Friday, November 23, 2007

Krugman - Enron All Over Again

New York Times columnist Paul Krugman sees real similarities between the Enron collapse and the subprime mortgage crisis now spreading through the US - bad executive management. In Enron's case, top management fudged the books and some went to jail for it. In the mortgage lending business it wasn't so much fraud as garden variety greed.

“What were they smoking?” asks the cover of the current issue of Fortune magazine. Underneath the headline are photos of recently deposed Wall Street titans, captioned with the staggering sums they managed to lose.

The answer, of course, is that they were high on the usual drug — greed. And they were encouraged to make socially destructive decisions by a system of executive compensation that should have been reformed after the Enron and WorldCom scandals, but wasn’t.
In a direct sense, the carnage on Wall Street is all about the great housing slump.


This slump was both predictable and predicted. “These days,” I wrote in August 2005, “Americans make a living selling each other houses, paid for with money borrowed from the Chinese. Somehow, that doesn’t seem like a sustainable lifestyle.” It wasn’t.


Krugman points out that the losses, upwards of $400-billion, aren't astronomic but they may cause such a loss of bank capital to force lending cuts of up to $2-trillion.

Around 25 years ago, American business — and the American political system — bought into the idea that greed is good. Executives are lavishly rewarded if the companies they run seem successful: last year the chief executives of Merrill and Citigroup were paid $48 million and $25.6 million, respectively.

But if the success turns out to have been an illusion — well, they still get to keep the money. Heads they win, tails we lose.

Not only is this grossly unfair, it encourages bad risk-taking, and sometimes fraud. If an executive can create the appearance of success, even for a couple of years, he will walk away immensely wealthy. Meanwhile, the subsequent revelation that appearances were deceiving is someone else’s problem.

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