The stories of personal and collective losses resulting from recent corporate failures have been told many times. But any discussion of the crisis—especially one that proposes recommendations to prevent a similar crisis in the future—must at least recount in summary the widespread devastation.
Investors
Obviously, investors—individual and institutional—suffered enormous financial losses in portfolio value as the markets plunged. As of spring 2003, the Dow Jones Industrial Average had lost almost 37 percent, the Nasdaq about 75 percent, and the S&P 500 about 48 percent since their highs in first quarter 2000. It is difficult to separate the relative market declines attributable to a slowing of the economy, a loss of confidence in reported earnings, a loss of trust in corporate leaders, and a reassessment of historical growth rates that implicitly led investors to expect lower future growth rates. Most CEOs and directors find it less threatening to blame “the economy” than the governance-related causes of a declining market.
Some have argued that losses in real value were not that great because stock market valuations never should have been so high anyway. They say that wealth creation was not real and only temporary in the bubble so that losses were overstated. While this argument may be true in the aggregate, it is certainly not true for each individual who bought heavily in the late 1990s based on unrealistic forecasts of future growth and current earnings. It is cold comfort for investors who, based on paper profits, borrowed heavily to consume, only to see profits disappear rapidly while their debt now remains. This predicament will be exacerbated if interest rates rise as a result of increasing defaults or rising inflation.
Individual investors may have suffered more relative pain than institutional investors because they lack the experience, access to information, and ability to convert information to knowledge leading to the better decision-making capacity of their more sophisticated institutional counterparts. Not that access—at least to the information available—served institutional investors all that well. Many have written off billions in practically valueless stocks and bonds.
Access to the information available didn’t serve institutional investors all that well. Many have written off billions in practically valueless stocks and bonds.
Employees
Psychologists say that losing one’s job ranks in terms of human trauma with the death of a loved one. This trauma is magnified many times when pension assets, accumulated over many years of labor and thought to be protected, are wiped out by catastrophic governance lapses. More subtle, but perhaps just as devastating for employees retiring in the future, is the systematic underfunding of pension plans resulting from the need to bolster reported earnings. Finally, the loss of employer-paid health insurance has hurt many employees and put pressure on government to provide these entitlements, similar to the situation in Germany and other European countries.
Labor mobility—including movement due to layoffs and even bankruptcies—is a necessary part of the capitalist economic system. It allows labor resources to be shifted to businesses that are growing. Because there is a cost to society of this reallocation process (including lost productivity in transition, disincentives of unemployment insurance, human anguish, and the cost of rehiring employees when growth resumes), many have questioned companies that lay off large numbers of employees, or buy or sell companies only to meet short-term earnings targets. Of the thousands of employees laid off as a result of corporate failures, many have found themselves virtually pensionless and, in many cases, without even basic health care coverage.3 According to the New York Times of June 28, 2002, public pension funds had lost in excess of an estimated $1 billion in WorldCom stock alone and untold billions of dollars more in other beleaguered companies’ bonds and stocks.
The same New York Times article quotes Tom Herndon, executive director of the Florida State Board of Administration, which lost more than $400 million in WorldCom and Enron stock: “The time is over for the chief executive to sit in his multimillion-dollar mansion in Aspen and laugh at all the share holders who have lost their life savings. These people ought to be punished, and the institutional investors ought to be one of the parties to take up the cry.”
The Broader Fallout
In a free economy, the abuses or ultimate failure of a few or even one very large enterprise can have many secondary impacts. In economics, this is called the multiplier effect. For example, coordinated efforts by a handful of energy trading companies to inflate their revenue numbers may have contributed to power shortages and high energy prices in California, which in turn may have contributed to bankruptcy or harm to thousands of businesses. Doubtless there are other examples waiting to be discovered. Some have suggested that in the pharmaceutical industry, the time allotted to research and testing may have been shortened to get new drugs to market faster. If this is true, the consequences of focusing on short-term growth may become evident only over the long term.