The first thing that we have to take on board when considering the alleged moral turpitude of company accounts is the following undeniable fact:
eToys had a larger market capitalisation than Toys-R-Us.
I've mentioned this before, but I do think it's terribly important. There is a vast amount of revisionism going on at the moment, whereby knowledgable pundits are trying to insinuate that the equity bubble of the late 1990s was "propped up on false accounting and inflated profits". That quite simply isn't the case, but it's quite easy to see why it is useful for people to claim that it was; the "bad apple" theory avoids having to come to grips with the fact that this was a genuine crowd mania. Nobody ever claimed that eToys was making a profit, and it would probably have been given a lower market capitalisation if they had; it was considered uncool to be profitable in those days.
Now, getting on to the actual subject of the Worldcom and Enron accounts, I think what we've learned is that honest people telling the truth can deceive you far, far more than bad people lying to you. Because I will stand up for the following somewhat counterintuitive proposition:
Neither the published accounts of Enron nor the published accounts of WorldCom gave a materially inaccurate representation of the economic position of those companies.
We can see this most clearly by looking at what would have happened if they had reported under accounting standards other than US GAAP:
Enron would not have been able to get away with its off-balance sheet financing under UK GAAP; ever since Maxwell and Polly Peck, UK auditors have lived and died by the Accounting Standards Board paper "Reporting the Economic Substance of Transactions", which contains the major contribution to the world of Sir David Tweedie; the principle that if a company bears the risks and rewards of ownership of an entity, it should fully consolidate that entity. US GAAP attempts to cope with structures like the Enron partnerships on a case-by-case, rule-by-rule basis, an approach which has long been known to encourage the creation of loopholes. The UK approach is probably better in this regard, although it does put more emphasis on auditors' judgement, and I see no reason to believe that UK auditors are less susceptible to pressure than US ones. Say, if Enron had WorldCom's management and auditors, it would still have got away with its partnerships under UK GAAP.
WorldCom would never have been able to do what it did under German Commercial Code accounting. European accounts, in general, are drawn up for the benefit of creditors rather than equity investors, and thus always, semi-intentionally, err on the side of recognising costs early and revenues late, and of recognising liabilities but not assets. This tendency is exacerbated by the tendency of European tax authorities to use the published accounts ... WorldCom would probably have erred on the opposite side by deferring the recognitition of revenues to create hidden reserves.
But the key question is; would either of these companies have got away with it if they had filed under any other GAAP in the world? And the answer is, yes, of course they would.
If you look at the WorldCom accounts as published, you see the profile of a company which is not currently making a profit, which is not generating cash and which is taking on voracious amounts of debt in order to grow rapidly by acquisition. That's what it was. A few billion of EBITDA here or there was not what was at issue; WorldCom wasn't *meant* to be profitable because it was meant to be building up the communications infrastructure of the future. People weren't investing in WCOM because they thought it was making money hand over fist.
People were investing money because economists like Brad were telling them, truthfully, that all the evidence suggested that the technology and telecommunications revolution was transforming the US economy and vastly increasing productivity. Sometimes it was noted that this massive return on investment wouldn't necessarily accrue to any particular company, but people did not pay attention to this bit. The economists and commentators who --- correctly -- praised the US investment boom to the skies were vastly, vastly more responsible for people making the decision to pile into WCOM than the guys who drew up the crooked accounts, because investors were, frankly, not looking at the accounts. They were looking at the technologies, hearing about customer numbers and so on, none of which numbers were falsified. They were not being warned by the auditors that the cost numbers were being inappropriately capitalised; but nor were they being warned by the economists that there was a decent chance that much of the expansion in broadband fibre-optic capacity represented a huge malinvestment.
Similarly with Enron. Paul Krugman didn't endorse or know about the off-balance sheet debt. On the other hand, everyone who knew anything about Enron knew that it was as geared as hell -- specifically, that it was operating with much less regulatory capital than would be considered necessary for a CFTC-regulated derivatives broker with similar absolute sizes of positions. People didn't invest in Enron because they thought that it was a well-capitalised company.
People *did* invest in Enron because they thought that it was creating new markets in things that had never been traded before, and Krugman is squarely on the hook for telling the world that this was a Good Thing (the Fortune article refers). So are the "shock therapy" guys, the IMF, John Birt, and all the other people who pushed the idea that Ronald Coase was wrong and all forms of human activity work better if they're organised to resemble the New York Stock Exchange as closely as possible. People thought that Enron was changing the world, and that as a result the balance sheet wouldn't be a problem, because the equity market would always recapitalise them on advantageous terms whenever they needed it.
In other words, I'd argue that although the accounting profession disgraced itself in both cases, it did so because it abandoned its historical values. And it abandoned its historical values because *everyone* was abandoning them. And furthermore, that the misrepresentations of the published accounts by people who were fibbing on purpose were absolutely trivial compared to the misrepresentations of the whole world at the time by people who thought they were telling the truth.
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