The human nature constraint - Part II

In Part I of this article, we familiarised ourselves with the neo-liberal and government intervention debate, and the term “principal-agent problems”.

These set the context for some case study analyses of Enron Corporation, Lehman Brothers and Greece. The objectives here are to:

1. Identify the key human nature issues at the root of each collapse

2. Account for how the issues were resolved

3. Deem whether the resolutions were sufficient

Our findings will not uncover anything new about the cases. However, they will highlight recurring deficiencies in the process of resolution, particularly with respect to prosecution. We will conclude by answering the question, “What should be our leaders’ number one priority?”

Enron Corporation

Background

Enron was birthed out of the merger of Houston Natural Gas and InterNorth in 1985, to create an organisation with the second largest natural gas pipeline system in the USA. In 1989 the company began to successfully trade natural gas commodities on the deregulated market. Shortly after, operations were diversified into other tradable areas, under the stewardship of a team headed by Mr Jeffery Skillings. However, several years into the business, things began to turn sour. Exorbitant losses were experienced due to poor trading decisions, based on huge speculations (ie buying and selling based on the expected future value of a commodity rather than its current value).

Unfortunately, instead of reeling in operations at this point, the executives opted to employ “cover-up” tactics and in cohort with their auditors, used complex accounting strategies to dissolve debts and inflated earnings. The result was an elaborate and ingenious scam that scandalised the world.

In 2001, after 15 years of existence, Enron plummeted from the position of seventh largest US company to bankrupt.

“Enron left behind $31.8billion of debts, its shares became worthless, and 21,000 workers around the world lost their jobs.” (BBC News, July 5 2006)

Key Human Nature Issues

The Enron case is riddled with regulatory deficiencies, however, for the purpose of this study, we identified six main human nature issues at its core, namely, greed, recklessness, fraud, conspiracy, insider trading (ie buying or selling of shares based on company information that has not been made public) and lying. Fifteen individuals were identified as key players in the scandal.

Resolution

Possibly the most disturbing outcome of the Enron scandal is the failed legal process, which to this day still continues, due to appeals. It is undeniable that the justice system was incapable of bringing about a just conclusion to the matter. Therefore, aside from Mr Skillings, who is currently serving a 24-year sentence due to end in 2030, the surviving culprits more or less got off with a slap on the wrist, and well lined pockets.

Nonetheless, on the regulatory front, the Sarbanes-Oxley Act of 2002 was passed on July 30, 2002. This act improved the required standards for accountability and responsibility for all US public company boards, management and public accounting firms.

The act was touted as the safeguard against future scams of such magnitude, and the world temporarily breathed a sigh of relief…until it dawned that nothing had effectively changed.

Lehman Brothers

Background

Lehman Brothers was founded by two German brothers, Emanuel and Mayer, in 1850. It functioned successfully, growing to be the fourth-largest US investment bank at the time of its collapse, on September 15 2008, with 25,000 employees worldwide…bigger than Enron! The trigger for Lehman’s undoing was the collapse of the subprime mortgage market, in which billions had been invested.

At its core, Lehman’s investment activities were no different to Enron’s, except they gambled with housing prices rather than oil prices. Investments performed extremely well until the housing market began to totter. Naturally, this is when the cover-ups started. According to reports, an accounting manoeuvre was used where short-term loans to Lehman were recorded as sales, and the cash “earned” was used to the company debts, just until financial reports were published. After publication, the company borrowed to repay the loan, thus returning to the initial indebted state. This repurchase agreement was classified as a Repo 105. Once again, auditors were aware of the shady transactions, but remained silent. This marked the very risks that led to the bank’s demise.

Key Human Nature Issues

The grand Sarbanes-Oxley Act had failed to regulate the greed, recklessness, fraud, conspiracy, insider trading and lying.

Resolution

This time around, the attempt to prosecute executives at Lehman Brothers was even more unsuccessful than in the case of Enron, even though there were clear breaches of the Act. According to an ex-official of the FBI Justice Department, David Cardona, it is too difficult to hold executives criminally accountable and therefore, regulators should be responsible for bringing financial wrongdoing to account, via civil cases. Unfortunately, civil cases are futile for offences of this stature, as even when successful, they amount to no more than a slap on the wrist.

On the regulatory front, in response to the collapse, once again stricter rules were implemented by the Federal Reserve. The latest proposal is that “Banks with more than $50billion in assets will have to increase the minimum amount of cash they hold” (BBC, 21 December, 2011).

Greece

Background

Greece joined the Euro in January, 2001, as one of the least developed economies, having lied about its government deficit. This move opened the door to a huge inflow of foreign capital. For about seven years, things appeared to be going well for Greece, with an annual GDP growth rate averaging 4.2% (International Monetary Fund (IMF), they were an EU success story. However, all was not as it seemed, the government used this time of plenty to rack up unsustainable public debts, which moved from 141 billion Euros in 2000 to 329.4 billion Euros in 2010. Successive governments hid these debts from the EU and Greek citizens through special arrangements with foreign bankers.

When the financial crisis hit Europe, the entire plot unravelled at its seams. Almost overnight, Greece found itself on the brink of default. An almost unbelievable reality for citizens, and much of the world. The government had effectively pushed the economy off a financial precipice.

Key Human Nature Issues

Once again, everything boils down to the now all too familiar issues of greed, recklessness, fraud, conspiracy and lying.

Resolution

The Eurozone agreed to a $155billion bailout package that holds Greece to certain criteria. However, the falsification issue was largely ignored.

Conclusion

As previously stated, these analyses are not intended to reveal anything new about the cases. However, they underscore a key area that must be addressed. It is becoming more and more apparent that regulation without an effective justice system is impotent. Good governance has its foundation in justness and justice.

The two cannot be separated. In Part III of this series, we will discuss excerpts from the High Sheriff’s Lecture on 13th October, 2011, in Leeds, UK entitled “Justice in a Time of Economic Crisis and in the Age of the Internet”…Stay tuned! For further information visit www.consultinginterface.com or visit our Facebook Page.