OBSERVER: "Enronitis" has spread through Wall Street like a virus. The collapse of the seventh-largest US corporation has damaged already-fragile investor confidence.
Enron was one of the US's largest and most respected companies just a year ago. One year on and financial shenanigans have confined it to the corporate dustbin, while its employees have lost their jobs and retirement savings. Investors' increasing risk-aversion has shaken the market and several stocks, including Athlone-based Elan, have declined in sympathy.
Yet "Enronitis" is nothing new - greed and excess run in tandem with a stock market boom. The cleansing of the excess is the bedrock upon which a new bull cycle is built.
Turn back the clock to the 1960s and the rise of the "conglomerates". Diversification was the new buzzword on Wall Street. High price/earning (p/e) multiples enabled aggressive companies to raise equity easily and capitalise on their lofty positions. Gulf & Western, ITT, Litton Industries, LTV Corporation and Textron were among investors' favourites.
Investors eagerly snapped up shares in the conglomerates, with the leading companies boasting a p/e of 30 times or more at their peak.
The conglomerates spelled trouble for regulators; the Securities and Exchange Commission called them "one of the very serious problems facing the American industrial capital structure".
They employed aggressive accounting techniques to report increases in earnings per share that were largely illusory. ITT was particularly aggressive in this respect, acquiring more than 100 companies during the decade to become the 11th-largest US corporation. A Congressional study subsequently found that its earnings between 1964 and 1968 would have been 40 per cent lower than reported if more conservative accounting techniques had been employed.
The music stopped in January 1968 when Litton Industries announced that second-quarter earnings would be substantially less than it had previously forecast. Its stock price halved within a month and by the following year its p/e multiple had fallen from a peak of 60 times to just 13 times.
The conglomerates fell from favour, losing almost half their value by early 1969 compared to a less than 10 per cent drop for the overall market. The final death knell came the following June when the supposedly unshakeable Penn Central suddenly collapsed.
The stock market went into a tailspin following the bankruptcy but rallied almost 32 per cent in the following 12 months as a new bull cycle emerged.
Ten years later and the 1980s saw the emergence of the hostile takeover and the birth of the leveraged buyout (LBO). Almost half of all major US corporations received a takeover bid during the "decade of greed".
Michael Milken was the undisputed king of the "junk" bond and his firm, Drexel Burnham Lambert, dominated the market.
Drexel had stakes in more than 150 companies by 1986. Milken earned a bonus of $550 million that year, making him the highest-paid individual in US history.
The collapse of the United Airlines transaction in 1989 brought the deal craze to a close. The quality of deals had steadily deteriorated as the decade progressed. Roughly one-third of the LBOs that were completed after 1985 subsequently defaulted.
Milken, once touted as the modern JP Morgan, had been implicated in the Ivan Boesky insider-trading scandal and was by now the most reviled individual in the US.
Drexel closed its doors in February 1990 and by the time Milken was sentenced to 10 years' imprisonment in November the benefits of the decade-long restructuring had become evident and a new bull cycle was under way.
Few events in modern financial history match the scandal involving the Bank of Commerce & Credit International (BCCI). BCCI was set up in 1972 with backing from the Royal House of Abu Dhabi and other Middle Eastern investors. Its growth was phenomenal and by the mid-1980s it was operating from 73 countries with assets of around $22 billion.
Although there was some knowledge of BCCI's unscrupulous activities long before the scandal broke, no decisive action was taken. Just two weeks after the completion of the confidential Sandstorm Report in June 1991, which documented evidence of massive fraud, BCCI's operations were shut down.
Investigation following its closure exposed a host of criminal activities, including money-laundering, bribery of government officials, arms trafficking, the sale of nuclear technologies, support of terrorism, tax-evasion, smuggling operations and huge financial fraud.
Financial history is strewn with examples of what happens when risk strategies turn to speculation and greed.
Recent examples include the collapse of the US savings and loans industry, Maxwell's Mirror Group, Barings Bank and more recently Long Term Capital Management. Enron is just the latest on a long list. The propensity to overstep the confines of law runs parallel to the propensity to speculate during a stock market boom.
The inevitable downturn encourages more to cross the line in a desperate survival bid. This process is as old as the capital markets. Bear markets expose and purge the excesses that accumulate during booms. It is this cleansing process that paves the way for a new bull cycle.
Noel O'Halloran is chief investment officer, KBC Asset Management
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