>WILL ENRON PROVIDE A WAKE-UP CALL FOR A RETURN TO"OLD-TIME RELIGION"?
In times of booms, manias and bubbles, there is almost always a tendency to believe we are truly in a"new era" and thus the old rules are no longer valid. In this cycle, which ended in the"Bubble of 2000", it was felt that rapid technological change had created a"new paradigm" of productivity and profits and that the"old-time religion" standards (GAAP) no longer applied. The markets
were deregulated and earnings reports were freed up to be whatever a company and its accountants said they were. With no standards like GAAP (generally accepted accounting principles) companies shifted to so-called"operating earnings." Companies were then free to give stock options to high-priced employees instead of wages, and these options did not need to be counted as a
compensation expense (which, of course, they were). Companies took into earnings capital gains on stock investments, profitable real estate sales and over-funded pension plans (thanks to the boom in stock prices) without any need to say these might be non-recurring earnings. Money was borrowed, pushing corporate debt to record levels versus GDP, and then used to buy back shares of
stock to magically increase earnings per share. Mergers became vehicles to get huge tax write-offs. And companies were free to comb through any and all expenses to decide which ones might be unusual and thus leave out (write-off the expense) and report operating or pro forma earnings"AS IF" the actual expenses did not exist.
Why did all of these"abuses" of old-time religion standards occur? (1) Legitimately, in a time of rapid technological change, there is always some"creative destruction" and it is logical to want to write-off some assets as obsolete. (2) Stocks were simply too high to justify based upon GAAP earnings, so companies, analysts, and their accountants needed a way to goose earnings, and operating earnings with no standards allowed that. Some 500 companies used pro forma earnings reports in 1996, 1000 in 2000 and
1500 in 2001 (according to a report given at the Fed seminar in Jackson Hole). Now 2 + 2 can actually equal 7! (3) Nobody wanted to take away the punch bowl when everyone was having fun and making money. And thus conflicts of interest, like those between analysts and companies and companies and their accountants, got blurred when there was tons of money at stake. (4) Finally, after great experience with free markets in the 1980s and 1990s, nearly everyone loved corporations and Wall Street, and nearly everyone agreed that free markets were great and that more deregulation would be even greater. As to the last point, I do feel quite strongly that it is indeed freedom that has made this country great. But the Founding Fathers also blessed us with a Constitution based upon a series of checks and balances to guard against abuses of power. In that regard, hopefully, Enron has provided a wake-up call that we need conservative accounting standards -- not the current"trust me" standards.
Probably the most accurate picture of real world actual earnings is shown on chart E0621 below. It looks nothing like the earnings shown on Wall Street in 1997-2000.
I will be Lou Rukeyser's guest on Wall $treet Week this Friday night. Hopefully I will have a chance to make the case for some checks and balances to provide less polluted earnings reports.
Last week Big Mo was 53.9%, Big Mo's Tape was 52.8% bullish, and the Super-10 is +10. The evidence is mildly bullish.

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