We’ve all been amused by former Enron Chief Executive Ken Lay trying to present himself as a regular guy who did not understand technology and did not understand finance. The court didn’t believe him and has sent him to prison.
But the collapse of Enron and of Worldcom should make us wonder what we are paying stock market analysts and traders to do all day. Well functioning financial markets are hugely important. We need to channel capital efficiently to the most profitable businesses, to enable them to invest and grow. That benefits all of us, as customers of those goods and services, and it is good for everyone with savings and pensions. I thought the reason we pay huge salaries to people who work in financial services – such as traders and analysts, some of whom are earning several million dollars a year – was that they are very good at doing this. The story is that they understand the market, they understand the numbers, they understand each firm – how it is managed, its strategy, its customers, and its prospects – and they invest our money wisely to earn the best return. If they do all this well, then I for one do not begrudge them large salaries, big houses and lavish lifestyles.
But the Enron and Worldcom scandals tell us that none of these people can tell the difference between a company with sound business, and a financial house of cards. For example, in July 2001, Ronald Barone, a "natural gas/energy convergence" analyst with UBS Warburg in New York – now a managing director at S&P (!) – lowered his price target for Enron from $102 to $70. (Of course, the company turned out to be worthless.) My friends from the City tell me they are not to blame: the accounts were falsified, the auditors were not doing their job. This is true, of course. But if analysts and traders are merely reading the accounts and investing our money on the basis of what they see there, then we don’t need to pay them all that money for their alleged expertise. Any fool can read the annual accounts and invest in the companies making the biggest profit. We pay these people for their insights over and above what we can all see in the accounts, for their intimate understanding of the markets and businesses in which they invest. Their excuses are no more credible than Ken Lay’s defence: if they don’t know about the businesses, what on earth are we paying them for? If all it cost us was the astronomical salaries we pay them, then perhaps it might not matter much. But hundreds of thousands of people have lost a lot of money – in some cases, their entire savings or pension – because of the incompetence of the people paid handsomely to make sure that our savings are invested well. It is like a newspaper paying an expensive wine critic, and then finding that in a blind tasting, the critic can’t tell the difference between red wine and white wine.
I have little sympathy for Ken Lay: he is a conman who made himself rich at our expense. But in my view, the real scandal is the tens of thousands of people in the financial services industry creaming off a very nice living from our savings, on the pretense that they are making subtle, finely-tuned decisions about the value of different businesses, when the reality is that they cannot tell the difference between a company with a sound, profitable future and a company that has no customers, no revenues, no profits, and no prospects.