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Could Capitalists Actually Bring Down Capitalist?

By: Kurt Eichenwald
New York Times, June 30, 2002

OVER the last few centuries, capitalism has been the heartiest contender in the global bout for economic supremacy. It emerged from its decades-long death match with communism as the unquestioned victor. Its dust-up with socialism barely lasted a few rounds. It flourished in wartime, and survived wrongheaded assaults from embargoes and tariffs. Even terrorism aimed at capitalism's heart failed to deliver a knock-out punch.

But now, a staggering rush of corporate debacles is raising a disturbing question: can capitalism survive the capitalists themselves?

The scandals that have oozed out of corporate America with alarming regularity in recent months have repeatedly featured executives betraying the marketplace for their own short-term self-interest. From Enron to Global Crossing, Adelphia to WorldCom, the details differ but the stories boil down to the same theme: the companies lied about their performance, and investors paid the price.

To those inured to corporate wrongdoing — perhaps by the insider trading scandals or the savings and loan debacle of recent decades — the latest scourge of white-collar malfeasance might seem like more of the same, with greedy executives cutting corners to make a profit. But in truth, the corporate calamities of the new millennium are of a different ilk, one that challenges the credibility of the financial reporting system, and in turn the faith of investors in the capital markets — the very engine that has driven capitalism to its success.

It wasn't supposed to be like this. In the wake of the stock market crash in 1929 and the ensuing revelation of the scams and rigged dealings that had helped inflate the market, America faced what appeared to be capitalism's chief vulnerability. Through Senate hearings in the early 1930's with the special counsel Ferdinand Pecora, investors learned about stock price manipulation, insider trading and profiteering through so-called investment trusts, all of which had made fortunes for the capitalists, while costing investors their savings.

How did it happen? Capitalism, at its most basic, dictates that the company producing the best product at the lowest price wins. For capitalists, victory is measured solely in profits. Left to their own devices, it was clear, some capitalists would aggressively pursue profits even if it meant cheating the investors who provided all the capital.

So, the game stayed the same, but the government put in referees. Congress passed the Securities Exchange Act of 1933 and 1934, and created a new federal agency, the Securities and Exchange Commission, to enforce those laws. Disclosure became the centerpiece of the system. Companies could pretty much make whatever business decision they wanted, so long as the material information was revealed to investors in periodic filings with the S.E.C.

The result was an entire bulwark of protections: the board of directors entrusted with overseeing corporate managements, the independent accounting firms relied upon to insure the numbers were accurate, the government regulators in place to supervise the rules.

Despite all the apparent bricks and mortar of these protections, they turned out to be as permanent and impenetrable as smoke. At bottom, the system still relied on faith — just in someone besides the top executives or company owners. The trust was given to the competence of the directors, the integrity of the accountants and the abilities of regulators.

That was evident back in 1933, when a member of Congress asked Col. A. H. Carter, senior partner of Deloitte Haskins & Sells: if accountants would be auditing the companies, who would be auditing the accountants? The reply was noble — and proved to be hollow. "Our conscience," Colonel Carter said.

By the late 90's, as is now becoming clear, that foundation of personal integrity had been eroded by easy profits. Eventually, driven by shareholder expectations and their own stock-option packages, some executives began hiding losses incurred in the faltering economy, manipulating the numbers they reported to investors.

The fact that their companies are, in all probability, bad apples among many, many honest corporations makes little difference. By being deceptive on their disclosures for short-term gain, these capitalists have led investors to question the reliability of all the reported data — and the reliability of the checks and balances instituted to keep the data valid. Not only has the accounting branch of the market been tarred by Arthur Anderson's enabling of Enron's schemes, but, from company to company, insular boards of directors, incompetent internal auditors and underfunded regulatory oversight have allowed the perception of stringent standards and protections to wither.
IT is not as if corporate cheating comes out of nowhere. History holds many tales of businessmen who begin breaking the rules in boom times, when rising stock prices literally give them a sense of invincibility. Then, as the markets turn — and they always turn — these men try to preserve their power and wealth with more wrongdoing. They keep believing that stock prices will rise and cover their misdeeds. They really seem to think they won't get caught.

This time, the crisis in investor confidence is becoming a primary policy issue for the leaders of the industrialized world — a world largely formed on the American model, and that the United States has insisted virtually everyone else follow, too.

"It's a preoccupation of all the leaders that this is creating at this time a lack of confidence in the markets, and people are not sure about the way that information is transmitted to the public," Jean Chrйtien, the prime minister of Canada, said on the first day of a summit of the Group of Eight leading industrialized nations.

Workers are going to take it on the chin. WorldCom started laying off 17,000 people on Friday. Many more people, at many other companies, are worried.

And investors — shaken by the past and uncertain where the next disaster might emerge — are moving their money about, dumping many stocks and moving cash into safer havens, like Treasury bonds.

Could the short-term, self-rewarding mentality of a handful of capitalists truly destroy capitalism? Bring on hundreds of bankruptcies, force banks under, end the giving of loans? Destroy America as we know it?

Not very likely. The system has a built-in corrective factor, which kicks in when abuses go too far. Harm to investor confidence harms the market, which harms the ability of corporations to raise the capital they need to grow and be profitable. Eventually, the capitalists' desire get investor confidence back wins the day.

Already, after years of sniffing at naysayers who wagged fingers about fundamentals, investors seem to be discovering a new affection for stodgy old stock analysis. "Nobody was paying attention to seemingly boring topics like accounting and corporate governance," said Troy Paredes, an associate professor at Washington University School of Law. "People are realizing that those are the things that matter."

At the same time, a range of proposals has emerged from Wall Street and Washington to overhaul corporate America. The S.E.C. is making moves to get tough on accounting standards. But still, there are some capitalists who are keeping their eyes on their short-term prize, betting that, despite all the evidence of corporate lies, investors need no substantial changes to justify keeping their confidence in the market. Many Wall Street firms are lobbying to cut back the power and authority of state securities regulators, the very individuals who historically have been particularly hard-nosed in their dedication to proper disclosure and investor protection.

Meanwhile, accounting firms are doing their all to beat back efforts to strengthen their regulation. On Capitol Hill, there were rumors that tough accounting legislation was dead — until WorldCom exploded.

ULTIMATELY, capitalism will almost certainly survive this onslaught from the capitalists — if only because survival is the most profitable outcome for all involved. Investors may well emerge wiser, less willing to jump into the latest fad and more concerned about the fundamentals. In the end, though, the experts say, that will only last as long as the memory of this period, which will wash away the next time unbridled exuberance creates a booming market.

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