According to John Kenneth Galbraith, the economy will at any given moment contain a certain inventory of undiscovered fraud. This inventory (he called it the “bezzle”) rises and falls with the business cycle. When an economic shakeout brings specific cases before the public eye, politicians cry for “reform!” They are unfortunately less interested in corporate morality than in avoiding responsibility for the consequences of their own policies. They apply their skills in the redistribution of income to the redistribution of blame.
Consider the most recent turn of events. Alan Greenspan, whose easy-money policies helped inflate the stock market bubble that just popped, talks about “infectious greed” in corporate America. President Bush, whose tariff policies threaten our foreign trade, calls for more transparency in company reports. Congress, whose tax policies dam economic progress at its source, increases the penalties for corporate fraud. The Fed, the President, and the legislature, unable to agree about anything else, are unanimous in blaming dishonest CEOs and creative accountants for the volatility of share prices and by extension for the economic strains of 2002.
Prices in the stock market, though, are not set by CEOs, however dishonest, or accountants, however creative. Prices are set by investors, most of whom are not deceived by earnings reports simply because they never look at earnings reports. If investors cared about earnings, they would not have bid up the dot-coms, which never had any earnings. The Dow Jones Industrial Average does not change by a thousand points in a few days because millions of investors have suddenly become privy to new information about balance sheets.
There are admittedly a few investors who pay attention to the financials, but these are not taken off guard by later revelations. They have taken Accounting 101 and 102, and they read the footnotes in the annual reports. They understand the effect of options. They go over everything with a fine-toothed comb. They do not buy a stock until they know what they are getting into.
The behavior of such persons does not, however, have much impact on share prices. They are the ones who are buying when everyone else is rushing to sell, and selling when everyone else wants to buy. They are the oddballs and weirdoes from whose strange antics others politely turn their gaze. No one pays them any mind.
Most investors follow the crowd. If the price is rising, they buy: “It can only go higher.” If the price is falling, they sell: “I want to get out before it’s too late.” It is mob psychology. When panic reigns, even the professionals who manage mutual funds join the crowd, selling off their better holdings to meet redemption demands. In good markets, it is “infectious greed.” In bad markets, it is infectious fear.
In times of infectious greed, the members of the market mob congratulate themselves. In times of infectious fear, they look for someone to blame. This is where the government steps in. Understanding that investors who are given the time to think will soon turn an angry glance toward Washington, D. C., public officials cast about for villains, which the operation of Galbraith’s “bezzle” during the period of infectious greed always provides. And so we return to the curious agreement among Mr. Bush, Mr. Greenspan, and Mr. Daschle about how to calm the stock market.
This use of a diabolus ex machina, while it may bring a fleeting sense of moral closure, does not help to explain the economic realities. By refusing to face the facts about where we are, media-driven politicians prevent us from getting to where we want to be. Mr. Bush, for example, brags about the overall health of the economy and condemns the dishonesty of corporate leaders. He apparently does not understand that the economy cannot be healthy if the people who are responsible for its day-to-day management are crooks.
A recent headline reads, “House Toughens Penalties for Fraud: Guilty Execs Would Be Jailed 10-20 Years.” Nothing could better generate a sense of insecurity regarding the economy.
Dishonesty Not Prevalent
But of course few executives are crooks. Suppose for a moment that one-half of 1 percent of America’s CEOs really did want to rob their shareholders and ruin the lives of their employees. That would leave 99.5 per cent who are managing their companies honestly and to the best of their ability. That would be 99.5 to .5 or 199 to 1-pretty good odds. But even one-half of 1 percent of America’s CEOs is a figure much larger than the number of cases that have actually come to light. There is no factual basis for the belief that most business leaders are dishonest.
Still, it is to the moral failings of business that politicians direct attention, and not for the first time. The easy-money policies of the late ’20s made the stock market boom as investors chased after quick gains. When share prices began to drop, Herbert Hoover set precedents for Mr. Bush by insisting on the health of the American economy and calling for an investigation of the stock exchanges. He then put his signature to a protective tariff bill and stood by silently as the Fed turned to a tight-money policy. The Great Depression was on.
The excuse that these blunders were the result of ignorance about the relationship between policy and the economy will not hold water. In 1928, Canadian Ambassador William Phillips warned Hoover about the dangers of a protective tariff. When the Smoot-Hawley bill reached Hoover’s desk, more than a thousand economists petitioned him to veto it. Having served as secretary of commerce under both Harding and Coolidge, Hoover himself had more than just faint glimmerings that the bill was economic folly.
Leaders at the Fed, similarly, understood the effect of their decisions. In 1927, Benjamin Strong said, “I will give a little shot of whiskey to the Stock Market.” Hjalmar Schacht of the Reichsbank and Charles Rist of the Banque de France pointed to the dangers, but Strong ignored them. Interest rates fell and stock prices skyrocketed. The tight-money policy that followed the crash was the result of political infighting at the Fed, not ignorance.
This is not to suggest that every business leader is above reproach. Names like Insull, Kreuger, and Hopson deserve the opprobrium that attached to them in the aftermath of the Great Crash. Such men undoubtedly made a contribution to economic inefficiency, but the impact of their private corruption was tiny compared to the impact of public policy. The executives whose names now fill the news may be just as guilty as politicians claim and yet far less blameworthy than the politicians themselves.