Goldman CEO on Enron effect

February 4, 2002: 5:22 p.m. ET

Paulson says initial backlash could be followed by more M&A activity.

NEW YORK (CNN/Money) - The crisis of confidence caused by the Enron debacle is one of the challenges the investment banking industry will face this year. But it ultimately could prove to be a benefit, the top executive of Goldman Sachs said Monday.

"We're all trying to get our heads above the battle smoke and look for the real meaning of Enron to put it in perspective," Henry Paulson, Goldman's chairman and CEO, said at the World Economic Forum, which wrapped up here Monday.

"We've all got to work to restore business confidence...but I believe that longer term we may look at Enron as being a positive as opposed to a negative," Paulson said. "It may lead to greater transparency."

The high-profile bankruptcy of the energy-trading firm and startling revelations about its accounting practices have created a ripple-effect on Wall Street and prompted everyone from ordinary investors to government officials to seriously question the way companies disclose their financial information.

At least 10 congressional committees have been charged with getting to the bottom of what happened at Enron, and the case has prompted more scrutiny on other companies' accounting practices as well.

Paulson said it is likely that the magnifying glass with which accounting practices are now being examined is likely to turn up "fraud, malfeasance, and a breakdown of all kinds of controls."

At the same time, he warned that there could be a regulatory backlash that may be overly harsh.

"I think the danger is to just look through that lens, to lose a sense of perspective and rush toward harsh regulations that are unnecessary," Paulson said. "Some regulation will be necessary, some changes in accounting rules."

Some market observers have noted recently that merger and acquisition activity, a key part of Goldman's (GS: down $2.90 to $82.50, Research, Estimates) business, could be hindered by all the attention on accounting irregularities as investors question the accuracy of the financial data and projections provided by the investment banking firms doing the deals.

Although that may be true in the short term, Paulson suggested that changing the accounting rules to give the public a clearer picture of companies' financial health could be a catalyst for M&A in the longer term.

"M&A activity is driven by fundamental restructuring, fundamental globalization, and it will pick up when there's more visibility in people's earnings," he said.

Goldman was the world leader of mergers and acquisitions in 2001, with business in excess of $575 billion.

Overall, Paulson said he expects 2002 to be "a tough year," primarily because of a slow return of M&A activity. He also said he expects the economy to continue to be weak, with only slow growth likely, but that the Federal Reserve will not be as aggressive in cutting interest rates as it was in 2001.

He said the industry also needs to change gears after speeding through the boom times of the late 1990s with blockbuster growth, riding the slipstream of a robust U.S. economy.

"I think all of us know that what we went through in the last half of the Nineties is not sustainable," Paulson said. "We're going to need to adjust ourselves to a period of more normal growth. How we think about managing our businesses in that environment is the tricky question we're all grappling with."