Lessons from WorldCom-Greater Market Discipline Is Needed. (from Consumer Alert)
Smith, Frances B., Consumers' Research Magazine
Markets in the United States reeled, with the Dow Jones Industrial Average dropping below 9,000 in the opening hours of June 26, but rallying later to be virtually unchanged for the day. World markets also went into turmoil, with steep plunges in the U.K., Germany, and Japan. Not only telecommunications stocks, but banking and insurance stocks were hard hit over fears of their exposure to this and earlier crises.
With about $30 billion in debt, WorldCom is likely to find its ability to make its debt payments and to raise cash severely impaired, and the company may have no other option but declaring bankruptcy. Already WorldCom has announced that it would be laying off some 17,000 employees.
"Enrongate"--the discovery of Enron's complex maneuvers that involved shifting assets to newly created companies and Andersen's accounting irregularities--seemed to serve as a wake-up call to other corporations and their accounting firms. A series of large companies began to restate their earnings. Accounting firms reaffirmed their profession's ethics. Ratings agencies and investment banking firms talked about greater diligence in reviewing corporate balance sheets. The fallout from this heightened scrutiny has been more exposure of corporate corruption, which has undermined investor confidence.
Except for the stock market (and that's a big exception), other economic news in the United States has been better than expected. Consumer spending is still showing positive signs, and durable goods orders are up. Home buying is still very strong, in part stimulated by low mortgage rates, currently about 6.6%. Unemployment in May was 5.8%, with about 134.4 million people employed. The Federal Reserve at its meeting June 26 decided to leave rates unchanged. Consumer confidence was a bit lower in June with concern about employment, the stock market, and corporate shenanigans. The combination of a perking economy and a falling stock market doesn't usually happen.
While small investors usually wait and see instead of making abrupt changes, this latest example of corporate shell games adds to consumers' skepticism about the market and about corporate leadership. This latest blow to investor confidence--and likely consumer confidence--could have a broad impact. Coupled with uncertainty and worry about future terrorist attacks, how the corporate scandals are dealt with could affect the fragile economic recovery. Already, some politicians are calling for large-scale investigations and new regulations, and the Democrats have said they are considering using corporate crime as their campaign focus.
Yet the recent scandals can also provide a good illustration that markets do work and do discipline those companies and those individuals who, through fraud or ineptitude, fail. Some of those companies will declare bankruptcy, with some restructuring to scale back lines of business. Others will disappear or be taken over. Those corporate executives who committed fraud or other crimes will likely be discovered and should be punished under existing laws. …