By Steven Pearlstein
Washington Post Staff Writer
Friday, June 28, 2002; Page A01
The sums of money this time are enormous, the audacity of the corporate misbehavior breathtaking. But according to economic historians, the kind of corporate chicanery that has come to light in recent months has been a part of every financial bubble since the Dutch Tulip Mania of the 17th century. And, they say, it could be months or years before the full extent of it is revealed and the final bills come due.
"This is all very typical," said Eugene White, a Rutgers University professor and editor of a book on financial crashes and panics.
In the euphoria of any boom, White said, rising profits and stock prices provide easy cover for underlying financial problems, allowing executives to convince themselves that even faster growth the next year will provide a magic cure. The longer the boom lasts, the more people become convinced of the inevitability of success -- and the more brazen they become in cutting corners and taking a little more off the top. In the boom environment, the risks of getting caught appear small while the potential rewards loom large.
It is only after the bubble bursts and great piles of money are lost that people ask the critical, penetrating questions that they should have asked before, White said. As many companies are now discovering, hard questions can lead to unpleasant answers, forced resignations, lawsuits and criminal investigations.
So far, the reflexive instinct of the business community and the Bush administration largely has been to blame a handful of executives. Administration officials and many in business also acknowledge that a few laws may need to be tweaked and a few more cops put on the beat while a revised set of "best practices" are worked out for executives and directors. But even with its faults, they say, the American system remains the most open, honest and efficient in the world.
Others say, however, that while the kind of headline-grabbing fraud, self-dealing and insider trading coming to light might be relatively rare, the extended euphoria of the boom years led to a slow, steady deterioration in professional and ethical standards. By the end of the boom, they argue, many companies were engaged in the kind of fudging, gamesmanship and ethical corner-cutting that, while legal, would be viewed as unacceptable in today's post-bubble environment.
"I think it is fair to say that there was nobody in the business community who is not implicated in this in some way," said Jeffrey Garten, dean of Yale University's School of Management. "Not the executives who were under the excruciating pressure of having to meet quarterly earnings targets, no matter what. Not the lawyers and the accountants and bankers who were forced to compete furiously to get and keep clients. Not the regulators who became so intimidated by all the exuberance in the air. Certainly not the underwriters or the analysts or the credit-rating agencies or you in the press.
"Even those of us at business schools are implicated," Garten said. "It's not like the educational establishment sounded any warning. We were cheerleaders, too."
Pay packages certainly did nothing to discourage executives from trying to manipulate the prices of their companies' stocks. In recent years, it was common for chief executives to be given options to buy, say, a million shares a year at a predetermined price. If your stock was selling at a price of 50 times earnings -- not unusual, at the height of the boom -- increasing reported profits by $1 a share would net you $50 million for every million options exercised. Executives with such options could -- and did -- make quick millions by coaxing share prices slightly upward.
As long as the stock price rose, others who might have blown the whistle -- auditors, investment bankers, analysts, directors -- also stood to profit greatly.
"The incentive to scam was enormous," said Kevin A. Hassett, a resident scholar at the American Enterprise Institute and author of a new book, "Bubbleology."
Six months ago, when the Enron scandal was breaking, Harvard Business School professor Jay Lorsch was among those who believed that corporate wrongdoing was the work of a "few rotten apples." Now he's not so sure.
"What's clear to me now is that we're coming out of this bubble and it was a period in which everyone in America thought they could get rich, and get rich quick," Lorsch said this week. "The pressure on CEOs and companies to produce earnings, quarter after quarter, resulted in a different kind of behavior. It was okay to manage earnings. It was okay to push the accounting envelope. That was the culture -- and it was more prevalent than we were aware."
If Lorsch is right, it is likely to be months before all the shenanigans are uncovered, the financial accounts restated and those responsible dispatched to early retirement. And the process is likely to lead to more sweeping reforms than Washington had initially contemplated.
According to Richard Sylla, the resident bubbleologist at New York University's Stern School of Business, that's what happened after the boom in the early years of the 20th century, when the Panic of 1907 gave way to Progressive Era reforms, including the creation of the Federal Reserve System. In 1913, a reform-minded accountant named Arthur Andersen started his firm on the promise of offering investors an alternative to the lax accounting standards then prevailing.
The better analogy to the present case, Sylla said, is presented by the market boom of the 1920s. Then, as now, the United States was emerging from a successful war effort -- in this case, the Cold War. At both times, new technologies promised great wealth to the companies that could harness and popularize them. In the 1920s, it was the automobile, radio and the regional electric utility. In the 1990s, it was the Internet.
After the great crash of 1929, there was a steady flow of revelations of insider trading, self-dealing and investor-snookering that eventually ensnared the president of the New York Stock Exchange. In a case similar to the current scandal engulfing Wall Street, congressional investigators uncovered evidence that the old National City Bank had pushed its brokers to sell Peruvian bonds to clients while knowing full well that the Peruvian government was on the verge of default.
Public anger over the scandals helped defeat President Herbert Hoover in the 1932 election and led to legislation that created the Securities and Exchange Commission and separated the banking industry from Wall Street investment houses. That separation was effectively repealed during the 1990s.
There is little indication that the bursting of the economic bubble will lead to anything like the Great Depression of the 1930s. But in other ways, the impact on American business and society is likely to be profound. Never before had so many Americans had so much of their savings, their compensation and their futures tied up so directly in the stock market. And never before had American business come to rely so heavily on the market, not simply as a place to raise capital but as the ultimate arbiter of success.
In the theory of "efficient markets" spun out by academics and gradually embraced by executives, policymakers and the financial press, stock price came to be viewed as better than even financial statements in determining a company's worth and prospects. The only thing that really mattered was the share price. It was the perfect intellectual foundation for a market bubble.
Jeffrey Pfeffer, a professor of organizational behavior at Stanford Business School, said it was only a small leap of logic from the theory of efficient markets to the notion that "a rising stock price justified just about any behavior."
"If your stock price went up, you were a hero. If not, not," Pfeffer said. "The only thing necessary to justify a high stock price was a high stock price."
Pfeffer thinks much of that ideology still needs to be wrung from American equity culture.
"Until people realize that capital markets are not as efficient and all-knowing as everyone thought, that companies have to be managed for customers and employees, not just for investors, that people who fleece investors ought to be treated no differently than people who hold up a bank -- until then, then I don't think things will really change very much," he said.
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