Investor Beware: The Next Enron May Be Lurking in Europe or Japan
Eric Pfanner International Herald Tribune
Saturday, January 26, 2002
LONDON While American business practices have come under scrutiny in the wake of the Enron scandal, international accounting experts stress that Europe and Asia are no strangers to questionable bookkeeping and corporate meltdown.
Litigation continues over accounting practices that are alleged to have contributed to the downfall of the venerable British banking institution Barings, and Enron's debacle harks back to the near-collapse of a giant German trading company brought to its knees after a disastrous foray into the oil futures market a decade ago.
But some economists say the ingredients for a collapse that resembles Enron - and on a colossal scale - exist in the Japanese financial sector.
Some corporate practices in Europe have also raised eyebrows - principally the willingness of telecommunications companies to saddle themselves with extraordinary debt for a wild ride in unproven mobile phone technologies.
What's more, some companies engage in legitimate bookkeeping magic - in full accordance with international accounting standards - but in the current environment, such behavior is raising analysts' fears of wizardry.
In Japan, the banks - among them two of the 10 biggest in the world - have been reeling for the better part of a decade, weighed down by an ever-accumulating pile of uncollectible debts. Analysts fret that it is impossible to discern a true picture of the banks' dire straits because the institutions are not forthcoming with disclosures.
Carl Weinberg, chief economist at High Frequency Economics, points out that the big banks still have not published their midyear balance sheets. They have only reported income statements, which exclude key items such as the value of their stock holdings.
Even when the banks do finally provide balance sheets, economists say, these complex documents may distort or understate the true severity of their problems.
"I don't know anyone who really knows how to read a Japanese balance sheet," said an analyst who insisted he not be identified.
He suggested that, like Enron, the banks may have found ways to hide additional liabilities off their books: "Do I think there are other problems lurking out there?" he asked. "Absolutely."
As the economic downturn unleashes a record round of corporate bankruptcies, some economists say that the Japanese banks' problems are coming to a head. "These latest hits are big ones for banks that were arguably insolvent to begin with," Mr. Weinberg said.
The biggest hit could come from Daiei, a huge supermarket chain that has struggled to put together a bailout.
Mr. Weinberg estimates that if it goes under, along with three other big recent bankruptcies, the banks would face a collective loss of nearly $40 billion.
That is on top of the tens of billions of dollars in nonperforming loans that the banks carry on their books. Their problems will be compounded by new regulations requiring banks to “mark to market” the value of shares they hold in Japanese companies.
Because the Tokyo stock market is hovering near its lowest levels in two decades, the banks' balance sheets for the fiscal year that ends in March are likely to be an eye-opener - that is, if the banks provide full disclosure.
There is no question about what the balance sheets of European corporate champions, the telecommunications giants, are showing: a massive amount of debt. France Telecom and Deutsche Telekom, for instance, have E65 billion ($56.4 billion) each on their books.
The debt, accumulated in a spree of spending on advanced mobile phone services, threatens the existence of some of the weaker telecoms, former state-owned monopolies that have been thrown at the mercy of the markets.
Most of these companies have seen their credit ratings slashed, and the stock market has virtually closed to them as a source of new financing.
To be sure, many analysts say that in controlling risk, corporate Europe has gained an edge: a set of accounting standards that may be superior to America's generally accepted accounting principles.
Even when companies adhere to international accounting standards, some analysts worry that the procedures still permit enough fudging to distort a company's true financial picture.
Consider the Swedish paper company Svenska Cellulosa AB. For a paper machine that it is building in Austria, the company is using a so-called sale-leaseback agreement with a group of banks to finance half of the 2.5 billion krona ($237.4 milion) investment. SCA, as the company is known, sold that 50 percent to the banks and will pay them back over the term of the lease.
Results from that 50 percent of the investment will be kept off its books, said Peter Nyquist, a spokesman for SCA, pointing out that its auditor, PricewaterhouseCoopers, has certified that the arrangement meets international accounting standards.
Still, Mads Asprem, an analyst who follows the paper industry at Merrill Lynch, worries about such arrangements, even if they are perfectly within the guidelines. "I think investors and analysts will increasingly be preoccupied with what is the right thing to do and will take a dim view of accounting tricks," he said.
In Enron's case, the practice of funneling debts and other liabilities into off-the-books entities appears to have exposed a weakness of American generally accepted accounting principles. Under those standards, companies can exclude from their financial statements any results from such entities as long as another shareholder has at least 3 percent of the vehicle.
The irony is that while the United States has long preached about the dangers, especially in Asia, of "crony capitalism," many accountants say that such financial shifting would have been impossible under international accounting standards being adopted by many big companies.
Under these rules, companies can exclude results only if they can demonstrate that they have relinquished control of the entity in question.
While accounting tricks may or may not have contributed to Enron's collapse, the root of the Houston-based company's problems was an overly aggressive business strategy that critics have likened to a Wild West approach.
But in reinventing itself from an old economy energy company to a new economy trading business that ultimately imploded, Enron had a precursor – in Europe.
In 1993, German banks were forced to arrange a $2 billion bailout of Metallgesellschaft, a metals and mining company turned derivatives trader, after the company lost millions of dollars on bad bets on oil futures. The company has since been revived.
Another European institution, Barings Bank, was not so lucky.
In 1995 it was brought down by a rogue trader, Nicholas Leeson, who piled up more than $1 billion in losses on derivatives trading.
Litigation continues against one of the auditors to Barings, Deloitte Touche, over how Mr. Leeson was able to conceal those losses for months. An action against another Barings auditor - Coopers Lybrand, now part of PricewaterhouseCoopers - has tentatively been settled.
Copyright © 2001 The International Herald Tribune
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