And none too soon. The drop in equity prices has sharply tightened financial credit in recent weeks, neutralizing to a large degree the massive monetary easing of the Federal Reserve. The stock market has risen 20% in all but two business-cycle recoveries during the past century. This time, however, it is actually down by nearly that much. A growing number of companies, most of them small and midsize ones, simply cannot borrow or raise money by selling stock. The situation threatens to spiral downward. Investors, unable to believe financial statements and unwilling to take risks, pulled as much money out of equity mutual funds in June as they did in the weeks after September 11. Unless checked, the recovery could be aborted--hardly what the nation needs at a time of terrorist threats, rising unemployment, and slumping markets.A SYSTEM CORRUPTED. The momentum for reform has been slowly building all spring and summer, but it reached its peak with the President's speech to a Wall Street audience on July 9. Bush began by putting on his best "hang 'em high" face, promising to "root out corruption" and establish "a new ethic of personal responsibility in the business community." At first, the President focused on punishing Corporate America's "bad apples." He used his executive powers to create a new federal financial-crimes "SWAT team" to hunt down culprits. He proposed doubling prison terms for CEOs guilty of financial fraud, freezing improper payments to corporate execs, forcing managers who benefit from false accounting to forfeit their gains, and getting the Securities & Exchange Commission to ban convicted chief executives from ever serving on a board.
But then Bush went further. For the first time since Enron Corp. blew up, he admitted that the system itself had been corrupted and needed repair. He threw his support behind a long list of changes being proposed from deep within the business community. This is critical because if reform is to work, it must come from within Corporate America and Wall Street. Bush endorsed the New York Stock Exchange's proposals to increase the number of independent members to at least half the boards of directors and to insist that all members of key audit, compensation, and nominating committees be independent. He praised SEC proposals banning accounting firms from providing many types of consulting services to audit clients. And he supported Wall Street efforts to make analysts "trusted advisers, not salesmen" by ending conflicts of interest. The President even backed institutional investors' calls for boards to stop making company loans to corporate officers and urged shareholders to vote on all stock option plans. Perhaps most important, he backed the SEC demand that by Aug. 14, the CEOs and CFOs of the top 1,000 public companies must personally certify recent financial statements--and all future ones. This should provide a new, honest, and believable bottom-line benchmark for investors.LET'S GET CRACKING. Yet the President should have gone further. He did not come out in support of the tough Senate accounting-reform bill proposed by Senator Paul S. Sarbanes (D-Md.). This bill would establish a strong independent oversight board for the accounting industry, which desperately needs one. While preferring the weaker House bill, the President has promised to sign whatever reform legislation lands on his desk. It's now up to Congress to deliver.
President Bush--and Vice-President Dick Cheney--would also do well to address lingering doubts about their previous business dealings. Confusion over revenue recognition, insider trading, and a pattern of late filings of stock sales with the SEC is undermining the President's credibility as a corporate reformer. Cleaning house and dumping Administration members tainted by Enron or other conflicts of interest would also send a powerful signal to the American public.
The markets are taking a "show me" stance toward reform, as they should. Weary of corporate malfeasance and bad judgment--the trusted drugmaker Merck & Co. is the latest to admit inflating its revenues--some investors may be waiting until Aug. 14, when CEOs sign off on their spanking-clean books, before buying stocks again. They want time to see how reforms are implemented.
The sooner reforms are put in place, the quicker people will return to the stock market, and the faster America can return to its brand of entrepreneurial capitalism. Indeed, the speed of reform itself may restore the country's reputation on the global scene by showing how quickly it can heal its economic ills, in contrast to Japan and other nations. The U.S. has reformed its economy many times in the past. We had an Age of Reform under Theodore Roosevelt and an Era of Reform under Franklin Delano Roosevelt. Today, we trust we are entering a new corporate cleanup. Let the reforms begin.