GIVEN THE PERFORMANCE
of most Americans' investments over the last few years,big business
makes an easy target for the ratings-hungry news media and a bloated government eager to prove it does more than take up twochannels
on my local cable system.
But while the media relish the chance to spin the recent scandals at WorldCom, Enron, Xerox and the rest into splashy "trend pieces," and while some pols shake their heads with righteous indignation, the real story behind the recent financial scandals isn't the failure of the free market, but rather its triumph.
Fraud isn't a way of life it's a fact of life. Go to any grocery store and you'll see a handful of bounced checks taped on the wall. In business large and small, there will always be a tiny minority intent on not playing by the rules. In fact, I would even suggest that there's less fraud in American business than there is sexual abuse in the clergy or embezzlement in politics, largely because American business is by far the most transparent and honestly analyzed of the three.
But because fraud does> exist (always has, always will), the architects of modern capitalism wisely created disincentives to deter transgressors and far more effective ones than anything to be served up by Harvey Pitt, Eliot Spitzer or a gaggle of overzealous Congressional committees.
Lost in the saturation coverage of this year's scandals is that the free market tends to anticipate, plan for and cope with major stresses much better than capitalism's detractors (and the public's "defenders") might think.
On June 26, just hours after WorldCom revealed the biggest accounting fraud in history, it was business as usual for the vast majority of Americans. The phones were working. There wasn't a run on the banks or looting in the streets. The Internet didn't shut down, the lights didn't go out. The Nasdaq even ended the day higher>. Most Americans even those who use WorldCom's products every single day have been almost completely unaffected by the news.
But what about the investors in WorldCom the "public" that regulators claim to represent? To begin with, after the dot-com crash, the Enron scandal and dozens of books from the Motley Fool, I'd like to think most investors were smart enough not to have put their life savings into a single stock.
And even those who invested aggressively in the company did it willingly and with the knowledge that they could lose money. As I first pointed out a few months back, investing is a speculative game for any number of reasons including the potential for fraud. But the beauty of the free market is that risk is borne solely by those who choose to take it on. While I empathize with those who've lost money on the stock (we've taken a bath on the bonds ourselves), let's not forget that this was a troubled investment long before it made the front page of the New York Times. Perhaps we didn't know there was outright fraud at WorldCom. But long before June 25, what we did know should have aroused concern in existing and prospective investors.
To begin with, if you're just now discovering that telecom has been a tough business lately, than you've been on drugs, in a coma or living in a cave. Even the most casual market participant has known for years that competition, overcapacity and mounds of debt plague the industry.
Even WorldCom's cooked books revealed a highly leveraged company. And regardless of whether or not Chief Executive Bernie Ebbers was in on the fraud, we also knew that he borrowed (with board approval) hundreds of millions of dollars of shareholder money to buy rapidly declining WorldCom stock. Most important, we knew the stock has been an absolute disaster since late 1999. And although the proponents of regulated economy will make the case that the free market is too cruel to be left untamed, the truth is that it gave investors big and small plenty of opportunity to cut their losses and save their skins.
If you bought WorldCom shares near their June 1999 peak, the stock's 50% decline over the next 12 months should've been a signal that something> was amiss, no? By June 2001, after another 50% decline, shouldn't you have been at least a little suspicious that this wasn't the great investment that Salomon Smith Barney analyst Jack Grubman said it was? And when the stock dropped an additional> 70% from June 2001 to June 2002, shouldn't you have at least considered taking a tax loss instead of buying more "bargain" shares below $5, a level most high-school investment clubs (let alone billion-dollar pension plans) know to be the domain of worthless penny stocks?
Cruel market? More like irrational thinking. How many times can you hold an investment that drops 50% before you finally throw in the towel and move onto your next trade? Therein lies the real triumph of WorldCom: Even if you bought the stock at the all-time high, the free market gave you three years' worth of chances to suck it up, cut your losses and get out.
As our elected officials prepare to play politics with big business, I'd suggest they start by giving us the same courtesy that Bernie Ebbers, Sam Waxal, Martha Stewart and the rest did that is, to give us the right not to invest in their crumbling companies in the first place. While investors were able to get out of WorldCom at any point during the last three years, we've all been stuck in another money-losing investment Amtrak for more than 30. And although the U.S. Postal Service is nearly $13 billion in debt, and has raised prices three times in three years, it has yet to allow independent auditors to evaluate its financial records. Given the fact that the U.S. Postal Service enjoys a monopoly on first-class mail, I'd take an audit from Arthur Andersen over no audit any day.
In the final analysis, I don't think we're experiencing a crisis of confidence as much as a slow news cycle. If investors really are nervous about corporate governance, it's sure not evident in their portfolios most of which are still largely overweighted in a relatively small number of large-cap stocks. For better or worse, scandals such as we've seen in the past few weeks might finally prompt investors to swallow their pride, open their financial statements and face the facts.
Jonathan Hoenig is portfolio manager at Capitalistpig Asset Management. At the time of writing, Hoenig's fund held the publicly traded debt of WorldCom.>