WASHINGTON--After the largest bankruptcy in American history, it is no surprise that commentators and politicians are waxing loquacious about the dangers of deregulation (energy in particular), the unreliability of markets and the urgent need for oversight and legislation to keep the system fair and honest.
That is the conventional story line. Of course it has some truth. Enron constitutes one of the great capitalist train wrecks, a spectacular example of the failure of the free market.
But there is another story line that has been largely overlooked: the remarkable self-correcting capacity of that same free market. We now have dozens of members of Congress falling over each other to write new rules and regulations--conflict of interest provisions, new accounting standards, etc.--to prevent the next Enron. But it will be months, years, before any of this will take effect, and the market has already acted with a terrible swift sword.
When the causes of Enron's collapse became clear--the use of outside partnerships to hide debt, the phony financial reporting that allowed Enron to appear far more profitable than it was--any company similarly situated was savaged by the market.
Tyco International, a once highflying conglomerate whose divisions sport finances of Enron-like opacity, lost 20 percent in market value on a single day (Jan. 29) and 23 percent a week later.
Williams Cos., which also deals in energy trading, lost 32 percent of its value in one week in early February when it disclosed previously unreported debt guarantees to a former subsidiary.
Dozens of other companies were hit by Enron fever. Any company with questionable financial reporting suffered immediate market punishment. Why, even venerable General Electric, which has a huge financial unit, took an initial hit of about 13 percent, as investors punished any company suspected of opaque accounting.
The other major cause of the Enron debacle was the watchdogs that did not watch, namely the Arthur Andersen accounting firm that, while auditing Enron, was reaping millions in consulting fees, in some cases signing off on partnerships that undermined the transparency and reliability of its own accounting.
Legislation separating auditing from consulting is undoubtedly coming. But the market has already acted. Companies know that they will be punished by the market if there are any doubts about their books--and the commingling of auditing and consulting raises immediate questions about anybody's books. Thus Disney, for example, announced that it would not permit its auditors to do any more consulting for the company. Other large firms immediately followed suit. Within a week, every one of the five major accounting firms announced that it would either spin off or detach or in some other way wall itself off from consulting.
That is market correction in action--transparency has become a valuable commodity--but alas, it is post hoc. Markets are not necessarily prospectively efficient. The S&L fiasco, the dot-com bubble, and now Enron and the slight-of-hand bookkeeping bust are testimony to capitalism's capacity for irrationality (and susceptibility to fraud). Irrationalities always occur. What is remarkable, and what makes markets so durable, however, is that when irrationalities are finally exposed, markets swiftly self-correct.
Still, give only two cheers for capitalism. It does deal in efficiency, but not in justice. In a macro sense, Enron has been disciplined and the Enron-like entities punished. But in the micro world--the world of real people--there is no justice. Most Enron insiders have not been punished by the market. They sold early, possibly corruptly with guilty knowledge, and walked away with millions, while those to whom they gave phony information and fraudulent accounting are left shirtless.
Two cheers, then, for politics and the law: for the publicity-hungry congressmen who perform the salutary, if ghoulish, function of hanging out to dry for public humiliation capitalism's newest devotees of the Fifth Amendment; and for the prosecutors who will likely try to put some of the malefactors behind bars.
These are useful functions, and they go beyond justice to deterrence. They will make future (and current) executives think twice about pulling an Enron. Nonetheless, when it comes to macro regulation, the politicians, for all their huffing and puffing, will be just following the market--at considerable delay. Legislation will merely codify the message that the market has already pronounced and brutally enforced: Act like Enron, and you're in big trouble.