KONGWhy is the world of finance purporting to be surprised and shocked
by the Enron affair? The potential for such events has long been obvious. Enron
is just one result of a decade of slowly spreading cancer throughout the
financial services business. The only solution is the breakup of the industry
into its component parts: separating banking from investment banking, from stock
brokerage, from pension fund management, from derivatives trading, from
insurance - and consultancy from auditing. This is not just a story of one rogue
company and a complacent auditor. It may be the biggest scandal so far but fits
a pattern which has grown out of the way the financial services industry has
evolved in recent years. Horizontal integration, amalgamations into ever bigger
units, has reduced competition and created hard-to-manage behemoths. Vertical
integration has brought about so many conflicts of interest within firms that
some clients can only be served at the expense of others, or by deceit. The last
symbolic barrier to such conflicts of interest, the Glass-Steagall Act which
followed the scandals of the 1920s, was abolished in 1999 just as the stock
market was being pumped up to more ridiculous levels than in 1929. Not
surprisingly, the removal of restraints occurred when the U.S. Treasury was in
the hands of an investment banker, Robert Rubin, previously with Goldman Sachs
and recently pleading Enron's cause on behalf of Citigroup.
The abolition of constraints occurred
despite the increase in new financial products such as derivatives which
increased risk levels, reduced transparency and took an increasing proportion of
the financial sector outside the purview of banking or securities supervision.
It coincided with an explosion in non-bank credit to the U.S. private sector. It
was supported by claims that bigness meant efficiency and increased capital
adequacy or was a natural consequence of globalization.
In practice it meant more conflicts of
interest. Risk assets grew far faster than capital bases, and off-balance-sheet
activity boomed. Warnings were aplenty. The Asian boom and bust from 1995 to
1998, to which investment banks were major contributors, was one. Even since
then Asia has produced more examples - such as Asian Pulp and Paper ($12 billion
in default) - of investment banks earnings tens of millions in fees by telling
fairy-tales. Barings and Long Term Credit Management were other warnings.
A former Securities and Exchange
Commission chairman, Arthur Levitt, was eloquent on some of the conflicts -
between the investment banking and brokerage units of the giant firms, and
between auditors and their consulting businesses. But Mr. Levitt was thwarted by
a cabal of "professional" interests. It is now almost two years since the Nasdaq
crash revealed the reality behind the banker-broker hype that inflated the
bubble. But the public, which lost so heavily, still sees no attempt to reform
the industry or bring criminal charges for breaches of trust toward investors.
The big houses continue to publish "research"often tailored not to the interests
of investors but in the interest of their corporate finance business, which is
far more profitable than stock brokerage.
Auditors have long been mostly captives
of the boards which appoint them. What is new is the cartelization into a
handful of huge players, and the emergence of conflicts of interest over
consultancy. The whistle-blowers became the designers of camouflage.
Investigative financial journalism is
back in vogue after Enron, but very belatedly and overly excited about the Bush
The media joined in the hype making
heroes out of investment bankers and brokerage analysts. The wire services
remain a source of worry for those wanting dispassionate financial news. Their
main clients are not the public media but the financial sector which needs
scrutiny. They overexpose the self-interested views of these clients.