, I'm a social democrat, and the editors of the Economist are not. Economist.com ...the most important remediable failures of corporate America fall into three overlapping categories: audit, independent directors and bosses' pay. In all three, the need is not to dictate to companies, but to help shareholders do a better job of protecting their own interests, should they be in the mood to try. Auditing is dull--or damned well ought to be. Shareholders are helpless if they cannot rely on the unvarnished accuracy of the numbers their managers show them. The desire of the accounting profession to express flair and originality must be quashed, and the conflict of interest that arises when managers in effect appoint and pay their own auditors must be resolved. The elements of...

Posted by DeLong at 09:36 AM

July 15, 2002
Alan Murray on Corporate Surveillance and Control

The Wall Street Journal's Alan Murray calls for the reform of American corporate governance. Since 1933 America has not had families of plutocrats who control leveraged corporate empires through pyramids of companies and special classes of stock, and thus have both the incentive and the means to keep managers at heel (but woe betide you, small shareholder, should the family of plutocrats decide that there is more money to be gained from fleecing the small shareholders than from playing the honest broker). Since 1933 America has not had universal banks who control companies by voting both their own and their banking clients' stock (but woe betide you, small shareholder, should the bank lose its entrepreneurial edge and descend into bureaucratic mediocrity: Quid custodit ipsos custodes? has long been a difficult question). Instead, America has relied on a combination of: A few companies with large shareholders. Lots of publicity and mandated transparency about corporate doings. Takeover artists who promise to throw out badly-behaving, entrenched management and enhance shareholder value. Shame (on the part of executives) and altruism (on the part of those voluntarily taking on the duty of watching executives). The American system has not worked badly compared to those of...

Posted by DeLong at 04:30 PM

Business Week's Reporters Go After Halliburton as Well

Business Week's reporters take off after Halliburton as well: Business Week Online:The Cheney Question At issue is how Halliburton accounts for cost overruns and changes on its billion-dollar contracts.... Until 1998, the company wouldn't report revenue from such claims until the customer agreed to pay.... But since 1998, Halliburton has estimated how much of the disputed costs it expects to collect and booked the not-yet-received payment immediately.... While it's aggressive, Halliburton's switch is supported by a 1981 accounting rule because it helps meet accountants' goal of matching revenues with associated costs as they occur.... More troubling: Halliburton didn't disclose the switch to the SEC or investors for more than a year, until March, 2000......

Posted by DeLong at 08:02 AM

July 13, 2002
The Aloha Petroleum Deal

I haven't seen the details of the Aloha Petroleum deal set out anywhere in a comprehensible way. So I might as well do it here: In 1989 the managers and directors of Harken Energy Corporation were presiding over a company that was losing a lot of money that year. The SEC-cleaned accounting statements would eventually report that Harken lost $12.6 million that year. Anxious to report better numbers, the managers of Harken came up with a plan. Harken would sell 80% of its chain of Hawaiian gas stations--Aloha Petroleum--to a group of investors that included Harken's chairman Alan Quasha and another of its directors. Harken would loan the buyers $11 million and the buyers would kick in an additional $1 million up front for a total sale "price" of $12 million. Since Harken had carried Aloha on its books as worth $5.1 million, this "sale" would produce an immediate $7.9 million profit--$12 million in the sale "price" minus the $4.1 million valuation of 80% of Aloha. For Harken, this was enough to turn a bad loss for the year into a modest loss. The net effect on Harken's balance sheet? Beforehand, Harken had had Aloha Petroleum as an asset carried...

Posted by DeLong at 10:18 AM

July 10, 2002
A Cheat Sheet

The Economist provides a cheat sheet on recent American corporate accounting scandals: who did what to whom when. Economist.com A guide to corporate scandals Jul 10th 2002 From The Economist Global Agenda Corporate scandals have plagued America, sent shudders through stockmarkets and given the mighty dollar a knock. Even President George Bush has been forced to defend himself over his own links to big business and allegations of improper dealings. But not every “scandal” is the same, and not every businessman a crook AMERICANS are perplexed. They were convinced that they had the best economy in the world, where the most productive workers produced the most innovative companies, which shored up the strongest currency that flowed through the cleanest and most liquid capital markets. If any other country wanted to do half so well, they would have to emulate American-style capitalism. Not for America the “crony capitalism” of Asia or the egalitarianism of Europe. America rewarded hard work and smart people. But now Americans are asking just how much of the great boom the country has gone through was real, or the result of corrupt executives enriching themselves at shareholders' expense with the help of complicit accountants and greedy bankers....

Posted by DeLong at 12:07 PM

July 09, 2002
The Troubles of Harvey Pitt

Joshua Micah Marshall explains why it is that no politician can be found in Washington to back SEC Chair Harvey Pitt. Talking Points Memo: by Joshua Micah Marshall I don't have much sympathy for [SEC Chair Harvey] Pitt. But the calls for his resignation don't seem to have much to do with anything he's actually done. Or at least not anything he's done since the Senate (if I recall right, unanimously) confirmed him as head of the Securities and Exchange Commission. The problem for Pitt is that his calling card was the proposition that the SEC was simply too harsh on corporate America and that anti-business busybodies like Pitt's predecessor Arthur Levitt needed to just give the CEOs a *$%#*%* break and let them get about the business of doing the right thing without so much un-fun big government oversight. Now of course we know that at just the time Pitt was parading these views corporate America was actually becoming a Hieronymus Bosch painting of fraud, skullduggery and 'aggressive accounting,' and that, if anything, the SEC hadn't done nearly enough to make folks behave. That of course makes Harvey Pitt into something like the Neville Chamberlain of corporate governance. And...

Posted by DeLong at 08:05 AM

July 07, 2002
Before Paul Krugman Leaves for His Vacation...

Before Paul Krugman leaves for his vacation, he takes one more shot at George W. Bush. Between the two options Krugman gives us--Bush knew about and benefited from Harken's accounting frauds, and Bush was just a very negligent and disconnected director--I think the second is by far the most probable. Succeeding in Business ...the ploy works as follows: corporate insiders create a front organization that seems independent but is really under their control. This front buys some of the firm's assets at unrealistically high prices, creating a phantom profit that inflates the stock price, allowing the executives to cash in their stock. That's exactly what happened at Harken. A group of insiders, using money borrowed from Harken itself, paid an exorbitant price for a Harken subsidiary, Aloha Petroleum. That created a $10 million phantom profit, which hid three-quarters of the company's losses in 1989. White House aides have played down the significance of this maneuver, saying $10 million isn't much, compared with recent scandals. Indeed, it's a small fraction of the apparent profits Halliburton created through a sudden change in accounting procedures during Dick Cheney's tenure as chief executive. But for Harken's stock price -- and hence for Mr. Bush's...

Posted by DeLong at 03:36 PM

The Economist Looks at the Bear Market of the 2000s

The magnitude of the decline in stock market values since their peak is not surprising: stock prices were substantially overvalued by historical yardsticks. (Moreover, they remain overvalued by historical yardsticks--albeit less so--today.) The important questions are two: (1) Will skillful economic management be able to keep irrational exuberance from becoming irrational depression? (2) Will skillful economic management be able to keep falling stock prices from triggering falling demand, and depression? We may well have a chance to see exactly how good at central banking the Federal Reserve is. | Economist.com | Watching Out for the Great Bear | THESE are not times for nervous investors. The recent sharp fluctuations in the world's stockmarkets have brought the doom-mongers out in force. They point to the relentless downward slide in share values since their peak in 2000 in America, earlier in London and more than a decade ago in Japan. The collapse in share prices has sent many investors scurrying for cover in safer assets like bank deposits or bricks and mortar; and workers due to retire have begun to worry about the safety of their pension funds. Stockmarket volatility has been matched by swings in currency values--if there's panic around, foreign-exchange...

Posted by DeLong at 03:12 PM

July 05, 2002
The Head of the Financial Accounting Standards Board

The Economist profiles a guy who will actually have quite an important job over the next several years. It's interesting to note that even with all its problems the American regulatory surveillance system over corporate accounts is better than anywhere else. Yet clearly the American system is not good enough. Economist.com | Face value | Called to account | Bob Herz faces the daunting task of restoring confidence in American accounts. "ARE you nuts?" was the response of close friends of Bob Herz when told that he was accepting the job of chairman of America's Financial Accounting Standards Board (FASB). Mr Herz, after all, was leaving a safe position as a senior partner at PricewaterhouseCoopers, the world's largest accounting firm, to step into the heart of the current crisis of confidence in corporate America. Only last week, WorldCom and Xerox announced the two largest profit restatements in history. This week, on July 1st, Mr Herz took up the job of steering American accounting standards in a safer direction. Nuts? Probably not. Brave? Certainly. Ever since Enron, the bust energy-trading company, admitted last year that its numbers for the previous five years were wrong, FASB has been under attack. It takes...

Posted by DeLong at 08:29 AM

July 03, 2002
I Wish I Could Write Like This

Why Michael Kinsley gets paid the big bucks: the best sentence I have read this summer: It's Good Enough - Freedom, Justice, and Martha Stewart. By Michael Kinsley | ...It dawned on the accountants in recent years that being the designated driver during a carnival of financial drunkenness isn't cool, but they could become quite popular by lowering their precious standards just a hair......

Posted by DeLong at 03:18 PM

How Did WorldCom Get Away With It For Even an Instant?

Amey Stone tries to understand how WorldCom could have gotten away for so long with what was really a simple, simple, transparent fraud stream. Certainly the auditors--Arthur Anderson--should have caught it. And why didn't the analysts following WorldCom catch it? They were supposed to have a good sense of what WorldCom's investments plans were. BusinessWeek Online: How Everyone Missed WorldCom | JULY 3, 2002 COMMENTARY By Amey Stone: The accounting fraud was obvious -- only to the few who had full access to its books. At least now real reform is almost certain A major source of the gnawing sense of insecurity generated by the WorldCom (WCOME ) scandal is that so many people missed what seems to have been the most basic of accounting tricks. The foundering telecom giant admitted on June 25 that it essentially disguised billions of operating expenses as capital expenditures, allowing it to report fictitious profits. With outside auditors, stock and bond analysts, bankers and regulators, even journalists, all scouring the finances of this already ailing company, how could they not notice that billions in operating expenses had gone missing? Chief Executive John Sidgmore did his best to build confidence in the new management team...

Posted by DeLong at 10:15 AM