FRFI 168 August / September 2002

Global crisis, plunging stockmarkets and corporate swindles

David Yaffe

‘In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.’ J K Galbraith 1

These are not good times. The spectre of 1929 hangs over the global capitalist system. Stockmarkets are plunging, debts are increasing, and corporate defaults have reached record levels. Systematic fraud is being exposed at the heart of the capitalist system. The great international auditing corporations are being called to account. The general panic has even begun to rouse the corrupt and complacent ruling class clique that governs the United States of America. If President Bush, who won the presidential election on the basis of fraud, is ready to talk about ‘well-enforced laws against fraud and corruption’ in the corporate world, then the crisis facing global capitalism is very serious indeed.

In October 2000, Robert Shiller, author of Irrational Exuberance, saw the ensuing fall in the US stock market as a drawn out process, like a ‘slowly deflating ball’ (The Guardian 18 October 2000).2 Today that image is inadequate. The fall in the US stock market has significantly accelerated. On Monday 22 July, the day that WorldCom filed for the largest bankruptcy in US corporate history, the Dow Jones share index fell to 7,785 – a fall of nearly 3% on the day and its lowest level since October 1998. This was on top of a fall of more than 7% the previous week. The Dow Jones had now fallen 33.6% below its January 2000 peak of 11,723. The more broadly-based Standard and Poor’s index of 500 leading stocks (S&P 500) was now 46% down from its 2000 all-time high and the Nasdaq (high technology shares) a massive 75%.

More than $7,000bn have been wiped off the stock market capitalisation of the US market since its 2000 peak as the fictitious nature of much of this capital is brutally exposed. There is more to come with the latest price/earnings ratio of the S&P 500 still almost three times its long-run average.

Outside the US, the markets are also plunging. In Japan the Nikkei has continued its fall and is more than 50% below its 2000 high and 75% below its all-time peak at the end of the 1980s before the Japanese stock market bubble burst. In London the FTSE 100 has fallen 25% in five months and is now at its lowest level for six years, 44% below its all-time high (December 1999). The German DAX and the French CAC 40 are more than 54% lower than their 2000 peaks. These are not good times!

There has been no shortage of ‘experts’ wheeled out, as was the case during the 1929 stock market crash, to tell us that the ‘economic fundamentals are sound’ but as yet no one is listening. Even President Bush has entered the fray. On the day World-Com filed for bankruptcy he said ‘I am not a stockbroker or stock-picker but I do believe that the fundamentals for economic growth are real’. This modern King Canute (who sought to turn back the tide) will have as much impact as his historical predecessor.

Corporate swindles

‘When abuses like this begin to surface in the corporate world, it is time to reaffirm the basic principles and rules that make capitalism work: truthful books and honest people and well-enforced laws against fraud and corruption.’ George W Bush 9 July 2002

The deepening crisis has definitely affected the ‘rate of discovery’ of systemic corporate fraud. The latter was dramatically brought into the public domain with the scandal surrounding Enron, the US energy conglomerate.3 Over a 15-year period to the end of 2000, Enron’s market capitalisation soared from $2bn to $70bn. It had launched EnronOnline in 1999, the biggest web-based transaction system in the world, and traded nearly 2,000 products over the internet. Enron’s revenue had more than doubled to $101bn between 1999 and 2000. No one questioned these developments at the height of the market. It took the casual mention of a $1.2bn adjustment to Enron’s balance sheet by its Chief Executive (CEO) Kenneth Lay at a press conference last year to raise serious questions about its accounts.

What eventually emerged was a systematic and fraudulent overstatement of earnings. Its share price fell from a high of $85 in late 2000 to under $1 by November 2001. In December 2001 Enron filed for bankruptcy protection. The game was up. Many of Enron’s senior executives had sold their shares in the company before they began to crash, while long serving employees, whose pension funds were invested in Enron shares which could not be sold, had their retirement income wiped out. Enron’s auditors, the financial services corporation Andersen, who ‘failed’ to spot the earnings anomalies, were soon themselves totally enmeshed in the affair after destroying documents and files crucial to an investigation into Enron’s accounts by the Securities and Exchange Commission. A criminal investigation was soon underway and Anderson was found guilty of obstructing justice. Andersen earned $25m for auditing Enron’s accounts in one year as well as $27m for other ‘consultancy’ services, creating a clear conflict of interest between its two roles. 300 middle and senior managers at Enron were former Andersen employees. Highly paid crooks were working together. Two of the world’s largest US banks, Citigroup and JP Morgan Chase, have recently been implicated in the fraud after congressional investigators showed how the two banks helped Enron disguise its debts.

WorldCom, the second biggest US long-distance telephone company, began this year with assets of $107bn and outstanding debts of around $40bn. It is under investigation for the biggest corporate fraud in history. It transferred some $4bn from ‘line-cost expenses’ to capital in its accounts to inflate its net income. If it had accounted for these expenses correctly it would have made a net loss in 2001 and in the first quarter of 2002. Its shares reached $64 at their height in 1999, valuing the company at around $180bn. In June this year they were trading at 9 cents. On 22 July World-Com filed for bankruptcy. Andersen was the auditor of the WorldCom accounts.

WorldCom is among a long list of corporations now being investigated for accountancy fraud. The US computer corporation EDS, which runs multi-million pound IT projects for the British government, has been drawn into the WorldCom scandal. A former employee from WorldCom’s UK subsidiary has produced a number of invoices from EDS to WorldCom which, she alleges, helped to inflate the latter’s profits. EDS had a contract to provide technology services to WorldCom and a related deal to take some $6bn of WorldCom’s services. Scandals and accounting ‘irregularities’ have hit Xerox, the bankrupt cable company Adelphia (five former executives have now been charged with fraud), the industrial conglomerate Tyco International and many other corporations. The accounting practices of AOL Time Warner are now under investigation. Nearly 1,000 companies have been forced to restate their earnings as calls for transparency and accountability are becoming more insistent. ‘Money is watched with a narrow, suspicious eye’.

False accounting practices are the inevitable result of paying executives and managers with stock options. It provides strong incentives to get the share values of their stocks as high as possible. Short-term considerations become paramount. Most companies do not treat stock options as a cost to be deducted from profits. Overstating earnings can be very lucrative for managers and executives. Business Week reports that companies have been overstating earnings by as much as 15% annually over the past five years. The major accountancy corporations are very accommodating. PricewaterhouseCoopers has violated US federal independence rules in 16 separate audits over the last six years and has agreed to pay a $5m fine to settle the cases. Last year Andersen was fined $7m for fraud in its audit of Waste Management. This is to be expected when auditing corporations often earn more from ‘consulting’ than providing auditing services for the same companies.

Gambling and crime are common bedfellows. With the well-being of the major capitalist economies so evidently dependent on the fortunes of a global gambling casino – the world’s major stockmarkets – it is no surprise that fraud and corruption are commonplace within the corporate world. Inevitably this spreads from the corporate world to the government of the corporate state.

Links between the US government and Enron are intricate. Enron is based in Bush’s home state Texas. It has contributed some $800,000 to Bush’s campaigns for governor and president. The CEO of Enron, Kenneth Lay, is a close friend of Bush. Robert Zoellick, US trade representative, served on Enron’s advisory council. The president’s top economic advisor, Lawrence Lindsay, was a consultant for Enron. Vice-President Cheney regularly met with representatives of the energy industry, including Enron, while formulating the US government energy policy. That policy, unsurprisingly, ended up offering $33bn in tax breaks to energy firms. The attorney general John Ashcroft was forced to step down from the investigation to Enron’s affairs because of a donation of $58,000. Karl Rove, the chief political advisor to Bush, owned Enron shares.

WorldCom has spent over $7.5m financing political campaigns over the past decade including a $41,000 donation to Bush’s election campaign in 2000. It handed over $100,000 to the Republicans at a fund raising event attended by President Bush. World-Com spent some $3m a year lobbying in Washington to influence tax policy and to oppose the planned deregulation of the long-distance telephone market. John Ashcroft took $10,000 from WorldCom for his 2000 Senate campaign (The Guardian 28 June 2002 and 9 July 2002). Wall Street banks donated $1.3m to Bush’s presidential campaign in 2000 and Citigroup alone gave $2.8m to political campaigns in 2000, and it has already donated $1.4m to US congressional candidates for the 2002 election.

Bush and Cheney have their own scandals to fend off. They personally profited from fraudulent operations similar to those now destroying large US corporations. In 1986 a Texas energy company Harken took over a loss-making and heavily indebted company run by Bush. It was paying for Bush’s political connections. In 1990 Bush, a director of the company, sold 212,140 shares for $850,000 just two months before Harken announced an unexpected quarterly loss of $23.5m. The sale came two and a half months after he had signed a letter saying he would not sell any Harken shares for at least six months. Harken had used an accounting device similar to that employed by Enron to disguise the real situation. The accountant was Andersen.

Cheney is the subject of questions concerning an investigation into the dubious accounting practices of Texas-based energy company Halliburton. The accounting practices of this company were apparently changed in 1998 to inflate the company’s earnings during the time when Cheney was CEO. Disputed charges for cost overruns in Halliburton’s projects were treated as revenues, even though they had not been paid. At a press conference on 17 July, Bush expressed full confidence in Mr Cheney. He also said that he had done nothing wrong in 1990 when he sold Harken shares. Crooks stick firmly together.

The economic fundamentals are unsound

‘This is not a crisis of capitalism. It is its corrective mechanism at work. Today’s plunging markets and state of disbelief are the linear descendants of the prior bubble and the prior belief. The credulous are being punished.’ (Financial Times editorial 20 July 2002)

The crisis of capitalism is the corrective mechanism at work.4 It occurs as a result of an overproduction of capital in relation to profitability. The accumulation and expansion of capital have outrun profitability. Further capital invested does not yield sufficient profits.5 During the crisis the ‘corrective mechanism’ aims to restructure capital towards greater profitability so a new profitable accumulation of capital becomes possible. The crisis is therefore the most poignant expression of the ‘disease’ of the contradictions of capitalist production. But it is also the ‘cure’ – ‘the forcibly established unity of elements that have become independent’ (Marx). Nothing is more clear in the crisis than the wasteful and destructive side of capitalism. The economy stagnates or contracts, corporations are driven into bankruptcy, factories are closed, millions lose their jobs and face a future of poverty. The ‘civilising’ tendencies of capitalism are seen to be brought about at enormous expense.6 The degree, extent and savagery of the corrective mechanism, its impact not merely on the ‘credulous’ but on the millions of working people who actually produce income and build wealth, will determine the depth of the crisis of the capitalist system.

This present crisis is the product of an overaccumulation of capital in the heartlands of capitalism. The massive flows of capital around the world, the easy credit that has financed a global stock market boom, the mergers and acquisitions boom and the unprecedented autonomy of the financial system from real production are the consequence of this overaccumulation. Fictitious capital, an ever-expanding credit bubble built on a relatively declining productive base, careers around the world desperately searching for new sources of short-term profits.

The US economy has been the driving force behind world economic growth ever since the Japanese stockmarket and property market bubble burst at the end of the 1980s. The Japanese economy has suffered four recessions since that time and has still to recover. With the European economies relatively stagnant, the US economy generated around 40% of global incremental demand between 1996 and 2000. A severe US recession, therefore, would have dramatic consequences for the global economy. The record-breaking nine-year US expansion ended in March 2001 well before the 11 September events. The US economy experienced a short recession but quickly recovered after 11 cuts in interests rates in 2001, from 6.75% to 1.75% – the lowest level since 1958. The plunging stockmarkets, falling profits, unprecedented debt and the unsustainable trade deficit threaten to drive it back into recession again.

Rising stock markets and falling profits

A year and a half ago we pointed out the potential crisis points for the US economy.7 The first potential crisis arose from the fact that share prices were rising dramatically faster than the underlying profits/earnings of companies on which they were based. Between early 1994 and its January 2000 peak, the US market index more than tripled while profits rose by less than 60%. At some point a realignment had to take place. The share of profits in total income actually declined by around 25%, from 19.2% in 1997 to 14% in 2001 – the lowest share of the entire post-war period.8 Business investment has been falling for nearly two years. Towards the end of 2001, industry was operating more than 25% below its potential capacity. The plunging stock markets are underlining these points. With almost 50% of US households owning shares a sharp fall in the stock market will dramatically curtail consumer spending, the driving force behind US economic growth.

Growing debt

The second potential crisis arises from the unprecedented levels of private sector debt – household and business debt. Higher share values and rising house prices fuelled the 1990s US consumer boom with consumers spending and borrowing more on the basis of rising asset prices. Household debt has continued to grow to nearly 110% of disposable income, despite the downturn in the US economy. The personal sector’s financial deficit is still close to 4% of GDP, as opposed to an historic post-war surplus of just below 2%. This is not sustainable.

Corporate debts have also reached record levels. In 2001 they rose to 47.4% of GDP compared with 42.6% during the 1990-91 recession. Another measure of this indebtedness is the ratio of corporate debt to profit. This ratio grew from about 3:1 in the 1950s to a peak of 10:1 during the 1990-91 recession and the fell to around 6:1 from 1991 to 1997 as companies reduced their debt burdens. It has now risen above the previous peak to more than 11:1. Significantly some 50% of the money borrowed by corporations in the 1990s was used to repurchase the companies’ own shares, causing a short-term rise in share prices which increased the value of the stock options owed by highly paid company executives and managers – ‘a pack of cards, created by and for the short-run greed of corporate executives’.9 This debt burden shows the financial vulnerability of US companies to a downturn let alone recession in the US economy. It is little surprise that we are now seeing some of the largest corporate bankruptcies in US history. Overall the private sector’s financial deficit (businesses and households) towards the end of 2001 was still close to 2.5% of GDP, compared to a 1.5% surplus in 1995, despite the fall in expenditure relative to income. It has a long way to fall.

Financing the current account deficit

The third potential crisis is a consequence of the others. Real demand in the US economy grew consistently faster than real output between 1996 and 2000. The result was a large rise in the current account deficit to 4.5% of GDP in 2000, and a progressive rise of the US net external debt to the rest of the world. This debt has grown from near zero in 1988 to a massive $2,187bn at the end of 2000 and about $2,600bn at the end of 2001 – greater than all the foreign debt of all underdeveloped countries put together. Servicing this debt will drain the US economy for years in the future.

To finance its current account deficit, expected to reach $465bn this year, the US needs to attract some $1.3bn in overseas funds every day. The inflow of these funds is crucial for maintaining the dollar at its present level and, therefore, vital in keeping an estimated $6,500bn foreign owned assets in the US. However with stock markets plunging and corporate bankruptcies increasing, foreign investors will want to put their capital in safer outlets. The inflow of capital into the US is already falling, putting enormous pressure on the dollar.

Mergers and acquisitions (M&As) by foreign investors funded around 40% of the US current account deficit in 1999. In 2000 cross-border M&As worldwide peaked at $1,114bn driven by the buoyant stock markets and inflated stock prices of the previous years. Cross-border M&As fell to $600bn in 2001 as stock markets began to turn down. More than one-third of international takeovers agreed at the height of the market are now being unwound. Between 50% and 60% of M&As actually destroy shareholder value. At the time of the merger of AOL Time Warner its share price was above $80. Two years later it was between $10 and $12. Vodafone’s share price peaked at 383 pence after the $200bn takeover of Mannesmann – the world’s largest takeover. In July 2002 it was at 80.5 pence. In May 2002 Vodafone announced a £13.5bn loss – the biggest loss in UK corporate history. Falling markets and stagnant economic growth in the main imperialist economies ensure the fall in international M&As will continue.

M&As were the driving force behind foreign direct investment (FDI) into the main imperialist economies. In 2001 FDI flows declined by 40% globally from $1,300bn to $760bn due to falling stock markets and stagnant economic growth. Flows to the imperialist countries fell by half from $1,000bn to $500bn. In 1999 FDI inflows to the US were a record $294bn. In 2000 they were more than $288bn, but in 2001, preliminary figures show that they had fallen dramatically to around $144bn in the first three quarters of 2001. It is possible that FDI outflows from the US, estimated at $179bn in 2001 ($139bn in 2000), will be greater than the inflows – a net outflow of funds.

Foreign purchase of corporate debt which funded the major share of the US current account deficit last year fell from $15.5bn to $7.3bn from January to February this year. Growing corporate defaults and the ‘downgrading’ of corporate bonds, due to a higher assessment of probable default, suggest that the fall will continue. Foreign purchases of US equities fell from $8.6bn in January to $2.1bn in February, compared to average purchases of $11.6bn last year. The plunging stock markets make it unlikely that this will improve. Overall, in the first two months of this year average monthly net inflow was $14.6bn compared to $44bn last year. This is nowhere near enough to finance the current account deficit.

Bleak future for capitalism

The US economic situation is precarious and contradictory. If interest rates are increased to attract more capital, US economic growth will slow down as the overall burden of household and corporate debt increases and private sector spending falls. If, on the other hand, rates are lowered to prevent the economy stagnating, then the dollar will fall rapidly, reducing US imports from the rest of the world. Foreign investors will withdraw their funds as the value of their returns in depreciating dollars falls. The global economy will slow down and there could be another recession.

The fall in the level of the dollar necessary to reverse the current account deficit could turn this slowdown in the inflow of foreign capital into an actual withdrawal of existing foreign capital assets – capital flight. The US economy would be driven into recession with devastating consequences for the global economy.
The future for US capitalism looks bleak. International trade went into reverse in 2001, falling by 1% in export volumes and 4% in value terms for the first time in nearly 20 years. US exports fell by 7%. In May 2002, the US registered a record trade deficit of $37.6bn and the dollar hit a new two and half year low against the euro. The stockmarkets remain extremely volatile.

There is much dispute about the causes of the Great Depression in 1929. Apologists for capitalism have blamed it on bad economic policies, trade disputes, corruption and greed. But it is difficult to dispute that the principal catalyst was the huge overaccumulation of capital at the end of the 1920s, the unfounded optimism about economic prospects and a massive stock market bubble. That sounds familiar!

1 The Great Crash 1929 Penguin Books 1992 (1954) p153. The ‘bezzle’ is undiscovered embezzlement.
2 See David Yaffe ‘Globalisation: parasitic and decaying capitalism’ in Fight Racism! Fight Imperialism! (FRFI) 158 December 2000/January 2001 for references, available on our website
3 See Jane Bellamy ‘Enron goes bust’ in FRFI 165 February/March 2002.
4 For an explanation of the crisis of capitalism see David Yaffe ‘The Marxian Theory of Crisis, Capital and the State’ in Economy and Society, Vol 2 No 2, May 1973. This article will be available soon at www.
5 An article ‘An enduring miracle’ by Gerard Baker, in the same issue of the Financial Times as the editorial, grudgingly acknowledges this position when it argues that some of the investment in the late 1990s ‘was probably excessive, creating a capital overhang, driven by unrealistic expectations on returns to technology and telecommunications equipment especially.’
6 The 1929 stock market crash was followed by the Great Depression, fascism and World War II before that crisis of capitalism was overcome.
7 See ‘Globalisation: parasitic and decaying capitalism’ op cit
8 Figures from Fred Moseley ‘Goldilocks Meets a Bear: How Bad Will the US recession Be? Monthly Review website April 2002 at
9 Quote and statistics from Moseley ibid. There is a good discussion on the consequences of this debt.