Posted on 07/02/2002 7:00:48 AM PDT by wallcrawlr
"In God We Trust," it says on the back of a dollar bill. That may be the only bit of trust left in the U.S. financial system.
Enron. Andersen. Tyco. Qwest. Global Crossing. Adelphia. Now WorldCom. Or should that be WorldCon? Where can anyone have any confidence in the probity of corporate America if a company's accounts aren't worth the paper they are printed on?
As Francis Fukuyama argues in Trust: The Social Virtues and the Creation of Prosperity, high levels of trust facilitate economic interaction and lower transaction costs, thus encouraging development of large-scale corporations which help a society compete in the global economy. Low trust entails higher transaction costs, as suspicious people protect themselves with negotiations, detailed contracts and lawyers. Development lags accordingly.
There is nothing inherently trustful about business. That is why there are rules. Accounting rules, corporate governance rules, antitrust rules, anti-corruption rules, rules of contract and property.
Capitalism couldn't work successfully without them. The system is based on everyone--investors, executives, consumers and employees--making informed decisions based on information they can trust. Fraud undermines capitalism just as much as theft by violence.
That is why companies have to file financial statements in standard formats that comply with generally accepted accounting principles. That is why stock exchanges require information that could affect a stock's price to be disclosed to all investors simultaneously. Insider trading is illegal for a reason.
But the system only works if the penalties outweigh the potential gains from breaking the rules. In the tech bubble years they simply didn't.
The numbers were so big, the enforcement so lax that the temptation became too great for too many top executives who started treating their companies like personal piggy banks. Help yourself to stock options. Keep the share price high to cash in. Keep the earnings growing to keep the stock price up. Just do what it takes to get the numbers to come out right. Smart accountants write accounting rules. So hire even smarter ones to get around them. And everyone was getting rich so it seemed no one cared.
Now, like Claude Rains in Casablanca, Americans from the president downwards are shocked, shocked, to find improper accounting was going on here.
The solution is straightforward. Sure, some already proposed technical changes would help: stronger auditing rules and a Glass-Steagal-like separation for accounting firms of auditing and consulting; tougher corporate governance rules to ensure the rotation of auditors and that non-executive directors act as the guardians of shareholders' interests--not as management's cronies. More radically: modify the purely rules-based accounting of the U.S. to include the principles-based accounting used elsewhere in the world.
But more important: Make the rules we do have stick and the penalties for breaking them effective deterrents.
Case in point: The SEC's lawyers and accountants have been investigating WorldCom for three months. Still, it took the company to 'fess up publicly to its accounting misdeeds for the agency to file charges.
The SEC's chairman, Harvey Pitt, himself a former Wall Street lawyer, is now writing to the chief executives and financial officers of America's 1,000 largest companies asking them to certify the accuracy of their company's financial accounts. If those accounts turn out to be false, top execs could end up in jail, he says.
If all CEOs were to face serious jail time for fraud if their accounts were bogus and were sure they had little chance of getting away with cooking the books, you'd find trust in the numbers and corporate America restored faster than you can spend that dollar bill.
A previous generation of white-collar crooks learned that lesson the hard way. The abuses of the junk bond era came to an end once the likes of Michael Milken were put behind bars. That lesson needs to be taught to a new generation.
" ... As Francis Fukuyama argues in Trust: The Social Virtues and the Creation of Prosperity, high levels of trust facilitate economic interaction and lower transaction costs ... "
High levels of trust, in commerce, are affected by a judicial system which is subject to the will of the people who determine what policies they desire and will be, and laws, through their duly elected representatives sitting in legislative bodies. Whereas the judges and lawyers are made to be constantly aware that their transgressions, their digressions, their wanderings lost in extra-Constitutional space ... are all to be cause for the people to exact punishment of such government agents as well as said acts to be swiftly extinguished by the people.
As Edmund Burke said, in his March 22, 1775 "Speech on Conciliation With America" ---
Permit me, Sir, to add another circumstance in our colonies, which contributes no mean part towards the growth and effect of this untractable spirit. I mean their education. In no country perhaps in the world is the law so general a study...This study renders men acute, inquisitive, dexterous, prompt in attack, ready in defence, full of resources. In other countries, the people, more simple and of a less mercurial cast, judge of an ill principle in government only by an actual grievance; here they anticipate the evil, and judge of the pressure of the grievance by the badness of the principle. They augur misgovernment at a distance; and snuff the approach of tyranny in every tainted breeze
[See Rick Gardiner's "The American Colonialists' Library: A Treasury of Primary Documents."]
Our judicial system is rough, but it has worked as long as government agents have had to fear for their jobs, they serve at the pleasure of the people.
This changes when in a "world" of "judge-made laws," the judges are more in practice, royalty; and then, trust swiftly evaporates, the people knowing well that peaceful settlement of their differences in commerce, can no longer be achieved.
Capitalism requires a judicial system which is subject to, and serves, the people; not just serves.
In the former Soviet Union, in Red China, in the mid-East, in Cuba, in Africa ... the economic improvements suffer because the judicial systems are not subject to the people.
Lawyers did not apparently inform these companies, nor these companies' other agents, that the constructions were improper and/or illegal and/or unlawful.
Lawyers, self-interested for the large pay from these companies, failed their oath, failed their impressions of integrity, and failed integrity.
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