The Dirt a Bull Market Leaves Behind


For many observers and investors, the crisis of confidence consuming Wall Street has appeared almost out of nowhere. Certainly, no one could have predicted so many major corporate scandals involving so many different players -- executives, directors, accountants, and analysts.

Or maybe some could.

Many business historians aren't much surprised by the wave of shenanigans that has surfaced since Enron imploded six months ago. They note that in the past, misconduct and bad judgment have often topped off periods of unparalleled prosperity.

Typically, they say, the danger is greatest just as the economy reaches full-throttle, with profits mushrooming, stocks soaring -- and the individuals in charge starting to believe just about anything goes. Riding a greed-driven high, these beneficiaries of excess begin blurring the line between right and wrong, legal and illegal.

GETTING BURNED. "At the end of a boom, there tends to be out-of-control behavior," says Dan Raff, a business historian and management professor at the University of Pennsylvania's Wharton School. "A boom economy tends to fuel this kind of thing, where speculation goes mad," adds John Di Frances, managing partner of Di Frances & Associates, a consultancy in Wales, Wis., near Milwaukee. "It opens the door to [egregious] stuff."

It's a bit unsettling, but the precedent many experts point to is the roaring '20s, which preceded the market collapse of 1929. Back then, a glaring example of corporate misconduct was Ivar Kreuger, a Swedish entrepreneur whose pyramid scheme fleeced market players from widows to bankers and led to the largest bankruptcy then on record.

Kreuger founded Kreuger & Toll, an international conglomerate that built a monopoly in wooden matches, which were needed in most homes worldwide to ignite coal- or wood-fired kitchen stoves (the matchbook variety wouldn't do). At one time, his company's stock was the most widely traded security in the world, largely because it paid a high annual dividend -- up to 20%, notes Dale L. Flesher, associate dean of the School of Accountancy at the University of Mississippi.

SCAMS AND SHAMS. Kreuger solidified his company's market dominance by lending money to foreign governments in return for nationwide match monopolies -- the money for loans coming not from his marginally profitable match business, but from sales of his stock and bonds to unwary Americans. He also used the money from new investors to pay the high dividends that previous investors had come to expect.

The game fell apart with the market crash, which occurred the week Time magazine lauded Kreuger on its cover. As investors fled Wall Street and the Great Depression set in, it became impossible for Kreuger to raise money to pay dividends, and his empire collapsed. An audit after his 1932 suicide revealed nearly $250 million in assets on the books that never existed, a huge sum at the time. Essentially, the company -- with its 400 subsidiaries -- was a sham.

It was largely in reaction to Kreuger that Congress in 1934 created the Securities & Exchange Commission, which subsequently implemented accounting and financial reporting rules for publicly traded companies. Multiple safeguards were put in place in the years separating Kreuger's deeds and the Enron, Andersen, and other recent accounting scandals.

TECHNOLOGY'S TEMPTATIONS. That the latest misdeeds occurred simply proves, "When the conditions are right, you can produce a truly spectacular financial debacle," says Robert Bricker, an accounting professor at the Weatherhead School of Management at Case Western Reserve University in Cleveland.

The twist this time around, historians note, is that advances in technology and the development of ever-more-complex financial vehicles have increased the possibilities for taking advantage of gray accounting areas -- and thus made playing fast and loose more tempting.

"Technology has given [financial villains] the ability to do new things that aren't covered by old regulations," says David Blake, dean of the Graduate School of Management at the University of California at Irvine. "It's no accident what happened at Enron," notes Dean Stamoulis, head of the management assessment practice at Russell Reynolds Associates, a global executive recruiting firm. "They were involved in complex, abstract deals. The very business they're in [can be fudged]."

20-20 HINDSIGHT. It's tempting to complain that the financial transgressions at Enron and other unethical companies were discovered only in hindsight. Yet human nature being what it is, it's mainly "during a lousy market that attention and concern [about companies whose performance seems too good to be true] is substantially heightened," Blake notes. In fact, clarity achieved through the rearview mirror can provide useful insights for the future.

Here's one: When companies with no earnings are trading at hundreds of dollars a share, when stock-option millionaires are being minted by the day, when a company's business or books are indecipherable even to sophisticated investors, and when the chairman of the Federal Reserve is warning of "irrational exuberance," then everyone's scam detectors should be on alert. By Heesun Wee


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