During the past few weeks, the world has rendered a verdict on U.S.-style capitalism and the results are not pretty. Markets are plunging, the dollar is shedding value against major currencies and executives have been thrown to the lions. There is a crisis of confidence in U.S. business, and rightfully so. The productivity miracle of the 1990s — the longest economic expansion of the postwar era — now looks like a magician’s trick. And indeed, the revelations of the past few months show that many impressive gains were nothing more than accounting sleight of hand. Only firm action that restores integrity and credibility to businesses, and the markets that discipline them, will end the blood-letting.
The business scandals that have been revealed in recent weeks are both impressive and disturbing. The scale of the failures has been spectacular. Enron was once one of the largest corporations in the United States. WorldCom is one of the world’s largest telecommunications companies. Billions of dollars have disappeared; hundreds of millions have been siphoned off by executives. The spillover has hit solid, reputable companies: Any rumor or recalculation of profit sends a tremor through the markets.
According to one survey firm, over the past two weeks $17 billion has fled U.S. stock funds. Since its peak in 2000, the Nasdaq exchange has lost three-fourths of its value, the worst decline for a major stock average since the Depression. The Standard and Poor’s 500, a benchmark for the overall market, has fallen 40 percent over the same time. The dollar has breached parity with the euro and fallen against the yen to its lowest point since February 2001 and is now trading in the 115 yen range.
Former captains of commerce are now considered charlatans and worse. The sight of executives taking the Fifth Amendment before Congress, or claiming that they knew nothing of corporate misbehavior while pocketing tens of millions of dollars or more in salaries, is a sad spectacle. In testimony last week before the U.S. Congress, Federal Reserve Board Chairman Alan Greenspan condemned “an infectious greed [that] seemed to grip much of our business community.”
While the invisible hand of the market has been shown to be no match for the accountants’ sleight of hand, the flaws really reduce to failures in information flows. Accountants have done more to obscure corporate books on behalf of executives than they have to clarify them for investors. The permeable barriers between consulting and accounting practices have given the major firms conflicts of interest. It is difficult to enforce proper accounting practices when other members of the team are holding seminars on ways to beef up the bottom line.
Corporate boards, which in theory function as a check on management, have instead been lulled to sleep, confused by the trickery or complicit in the fraud. None of the options would seem to justify the hefty fees most directors pocket for their services. The brokerages are alleged to have inflated their recommendations to inflate their earnings during sales offerings. And finally, there is plain old insider trading and dealing. In simple terms, insiders have all sorts of information, while average investors, counting on the impartiality of the invisible hand, have been slapped.
Capitalism rests on the assumption that all traders are equal. Failure to ensure that all have the same access to information corrodes the very basis of the free market. The only way to fix this situation is to restore credibility to the markets. The imbalances have to be corrected and offenders must be punished. Unfortunately for the U.S., that is a tall order for the current administration. President George W. Bush took office promising an “MBA presidency.” Yet it is just that mentality that has created the current mess.
It does not help the administration when the president and vice president are accused of the same accounting manipulations and trading practices that are now under the spotlight. The claim that the allegations against Mr. Bush and Vice President Dick Cheney are merely partisan politics is probably true — the politicians making the accusations held diametrically opposed positions on the propriety of past behavior when Mr. Bill Clinton was president — but the questions about credibility remain unanswered.
Just as disturbing is the presence of Mr. Harvey Pitt in the role of chief enforcer in the fight against corporate excess. Mr. Pitt was formerly a lobbyist for the accounting industry, who fought many of the measures that now seem so necessary. He took over the chairmanship of the Securities and Exchange Commission, promising a more business-friendly SEC. Mr. Pitt argues that he knows what has to be done; his boss, Mr. Bush, says he has faith in his ability to get results. Today, all faith is in short supply — and that is the problem.
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