Install

Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Is Enron Just The Tip of The Iceberg?

The outrage over Enron is beginning to yield movement. President George W. Bush has proposed a modest reform to pension rules. The auditing industry appears to be dropping its once intense hostility to restrictions on its consulting business. The Financial Accounting Standards Board is said to be rewriting the rules on the off-balance-sheet partnerships that were central to Enron's downfall. This movement is welcome, but it is only a start. The nation's audit system suffers from a long chain of weaknesses that has likely corrupted the financial statements of an unknowable number of firms. Enron is probably the tip of the iceberg.

Consider last week's bankruptcy of Global Crossing, which failed after betting too heavily on the demand for fiber-optic telecommunications. In order to lure investors into financing a $15 billion effort that ultimately failed, Global Crossing relied on a mixture of new-economy hype and accounting tricks that created the illusion of revenue. The firm apparently signed long-term contracts with customers, then booked the income stream immediately. Meanwhile, it took the opposite approach to the equipment needed to deliver on these contracts -- such capital costs, in contrast to the revenue, were pushed off into the future. Global Crossing also seems to have colluded with other telecom firms to inflate revenue by cross-selling to each other. If you sell me your hammer and I sell you mine, we both get to report income.

It would be one thing if Global Crossing were a rogue firm, breaking rules that would have worked perfectly well if only they had been observed properly. But the company does not seem to have broken rules.

If the audit rules had been stricter in the first place, Global Crossing might have had a harder time hyping its way to stock market stardom; the ensuing crash, in which many ordinary investors got burned, might also have been avoided. Indeed, the broader high-tech bubble, which was inflated with much help from aggressive bookkeeping, might also have been mitigated. Firms cooked their books to raise more capital than they could wisely use; the resulting bust was the prime cause of last year's recession. Even today, one of the chief threats to the recovery is that more Enron-style disasters will emerge.

The nation's audit system needs a thorough overhaul, not just hasty tweaking.

This comment appeared as an editorial in The Washington Post.