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THE LESSONS OF WORLDCOM



Published: Wed, July 24, 2002 @ 12:00 a.m.



Washington Post: In the post-Enron debate, anti-reformers argue that capitalism will self-correct. There is often a lot of truth to this notion: The best government response to corporate crises is frequently no response. But accounting reform is an exception. The case of WorldCom, the long-distance telecommunications company that announced history's biggest bankruptcy on Sunday, illustrates both halves of this argument. It shows why government should resist interventions it might find tempting, and at the same time why it should fix the accounting system.

The financial fallout from WorldCom is staggering. Its shareholders once owned a company worth about $120 billion; they are now left with a wreck worth virtually nothing. Banks and bondholders have $41 billion in loans to WorldCom; a large chunk of that capital will never be repaid. What's more, WorldCom's bankruptcy may prove infectious. If the firm uses court protection to wipe out its debts, it may emerge strong enough to push wobbly rivals into bankruptcy as well.

Faced with this meltdown, it's natural to wonder whether government should seek to stabilize the industry. After all, retirement funds are hurting, workers face layoffs, and customers worry about disruptions to their telephone service. Last week The Wall Street Journal reported that Michael Powell, the chairman of the Federal Communications Commission, might favor relaxing the rules on takeovers, so that solvent local phone companies could buy failing long-distance ones, putting them on a sounder footing. The FCC denies that Mr. Powell said this, but industry commentators assume the question is in play.

Local monopolists

It shouldn't be in play. The local phone companies have been kept out of most long-distance markets for the good reason that they are local monopolists. They should not be allowed to leverage that power base to beat out existing long-distance providers and stifle competition. Yes, keeping the local phone companies out will mean WorldCom's investors and creditors lose even more money, but that, unfortunately, is what happens when bubbles deflate. The government's priority must be to protect consumers by promoting the low prices and innovation that competition brings.

Which takes us to the second lesson taught by WorldCom. The tough message to investors -- that they must be prepared to lose their capital -- is fair or politically sustainable only if they invested their money on the basis of honest corporate accounts. WorldCom's accounts were spectacularly misleading: Nearly $4 billion in expenses were misreported, creating a huge overrepresentation of the firm's profits. Under these circumstances, investors have a right to feel outraged -- and entitled to compensation.

This does not change the case against letting a local phone company buy WorldCom. But it does show that the capitalist system -- which is based on letting savers risk their money and in some cases lose it -- cannot function if the savers are misled. Precisely because the anti-reformers are right that capitalism must be allowed to correct itself -- the bubble should be allowed to deflate without government's riding to the rescue.




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