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7-25-02
How Big is the Bezzle?
Alan Greenspan, the head of the Federal Reserve, has a way with a phrase.
In 1996, he warned that the stock market might be overvalued, because
of "irrational exuberance." Now, in his recent testimony before
Congress, he spoke about the many corporate financial scandals making
so much news. He blamed it on "infectious greed."
It's not that people became greedier in the '90s. It's just that the
opportunities to make good on that greed were so much greater. Now that
the boom has collapsed, the scandals at Enron, WorldCom and the others
are coming to light.
Maybe we should have expected news of financial scandals. It's happened
before.
Economist John Kenneth Galbraith wrote a very readable book about the
October 1929 stock market crash, called "The Great Crash," published
first in 1954. After the crash, Galbraith said, the newspapers were filled
with stories about embezzlement. A lot of people stole a lot of money
to play the market. After the crash, the stocks they'd bought were nearly
worthless, so they were found out or had to confess.
Galbraith wrote, that, at any time, there is an "inventory of undiscovered
embezzlement." Money has been stolen, but the losses have not yet
been discovered. Galbraith suggested that the value of this inventory
could be called the "bezzle."
In good times, the bezzle gets larger. People are excited about all the
money being made, and they let down their guard. In bad times, the bezzle
shrinks. Galbraith wrote, "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."
Many of the financial scandals today are more sophisticated than mere
embezzlement. But Galbraith's words still apply. Let's see some more quotations
from Chairman Greenspan:
"At root was the rapid enlargement of stock market capitalizations
in the latter part of the 1990s that arguably engendered an outsized increase
in opportunities for avarice." Greenspan has a way with a phrase,
but he's also a master of the obscure. He's saying that the stock market
boom at the end of the '90s made it easier to steal, embezzle and defraud.
The bezzle grew.
"With profitable opportunities for malfeasance markedly diminished,
far fewer questionable practices are likely to be initiated in the immediate
future." Fraud is tougher now, because everyone is watching so closely.
Commercial morality is improving.
"Previously undiscovered misdeeds will no doubt continue to surface
in the weeks ahead as chastened CEOs restate earnings." The bezzle
is shrinking.
A lot of today's scandals have to do with making companies look more
profitable than they are. Over count revenues and under count costs and
profits on the bottom line will look bigger. This excites investors, if
they aren't paying close attention. Investors buy the company's stock,
which pushes up its price. The stock and stock options owned by the company's
managers become more valuable.
This works as long as financial statements are credible. If they aren't,
then investors won't buy, and the stock's value will fall.
The market will take care of some of this. Coca-Cola has tightened its
accounting standards on its own, because it wants people to trust its
earnings statements. Tighter accounting means lower reported profits,
but this is offset by greater trust in the numbers. That could increase
Coke's stock price.
After a point, though, tighter accounting standards could reduce reported
profits enough to reduce stock prices. We probably can't expect the market
to enforce the best possible standards. That's where tougher regulation
and enforcement comes in.
Shrinking the bezzle is a painful process. It requires an increase in
distrust and that causes further reductions in stock values, withdrawal
of foreign funds from U.S. markets and decline in the value of the dollar.
Unlike 1929, though, the overall economy is in pretty good shape. So
far, the distrust hasn't kept people from buying houses and cars. Probably,
we'll manage to shrink the bezzle without too much damage to growth and
employment.
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