Unexpected resilience in face of unexpected events

Geneva, 8 July (Chakravarthi Raghavan) - The global economy has shown unexpected resilience in the face of unexpected events that came on top of the global economic slowdown, but the world economy is on a lower expansionary path, and still faces considerable risks and uncertainties, according to the Bank for International Settlements.

The unexpected events it focuses on are the effects of the 11 September terrorist attacks in New York, the Enron affair as well as the Argentine crisis and its effects.

Referring to the Enron affair and the risks posed by it, the BIS points to the “already too evident erosion of trust” in both market information and people, and arising from the Enron case “a growing distrust, not just of innovative accounting at other firms, but accounting conventions themselves.”

The Enron developments have also called into serious question the professional competence and ethical standards of many people in positions of great responsibility. A whole host of internal and external levels of government failed, and conflicts of interest played a role at each level - with the common thread of the all too human reluctance to ask the right questions when the going was good, the BIS adds.

While pointing to conflicts of interest and failures of layers of governance, and the range of issues receiving close attention, with a “whole host of competing solutions” already proposed, the BIS says that the “markets seem to be self-correcting in many areas” and hence advices taking regulatory actions “after due reflection” - a kind of advice that has led in the past, and would in the future too, into cosmetic changes.

Though the BIS report speaks of problems of Enron and “a host of other corporations”, by talking of it as an Enron problem or development, it unintentionally helps in hiding the basic problems facing the current corporate globalization models and the ‘democratic governance’ in countries.

The other corporations that have been figuring in media reports include several dotcom and telecom companies, Dynergy, Adelphia, WorldCom, Haliburton, and several other ‘energy trading’ corporations, Wall Street firms like Merryl Lynch and many others.

In the Enron affair, except for the ‘conviction’ of Andersen as a corporation (and several US jurists have raised questions about the conviction itself), not one person at Enron or Andersen have been brought to book or even taken before a grand jury.

The New York Times columnist Mr. Paul Krugman has pointed out that each one of these corporations have followed a different strategy for “executive self-dealing.” In a column on 28 June, Krugman explains the different strategies of Enron, Dynergy, Adelphia, WorldCom and the ‘menus of mischief’ unveiled in them. US media reports have also brought up questions about Mr. Bush (before he ran for Texas Governor) and the SEC (when his father was in the White House) not taking any actions about late filings or possible insider trading; about Haliburton (a corporation headed by Vice-President Dick Cheney before running for elections) and several other personalities, including the present SEC chairman and his former law firm.

There are many in the administration at high cabinet level posts that benefited from Enron.

The ‘revolving door’ for high personalities and policy-level officials in governments, legislatures and corporations in the industrialized world has raised major issues.

In the continent too, other types of shenanigans are showing up.

And leisurely processes of reflection and measures to avoid future problems are unlikely to be able to restore the confidence of the public or the ordinary investors.

The problems unveiled have nothing to do with theories of free trade and free market, but involve the interests of a nexus of giant corporations (and all the appurtenances of governance of each), legislators and government policy makers, the judicial processes and law enforcement and international institutions promoting these interests. These have resulted in alienation of voters in democratic electoral processes and social conflicts and breakdowns.

Referring to the wide-ranging set of implications for financial markets, arising from the failure of corporate governance at Enron and at a host of other firms, BIS says that one lesson, but not new, is that high levels of leverage are dangerous, and easily disguised. These would have been easily ascertained if the right questions, though involving hard work, had been asked. But none were. A second one relates to conflicts of interest that can seriously erode the process of corporate governance.

There were many layers of governance and in virtually every case a conflict of interest can now be identified. These conflicts involving the behaviour of management, the board, internal auditors, external auditors, lenders, institutional shareholders, security analysts and rating agencies are currently receiving close attention, and a whole host of competing solutions have already been proposed. Meanwhile, markets seem to be self-correcting in many areas and in the light of this, decisions as to the regulatory actions required should only be taken after due reflection. Defining a proper set of incentives to induce appropriate behaviour is a subtle business indeed, and haste could easily lead to unforeseen consequences, says BIS.

On the Argentine crisis and the lessons to be learnt, the BIS report suggests consideration of a range of new incentive systems, for both debtors and creditors, that would lead to an earlier shared acceptance of the need for debt restructuring. Debtors would more easily face up to reality if the costs of doing so were less and the benefits more tangible.

While the main costs would seem to be litigation and a denial of access to credit markets in the future, recent experience showed these may not be so great in practice. The attractiveness of restructuring to debtors would be materially enhanced if the restructuring were to be accompanied by greater access to “new money”, and if it yielded material benefits in terms of future debt service. And creditors would be more willing to accede to an early restructuring if they could be convinced that it was truly necessary - as a result of an earlier realisation that their only practical choice would be between half a loaf and no bread. “Clearly, the potential for unlimited access to someone else’s resources impedes such a realisation,” says the BIS in a reference to past IMF-organised bail-outs, and in effect commending the IMF for making clear that huge funds for bail-outs would no longer be available.

Unfortunately, the BIS which has raised problems of conflicts of interest in corporate governance that cloud judgements, has not focussed on the conflicts of interest involved in the IMF and/or the World Bank as large creditors themselves, functioning as arbiters between creditors and debtors. Only an independent external panel, even one that creditors and debtors should agree on an ad hoc basis, could carry public weight. Without it, the system will be under strain, and at some point collapse.

As for the lessons from the terrorist attack of 11 September 2001 on the New York financial district, the BIS says that the principal lesson for the financial community relates to the operational risks when financial institutions, markets and infrastructure are highly concentrated geographically.  And when the firms involved are few in number, but account for a very high proportion of the global business, the risks of a massive, systemic shutdown are clearly compounded. However, it would not be easy to roll back the tendency towards concentration. But at the very least, firms must be forced to equip themselves with the redundant systems needed to ensure business continuity in a crisis; and contingency plans, including assured communications facilities, need to be put in place and regularly updated.

The plans should not assume that only individual firms might find themselves in crisis, but that a number of them might be affected simultaneously. All might need backup facilities to be able to communicate with each other in such circumstances. – SUNS5156

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