The 'Perfect Storm' and a sea of dirt

On 2 December 2001, Enron collapsed and, ever since, the reverberations have been felt from Wall Street to your street. Some have paid for their own misconduct, others are on a warning. One man, though, continues to lead a charmed life

Capitalism needs catastrophes to keep it sweet. All the experience of the market economy shows there will be periodic excesses that have to be corrected but can only be corrected by a disaster.

It would be great if banks were able to avoid lending to companies or countries that go bust, but at the height of a boom they tend to make mistakes. It would be great if investors in shares were able to stand back during a boom and ponder whether the shares were really worth the price.

But it is the nature of markets, and indeed of human- kind, to be overly optimistic and sloppy in times of boom – and to be correspondingly pessimistic and pernickety in times of slump.

The collapse of Enron is the best example – the perfect example, indeed – of both the excesses of the last boom and the response to those excesses. In the US they are calling Enron's collapse the "Perfect Storm" because of its devastating but cleansing effect. It has been as much of a jolt to corporate America as the demise of the Maxwell empire was to Britain 11 years ago.

What went wrong? Well, at least three things. The first was a failure of corporate morality. Enron grew from being a medium-sized oil pipeline operator into a global giant in energy trading. Much of its new business was sound enough; there was a need for intermediaries to carry out that function. But when growth and profits faltered, the corporate management basically cooked the books.

That led to the second failure: the auditors allowed all sorts of dubious accounting practices to pass unchecked, so that the company's accounts in effect concealed the damage that had occurred. When the pretence could no longer be kept up, the accounts had to be rewritten and the company folded.

But the management, and its auditors, would not have been allowed to carry on for so long had they not had the active support of the investment banking community. Supposedly independent analysts puffed Enron shares while their colleagues on the other side of the business were raising new funds for the company or supporting it in takeovers and mergers. This was the third failure.

Now, a year later, all three failures are in the process of being corrected. Enron is in Chapter 11 bankruptcy and its auditor, Andersen, is history – the capital punishment of the capitalism system. That in itself will have a profound effect on the way executives both in companies and accoun- tancy firms behave in future.

More than this, the various devices used by Enron to conceal what was really happening – in particular creating private companies that took liabilities off its books – have been outlawed. Com-pany officers in the US have now, in the face of criminal penalties, to testify that the accounts are correct – something one might reasonably have assumed they should have been required to do before. And the culture of corporate morality will be changed by all this; having to admit that past accounts have been wrong is not acceptable.

The arrangements for accountants are also being changed. The final outcome is not yet clear but it looks as though European and in particular UK-style accounting, which is more rigorous than that practised in the US, will be adopted. And some degree of separation between auditing and consultancy will be introduced.

Finally, there will be changes in investment banking. Again the final outcome is not clear, but several investment banks in the US have had to pay fines for misleading research. There may be a more formal separation between research and corporate finance, but even without that, the investment banks know they will have to be seen to be more independent.

Will all this make a difference? Yes, for a while. Killing one of the largest companies in the US and one of the biggest accountants in the world has had a huge impact. Humiliating the investment banks will force change too. So capitalism will be sweeter ... until the next storm breaks.