"The 1980s were not just a decade of greed and self-seeking, they were a decade of denial and blame. George Bush is happy to tell Israel what to do. Why won't he tell Wall Street what to do?"
Bill Clinton, September 22, 1991
Not even Bill Clinton's harshest critics could have foreseen what the headlines would look like a decade after he campaigned on that statement and after eight years of his leadership in the White House. Enron. WorldCom. Arthur Andersen. Xerox. ImClone. Tyco. Merrill Lynch. Credit Suisse First Boston. How did it all happen? The Wall Street Journal news pages intone that "a stock market bubble magnified changes in business mores and brought trends that had been building for years to a climax." That analysis contains a measure of truth, but it misses the larger forces that permitted undesirable trends to go unchecked until they burst. Today's news is different from the financial scandals of the 1980s not just in magnitude but in kind.
The corruptions of the 1980s were chiefly offenses by a few rogues in the system. Individual acts of wrongdoing stood out on the horizon and were punished. Already the names of the malefactors have mostly faded from public consciousness: Ivan Boesky, Martin Siegel, Dennis Levine, the "Yuppie Five."
The corruptions of the 1990s were corruptions of the system itself. Some of them relied on the non-existence of white collar law enforcement. Some relied on changing the rules to make wrong right. Most were hidden in plain sight. Offenders in the 1980s lurked on corners. Boesky literally repaired to an alley to pass Siegel a briefcase of cash in exchange for inside information. Their 1990s counterparts operated in the proverbial corner offices rather than on street corners.
True, there were scandals in the 1980s involving large institutions and large sums, notably the savings and loan crisis. But that crisis grew out of boneheaded public policy: extreme liberalization of deposit insurance and instant, massive changes in the depreciation rules. The corruption was on the periphery. Not so, it is now apparent, of the more recent class of malefactors.
One hint of what was wrong in the 1990s was the pervasiveness of shady practices and how long they persisted.
Consider the corruption of the initial public offering (IPO) process which in theory is about allowing promising young companies with a track record of growth to begin tapping the public stock markets for their capital needs. In the 1990s, this became a get-rich-quick scheme for investment banks who marketed wildly overpriced shares of infant companies that were barely more than concepts the venture capitalists who owned these companies, and the insiders and their friends who were allocated shares at artificially low prices before trading opened. This game went on far longer and got much further out of hand than one would expect in an allegedly regulated market. The principals in a very reputable investment management firm told me of their dismay and disgust as they found their IPO allocations reduced and then eliminated altogether when they balked at ever more explicit demands for kickbacks in the form of excessive commissions on other trades. "We kept asking ourselves," they told me, "'Where are the regulators?'" Where, indeed?
The regulators came only after and because the party ended. It wasn't until December 2001, nearly two years after the peak in the equity markets and with a new administration in office, that the SEC and the National Association of Securities Dealers (NASD) finally secured a $100 million penalty from Credit Suisse First Boston, whose IPO guru Frank Quattrone was widely believed to be the most flagrant corrupter of the process.
In the avalanche of news following the Enron collapse, the repeated calls that Enron made to the White House and Treasury Department pleading for a bailout were widely reported. Notwithstanding many Democratic insinuations that the Bush White House was a wholly owned subsidiary of "Kenny Boy" Lay's Enron, the Bush administration turned Enron down flat.
Less attention has been paid to the call that Robert Rubin made to Peter Fisher, the Treasury undersecretary who is the administration's point man on financial markets. And almost no attention has been given to the content of that call. While the call was not a crime or even a civil offense, it was in an important way the most telling event in all the recent financial fiascoes.
Rubin, secretary of the Treasury from 1995 to 1999, is no longer in government. He is a director of the Citigroup financial conglomerate. Rubin is the ne plus ultra of eminent Clintonians. Indeed, after Alan Greenspan, he is the most respected figure in international financial markets.
The casual reader of the business press might assume that Rubin, whose firm is a major lender to Enron, asked Fisher for the same thing that Kenneth Lay asked Treasury Secretary Paul O'Neill for: a bailout, some form of government financing. Not so the request was both more subtle and potentially more damaging to the good health of America's markets. What Rubin asked for, by all accounts, was for Fisher to call the debt rating agencies and ask them to find an "alternative" to a downgrade of Enron's securities. (As a lender, Citigroup was bound to be injured by a downgrade.)
This was an astounding request. The rating agencies are meant to be neutral arbiters of the financial strength of the entities they rate. The request Rubin made of Fisher was akin to the owner of a team faced with playoff elimination calling the league commissioner and asking him to see if he can get the referees to call the next game so that the owner's team doesn't lose. This request was coming from the man who personified the Clinton-era financial establishment. Rubin reportedly prefaced his request to Fisher with the phrase, "This may not be the best idea, but..." Students of Watergate will recall that Richard Nixon once instructed his subordinates in how to gather hush money for the Watergate burglars, then ended the explanation with the phrase, "But it would be wrong." Nixon later pointed to that sentence as evidence of his innocence. Plus ca change.*
Republican campaign committees are already encountering a predictable challenge with potential corporate donors. The donors want to know why they should contribute to the GOP when Rep. Billy Tauzin (R-LA) is hauling them before the House Energy and Commerce Committee for public scrutiny of their conduct. This tension is a natural outgrowth of a system in which elected officials both oversee industries and raise funds. In Tauzin's case, the hearings have gone on as scheduled.
The Clinton administration had a simple way to resolve this tension: law enforcement had to yield to fund-raising. It must have been difficult enough to persuade a CEO to come to the White House for coffee at $50,000 a cup. With pending securities law investigations in the background, it would have been impossible. So the dogs had to be called off.
Many of Enron's shenanigans grew out of an obscure, early-'90s regulatory opinion, EITF 90-15 (EITF being the Emerging Issues Task Force of the Financial Accounting Standards Board the people who make the accounting rules). This opinion paved the way for corporations to take entities such as Enron's notorious partnerships off their corporate books if outsiders contributed even 3 percent of the capital to the entity. The other 97 percent of the capital could come from the parent company.
Where to draw the line about what goes on whose balance sheet is a complicated subject, one that accountants have grappled with for years. But the 3 percent rule undermined the core principle of American financial reporting: consolidation, the notion that what is basically yours usually, something you own more than 50 percent of should appear on your balance sheet. It is consolidation that gives you confidence that when you look at a company's financial reports you are getting a real snapshot of the company's financial condition. In the hands of Andrew Fastow and Jeffrey Skilling, EITF 90-15 and subsequent regulations were a license to create imaginary profits and hide genuine losses.
Surely, the EITF didn't intend the result it got. In another era, the authorities would have put a stop to abuses. But not in the 1990s.
The tale of Merrill Lynch and its now-famous security analysts has similar outlines. "Sell-side" analysts (those who work for brokerage firms, as distinguished from the "buy-side" analysts who work for investment management firms) should never have been compensated on the basis of how well they could promote the interest their employers have in underwriting securities. The conflict of interest was obvious all along. As the problem grew to elephantine proportions during the Clinton era, regulators did . . . nothing. The now-infamous Jack Grubman earned an eight-figure annual compensation package from Smith Barney for steering his firm's clients into the stock of WorldCom and Global Crossing and, more important, for getting his firm underwriting fees from WorldCom and Global Crossing.
Now that regulators and law enforcement officials are finally dealing with this problem, they have a real mess to contend with. Many securities companies have merged and organized themselves to gain the profits that can accrue from having sell-side analysts and security underwriting in the same firm. Untangling this problem without sinking these firms, most of which have thousands of employees, in the middle of a bear market will be very difficult indeed.
Clinton's chairman of the Securities and Exchange Commission (SEC) was Arthur Levitt Jr., former head of the American Stock Exchange and son of a legendarily upstanding New York State comptroller. To his immense credit, Levitt saw the outlines of many of the disasters that have since emerged and sought to address them before they got out of hand. Problems have appeared in audit committee structure and authority, in security analyst conflicts of interest, and in the conflict of interest posed when accounting firms audit the books of and earn consulting fees from the same client. Levitt had flagged all of these issues for reform by 1999.
Levitt might as well have been suggesting a program of intergalactic travel. In 1994, a private pilot crashed his small plane onto the White House grounds. Washingtonians joked (such things were funny back then) that the pilot was James Woolsey, the CIA director, seeking a meeting with a president who had no interest in Woolsey's agency. The joke could have been about Arthur Levitt and the SEC. With Levitt's proposals lacking the promise of fund-raising, improved poll numbers, or the Nobel Peace Prize, Clinton had no interest in them.
One of the anomalous and confusing aspects of the Merrill Lynch investigation, which lately led the firm to agree to a $100 million penalty over analyst conflicts of interest, is that the investigation was initiated by New York Attorney General Eliot Spitzer. The New York attorney general is not the natural or primary enforcement agent against serious wrongdoing. That role is normally assumed by the United States Attorney for the Southern District of New York, in whose jurisdiction most of the securities industry is located. Ronald Reagan, whom Clinton accused of "denial" of ethical problems arising from greed, installed in
that post Rudolph Giuliani. Giuliani went at his job with a vengeance, indicting so many Wall Streeters for wrongdoing that he still faced bitterness from the financial community when he first ran for mayor in 1989.
In the same job, Bill Clinton gave us Mary Jo White. This was the same Mary Jo White who could not find any senior official to indict when Ron Carey turned the Teamsters' Union Treasury into a mutual money-laundering facility for his reelection campaign and for the Democratic National Committee. White is the person who should have taken the lead in Wall Street prosecutions. But over at the White House, the money, to quote "Evita," "kept rolling in from every side." White's boss, of course, was Janet Reno, whose name has become a synonym for a certain approach to law enforcement.
The system is in far worse shape when a central and respected figure like Robert Rubin feels free to try and rig the game than when an Ivan Boesky who even before his arrest was thought by most in the financial market to be a shady character is trading on inside information. Dennis Prager, the radio commentator and Torah scholar, has long emphasized the difference between a society with some people in it who behave immorally and a society in which the immoral change the rules to make their behavior acceptable. The latter situation, Prager tells us, is far worse. For any who had doubted the importance of this distinction, the news of the last six months has been an awakening.