The following op-ed written by Professor Jon Hanson, “In crisis, beware illusion of reform,” was published in the October 2, 2008, edition of the Providence Journal.
In case you missed it, global financial markets have been rocked by a series of unsettling events. The collapse of Lehman Brothers and the $700 billion government bailout package are only the latest in a string of shocks — a string that, if investors’ worst fears are realized, represents the beginning of a much more dramatic unraveling of the global financial fabric.
Seven years ago, American markets were in similar turmoil. Such companies as Enron were using “aggressive accounting,” “special-purpose entities” and other balance-sheet tricks to hide risks and represent themselves as healthier than they were.
The accounting scandals of the early 2000s and the reform that followed have much to teach us about our approach to the current crisis. Then, as now, the problem stemmed from convoluted financial instruments that few people could disentangle. Then, as now, corporate behemoths that had seemed invincible came crumbling down (Enron was the biggest bankruptcy in history until WorldCom, which was the biggest bankruptcy in history until Lehman Brothers).
Then, as now, virtually everyone agreed that a big part of the solution was to be found in some sort of additional regulation. Today, Barack Obama calls for “regulatory reform,” while John McCain (a long-term proponent of deregulation) has called for “comprehensive regulations that will apply the rules and enforce them to the full.”
It was that sort of regulatory impulse that, in Enron’s aftermath, gave us the Public Company Accounting Oversight Board and the Sarbanes-Oxley Act of 2002 (“SOX”), which President Bush called the most far-reaching overhaul of America’s business practices since the Great Depression.
Sure sounded promising. The latest bailouts and scandals will no doubt lead to similar reforms, some of which are already in the works. An important question, then, is what those reforms should be — a topic that will occupy many scholars, policymakers and commentators in the upcoming months.
Unfortunately, there is a good chance that those reforms will not have much long-term effect. The real risk is that we get the illusion of reform, not meaningful, substantive and lasting reform. Calls for change come loudly when a crisis rears its head. Inevitably, however, the fervor fades, as workaday duties, dentist appointments, American Idol and the pennant races distract the public and, in turn, policymakers.
While the rest of us turn to other matters, the regulated entities themselves will maintain a steady focus on one question: existing regulations and how to weaken them.
In the aftermath of Enron and WorldCom, corporations, to maintain their legitimacy, initially expressed outrage and wholeheartedly supported new regulations. Members of the Business Roundtable were “appalled, angered and, finally, alarmed” about the problem. President Bush was right, in their view, to berate the bad-apple business executives and to call for more rigorous regulatory standards for all. “We must and will be at the forefront of supporting these reforms,” the Roundtable concluded.
Riding the wave of that consensus, lawmakers took a series of steps, patted themselves on the back, and moved onto other matters, and we all assumed the problem was solved. With that, what had been implicit resistance turned to explicit pressure from the business community to minimize and undo the “reform.”
Consequently, the post-Enron reforms never lived up to the post-Enron rhetoric, and the regulatory teeth that Sarbanes-Oxley initially flashed have been blunted by pro-business revisions. Some provisions never made it into SOX, such as a requirement that lawyers report to the Securities and Exchange Commission if a company’s board failed to respond to warnings about misconduct.
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