Let's End Crony Capitalism
November 30, 2002

It’s been a year since the Enron scandal broke and, sadly, the state of Corporate America remains a disgrace. It’s not just the yearlong revelations of fraud, malfeasance, conflicts of interest, deceptive accounting, weak boards of directors, and outrageous compensation in executive suites, though that’s bad enough.

No, it’s the lack of genuine reform that’s troublesome. The Bush Administration is trying to ignore corporate corruption. Washington legislators, after many bi-partisan speeches of outrage and fury-along with a brief bout of reform-are avoiding the issue too. Federal regulators are in disarray, most notably the leaderless Securities & Exchange Commission.

That said, the stock market has staged a dramatic rally in recent weeks. The market is up some 20% since hitting a five-year low on October 9th. Does this mean the business scandal is over?

Hardly. Investors are simply trying to make some money. Take the Great Depression. The economic Armageddon revealed the sordid details of a crooked plutocracy that lined its pockets by rigging Wall Street in their favor. Yet the stock market staged its strongest rally of the twentieth century in 1933. The reason is that investors believed the economic fundamentals had changed for the better. Today’s investors are gambling that the recovery will stay intact.

No, the corporate scandals are a corrosive influence on society. Martin Fridson, chief high yield strategist at Merrill Lynch and a market historian, recently used Adam Smith’s famous image of the Invisible Hand to draw a critical distinction. The Invisible Hand, a metaphor for harnessing individual self-interest to the general well-being, is a powerful principle. In my view, the Invisible Hand worked well in the 1990s. Barriers to trade fell with the collapse of communism. Deregulation unleashed competitive forces in inefficient industries. The traditional command-and-control corporate hierarchy broke down as management embraced a more flexible, entrepreneurial culture. The Internet, a remarkable technology for financial democratization, bypassed traditional middlemen and created direct pipelines to consumers. Wall Street was no longer a private club, and equity ownership spread to the mass of workers.

But excesses emerged toward the end of the era. And here’s where Fridson’s second insight into the Invisible Hand comes into play: It’s a “very convenient cover story for people who are actually trying to stack the deck in their favor,” he says. America’s business elite preached the virtues of competitive capitalism while practicing crony capitalism. The elites are struggling to hold on to their ill-gotten gains through backroom deals. Vast sums of money are being spent in Washington to keep reform at bay. The market has brought about some needed changes. But a broad-based equity culture needs a reform agenda deeply committed to honest financial numbers and improved disclosure. Sad to say, we’re still waiting.

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