Towards the precipice

Louis Proyect lnp3 at
Thu Jan 30 11:09:45 MST 2003

LRB | Vol. 25 No. 3 dated 6 February 2003

Towards the Precipice
Robert Brenner on the crisis in the US economy

At 6 a.m. on 12 June 2002, four FBI agents barged into the SoHo loft of 
Samuel Waksal, the former CEO of the biotech company ImClone Systems 
Inc, and led him away in handcuffs: he was charged with insider trading. 
His father and daughter had dumped nearly 175,000 ImClone shares only 
days before the Food and Drug Administration announced that it had 
rejected Erbitux, the compay's cancer drug, leading to a steep price 
fall. (Waksal himself had netted $57 million on an ImClone share deal 
the previous September, and had made an additional $72 million in 2001 
from his stock options.) On 25 July, John Rigas, the former head of 
Adelphia Communications, was arrested, along with his two sons, on 
corporate crime charges. They were accused of using the company 'as the 
Rigas family's personal piggy-bank', spending hundreds of millions of 
the corporation's dollars on private jets, personal loans, luxury 
condominiums in Colorado, Mexico and New York City - and on the 
construction of a $12.8 million golf course. On 12 September, Dennis 
Kozlowski, the former chief of Tyco International - and described by 
Business Week as 'perhaps the most aggressive dealmaker in corporate 
America' - was put under arrest, charged with fraudulently obtaining 
over $400 million by selling Tyco shares while concealing information 
from investors. Kozlowski had used the funds to buy a mansion in 
Florida, lavish properties in Boca Raton, Nantucket and New Hampshire, a 
$7 million apartment for his first wife, diamonds from Harry Winston and 
Tiffany's, and a fleet of fast cars and Harley Davidsons.

By August, the Wall Street Journal's list of more than two dozen major 
corporations subject to official investigation included such household 
names as AOL Time Warner, Bristol Meyers, Dynegy, Enron, Global 
Crossing, Kmart, Lucent Technologies, Merck, Qwest, Reliant Services, 
Rite Aid, Universal, Vivendi, WorldCom and Xerox. The two largest US 
banks, Citigroup and J.P. Morgan Chase, are also being investigated, as 
is Merrill Lynch. Meanwhile, the 'barons of bankruptcy', as the 
Financial Times describes them - corporate insiders from the biggest 25 
companies to go bust last year - reaped $3.3 billion from stock sales 
and compensation in the three years before their companies went under.

When corporate scandals first hit the headlines early in 2002, the US 
Treasury Secretary Paul O'Neill attributed them to the immorality of a 
'small number' of miscreants. Apparently he'd been misinformed. The 
rapacious practices of these executives and firms - whether or not 
technically illegal - are typical of, and endemic to, corporate America. 
The recent scandals bear witness, however, not just to the level of 
individual corruption characteristic of US crony capitalism but to 
systemic problems in the real economy. It is because the epidemic of 
fraud makes manifest the ill-health of the corporations themselves that 
it has taken such a heavy toll on investor confidence and the stock market.

The corporate account rigging now coming to light is the direct result 
of the economic boom of the late 1990s, driven by an almost 
unprecedented increase in equity prices. Its raison d'être has been 
entirely straightforward: to cover up the reality of an increasingly 
desperate corporate-profits picture. Between 1997 and 2000, just as the 
fabled economic expansion was reaching its apex, the rate of profit in 
the non-financial corporate sector was falling by a dramatic 20 per 
cent, initially as a consequence of overcapacity in international 
manufacturing. Under normal circumstances, this would have caused 
capital accumulation and economic growth to slow. As it was, however, 
stock prices soared, in information technology especially, even as 
corporate returns fell. Companies could thus access funds with 
unprecedented ease, either by issuing shares at highly inflated prices 
or by borrowing money from banks against the collateral of those 
overpriced equities. On the basis of this financial windfall, US 
corporations, especially in the IT industries, vastly stepped up their 
capital accumulation. The investment boom continued, with increasing 
growth of output and productivity. Even the staid academic economists of 
the Council of Economic Advisers, not to mention the chair of the 
Federal Reserve, celebrated a new synergy of technological change and 
freed-up financial markets that was ushering in an unprecedented era of 

The catch, of course, was that fast-rising profits are normally required 
to justify and support fast-rising stock prices, as well as rapid 
investment. Instead, as investment accelerated in the face of declining 
returns, overcapacity worsened, and the fall in profitability extended 
from manufacturing to major high-tech industries - above all, 
telecommunications. Faced with this patent failure of 'fundamentals', 
corporate executives were under mounting pressure to keep stock prices 
high by any means necessary, in order to maintain access to cheap 
finance and the investment funds required to compete; the fact that they 
had come to depend heavily on stock options for their own compensation 
naturally quickened the temptation. One after another great corporation 
falsified its accounts to exaggerate short-term earnings.


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