Thursday, April 21, 2005

What do Enron, Iraq, and the Social Security Administration have in common?

Do you know why the Enron scandal happened? I’m going to oversimplify it but here it is. It happened because Enron was publicly held. Their stocks could be bought and sold on the stock market.

Here’s how I arrive at that conclusion. One of the best ways for stock brokers tell how strong or weak a company is is to look at their financial statements. A person that knows what she’s doing can, assuming that the financials are true, figure out how much growth the company experienced, what major assets they’ve bought and sold, how well they pay their bills and collect the money owed to them, how much the owners have invested, how profitable they are, how likely they are to continue to be profitable – well, let’s just say that there’s little you can’t tell about a company from accurate, complete financials. This is why companies issue long reports with their financials explaining every little nuance. They want investors to know why profits were down or the net worth of the company has fallen. They want to explain away each and every negative.

So, what does this have to do with the scandals? Well, I work at a publicly held company. I work in the accounts receivable department. Before the end of each quarter there’s a big push to collect as much money as possible so that our numbers will look better for that financial period. Ultimately my numbers will wind up on the financial statements issued to the SEC and published publicly. My company wants investors to feel confident in their progress so they put pressure on me to collect all the money I can. There’s nothing wrong with this, almost all publicly held companies do it. But it’s this kind of thinking that can be the first step down a long road to breaking some major laws. A company that becomes too obsessed with those quarter end numbers will cross the line at some point and begin hiding losses and exaggerating gains on their financial statement. Usually they expect to make these little white lies up on the next set of numbers but, when they don’t it can quickly snowball.

What’s my point? Stay with me, I do have one.

Now, when lying company gets tight with their auditors they don’t have to work so hard to hide the negatives because the auditors are the ones that are supposed to catch these improprieties. Once they’ve partnered up in their lie the skies the limit. That’s why Enron got so bad. I like to think of it as a papier-mâché skyscraper. A little financial lie, like a little papier-mâché creation, is easy to maintain and protect from breakage. But, the bigger it gets the more likely it is to break and crumble. By the time that Enron collapsed, their lie was like a huge 100 story papier-mâché skyscraper – brittle with no supporting structure on the inside. From the outside, on the financial reports everything looked fine. But it took very little to break it and make it crumble.

Now, let’s shift gears a little and look at another bunch of important people that got too caught up in reaching a stated goal.

It’s a familiar story about the weapons of mass destruction that failed to turn up in Iraq. Despite what the administration says now, we remember that this was the overriding factor in the latest Gulf War. They all believed it. After months of listening to one interpretation of the data coming out of Iraq, they all eventually came to that same conclusion. Saddam had WMDs and he must be stopped.

But theirs weren’t the only voices during those days. Go back and search for any newspaper articles with the name Hans Blix in them from any time during the six months leading up to the invasion of Iraq. He was the Chief UN weapons inspector and had scoured through Iraq looking for these things. Read those articles and you’ll find that he was saying over and over to anyone that would listen, “there are no weapons.”

At the time he might have been wrong or he might have been right. But he should have at least been listened to. He wasn’t and unfortunately, in a manner of speaking, he was right. Only one side of the story, the one that supported the administration’s goal of invading Iraq was heard by those in power. I’ve never known why, we probably never really will, but it seems obvious that they wanted, more than anything, to go in there.

What does one have to do with the other? I’m not just listing recent scandals here. These two incidents I think are clear cut reasons why any social security reform should not included privatizing social security.

The WMD story clearly shows that the government is as susceptible to the same flawed thinking that led to the fall of Enron. Until now the government and big business have been relatively separated, at least at the level that worries me. Going back to the Enron structure of reporting, the auditors check the financial statements which they’re supposedly certified to do in an honest and fair way. Then the numbers are given to the SEC and, because the SEC assumes the numbers are right since the auditors say so, they are published as gospel. When the auditors, in their role as representatives of the regulator of business in this country, were compromised, the whole system collapsed.

So, what happens when the regulator itself, the government, begins to take a vested interest in the success or at least in the reporting of successful businesses? This is what will happen when social security money begins to be tainted by the presence of big business. We know from the WMD fiasco that the government is susceptible to believing skewed data. How could we possibly believe that social security office won’t force the SEC to accept erred numbers from Microsoft, GM, Wal-Mart, or GE in the interest of keeping the stock market propped up? Just like the business owner that believes his erroneous numbers will be corrected in the next period, the government might decide to take the leap of faith with the business that they believe so strongly in and let them slide for a quarter, waiting until the next for the benefit. And so the snowball starts rolling.

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