Break Up the Financial Giants to Avoid Enron-Like Collapses
 
Philip Bowring
Tuesday, January 22, 2002
HONG KONG Why is the world of finance purporting to be surprised and shocked by the Enron affair? The potential for such events has long been obvious. Enron is just one result of a decade of slowly spreading cancer throughout the financial services business. The only solution is the breakup of the industry into its component parts: separating banking from investment banking, from stock brokerage, from pension fund management, from derivatives trading, from insurance - and consultancy from auditing. This is not just a story of one rogue company and a complacent auditor. It may be the biggest scandal so far but fits a pattern which has grown out of the way the financial services industry has evolved in recent years. Horizontal integration, amalgamations into ever bigger units, has reduced competition and created hard-to-manage behemoths. Vertical integration has brought about so many conflicts of interest within firms that some clients can only be served at the expense of others, or by deceit. The last symbolic barrier to such conflicts of interest, the Glass-Steagall Act which followed the scandals of the 1920s, was abolished in 1999 just as the stock market was being pumped up to more ridiculous levels than in 1929. Not surprisingly, the removal of restraints occurred when the U.S. Treasury was in the hands of an investment banker, Robert Rubin, previously with Goldman Sachs and recently pleading Enron's cause on behalf of Citigroup.
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The abolition of constraints occurred despite the increase in new financial products such as derivatives which increased risk levels, reduced transparency and took an increasing proportion of the financial sector outside the purview of banking or securities supervision. It coincided with an explosion in non-bank credit to the U.S. private sector. It was supported by claims that bigness meant efficiency and increased capital adequacy or was a natural consequence of globalization.
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In practice it meant more conflicts of interest. Risk assets grew far faster than capital bases, and off-balance-sheet activity boomed. Warnings were aplenty. The Asian boom and bust from 1995 to 1998, to which investment banks were major contributors, was one. Even since then Asia has produced more examples - such as Asian Pulp and Paper ($12 billion in default) - of investment banks earnings tens of millions in fees by telling fairy-tales. Barings and Long Term Credit Management were other warnings.
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A former Securities and Exchange Commission chairman, Arthur Levitt, was eloquent on some of the conflicts - between the investment banking and brokerage units of the giant firms, and between auditors and their consulting businesses. But Mr. Levitt was thwarted by a cabal of "professional" interests. It is now almost two years since the Nasdaq crash revealed the reality behind the banker-broker hype that inflated the bubble. But the public, which lost so heavily, still sees no attempt to reform the industry or bring criminal charges for breaches of trust toward investors. The big houses continue to publish "research"often tailored not to the interests of investors but in the interest of their corporate finance business, which is far more profitable than stock brokerage.
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Auditors have long been mostly captives of the boards which appoint them. What is new is the cartelization into a handful of huge players, and the emergence of conflicts of interest over consultancy. The whistle-blowers became the designers of camouflage.
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Investigative financial journalism is back in vogue after Enron, but very belatedly and overly excited about the Bush administration connection.
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The media joined in the hype making heroes out of investment bankers and brokerage analysts. The wire services remain a source of worry for those wanting dispassionate financial news. Their main clients are not the public media but the financial sector which needs scrutiny. They overexpose the self-interested views of these clients.
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Enron is symptom not disease.
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International Herald Tribune

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