Enronitis and other ills - TheStreet

"How corrupt is Wall Street?" asks the latest cover of the magazine BusinessWeek. When the leading business magazine in the U.S. puts the questions so bluntly, it is clear something fundamental is changing in America¿s relationship with its financial markets.

And we are willing to offer a short answer: very.

First of all, where there is other people's money, there is always corruption because the temptation is great.

Secondly, and perhaps more importantly, in Wall Street's five-year boom most of the industry went mad, and the entities charged with supervision ¿ accountants, the SEC, Congress, directors, the press and investors themselves ¿ generally preferred to ignore all the writing that was on the wall.

The most prominent expression of the corruption that spread on Wall Street is Enron: a company that raised billions, backed by most major investment banks, faked its financials with the help of its accountants and went in less than a year from one of the financial markets most "successful" companies, into bankruptcy.

But Enronitis is not the only chronic disease that ails Wall Street; there is a whole string of other ills that increase the risk of investing on U.S. financial markets and that will continue to accompany us in the years to come.

E*Trade-it is The Internet brokerage's CEO, Christos Cotsakos, announced over the weekend that, following investor criticism of his 2001 salary, he plans to return $21 million to the company.

How much is left after you return $21 million? No small sum ¿ Cotakos compensation last year cost the company $77 million, which the company explained was slated to ¿keep him with the company¿.

E*Trade (NYSE:ET) is one of Wall Street¿s greatest success stories of recent years: Cotsakos brought the company in seven years from revenues of $70 million to %1.3 billion in 2001 ¿ even after the collapse of the Internet and financial markets.

But E*Trade¿s financials from the last five years indicate an interesting event: the company never had positive cash flow from operations, and all its activity was financed by funds raised through bond and share issues. In other words, what financed Cotsakos¿s wages was fundraising, not profits. The claim that Cotsakos must be compensated for the company¿s performance is groundless because as founder, he still holds 5% of shares.

Wall Street is full of companies like this ¿ companies in which there is no connection between executive compensation and company performance, huge salaries that insured that, even if the company crashed and burned, the executives, their children their grandchildren, and their great-grandchildren would not have to work a day in their lives.

Worldcomitis: Two years ago, Worldcom (Nasdaq: WCOM) was synonymous with the impressive results an aggressive communications company could achieve. CEO Bernard Ebbers was considered a management genius. Today, the second largest long distance carrier in the U.S. is on the verge of bankruptcy.

Worldcom suffers from many ills, with suspicions raised recently of Enronitis, fake financials, but the most serious illness is the $30 billion in debt the company took on in halcyon days.

The debt disease may be the worst on Wall Street right now. In the boom yeas, public companies took huge loans under the finance theory ¿ the more debt the better. The increased debt allowed the companies to grow quickly and increase profits, but led to more and more risk in the even of managerial failure or a turn for the worse of the market.

Executives had a vested interest in increasing the risk to which the companies were exposed as most companies suffered from E*Trade-it is: executives received huge salaries as long as the companies grew, and since it wasn¿t their money, they had an interest in raising the stakes. If the bet paid off, they got huge salaries; if the risk came to pass and the companies collapsed, it wasn¿t their problem but that of the shareholders and creditors.

In the case of Worldcom, the combination of E*Trade-it is and Worldcomitis reached outlandish heights as we recently learned the company lent its founder a quarter of a billion dollars to save him from bankruptcy after he mortgaged his shares in the company for his personal investments in ventures like a Canadian cattle farm.

Cisco-it is: The revered equipment giant Cisco (Nasdaq: CSCO) suffered from a number of ills in Wall Street's boom days which became evident in last year's huge inventory write-offs. But Cisco is a relatively healthy company and, in its case, it is not the company that is ailing, but the stock.

We mean share price: Even after the fall of Wall Street and investors sobered up regarding the Internet, Cisco still trades at $110 billion, five times annual revenue and 100 times profits, despite the fact that the company isn¿t growing. Cisco is an excellent company but with a market cap like that it would have to show rare performance, unlikely in the current economic climate.

And this may in fact be Wall Street's greatest ill: investors fleeing companies that disappointed or even cheated, race to companies that are still profitable. The result is many companies that don't suffer from Enronitis, E*Trade-it is, or Worldcomitis, suffer from Cisco-itis ¿ their shares are simply too pricey.