Saturday, December 27, 2008

Crime Scene Economics

Watching the economy collapse is providing lessons that might never have been learned among business writers. Some of them are pretty diverting, such as hearing Rebecca Jarvis this morning on the Today Show telling us glibly that "there are too many retailers". Nothing about, say, too few jobs, or too little salaries. Next, I suspect we'll hear that we should Go Shopping.

Today cruising through some of the local geniuses, I did find a little jewel. A former employee of Ken Lay (think Enron) has concluded that government did it, in the cloakroom, with laws. The article is by Houston Chronicle's Loren Steffy. I won't post all of it here, but just in case you wonder, no, he doesn't talk about the need for independent regulators and law enforcement, such as has just been proved by our economic disaster.

A few weeks ago, I had lunch with Robert Bradley, a free market scholar and founder of the Houston-based Institute for Energy Research. Bradley, a former speech writer for Ken Lay at Enron, recently published Capitalism at Work, which looks at the role of business and government.

Bradley laments what he calls a "cluster of errors" by companies, especially on Wall Street, that dragged the global economy into recession.

The problem, Bradley argues, isn’t that capitalism failed us, it’s that we failed capitalism.

"The recession is bringing us back to basics," he said. "All we’ve learned from all this is that long-term value is key."

We knew that, of course. But in recent years, soaring prices for everything from commodities to housing have caused us to forget that good investing and good business are about patience and perseverance, rather than instant rewards.

"The present situation seems to present a paradox of capitalism whereby instead of good companies driving out bad, we have bad companies driving out, or certainly hurting, good," Bradley said. "The very best corporations are getting tugged down by the sins of so many others."

Rather than building profitable businesses on sound practices, companies resorted to gimmicks and relied on government policy. The problem isn’t that government did too little to protect us from crisis, it’s that it did too much to help create the crisis, Bradley said.

For example, it slashed interest rates, which encouraged a home-buying binge and inflated housing prices. That fed demand for subprime mortgages and risky debt instruments that Wall Street peddled to investors.
The answer may be that bonuses and incentives changed so that executives and employees lost sight of what was good for their firms. In a recent article in Portfolio, Michael Lewis, author of Liar’s Poker, the classic tale of Wall Street excess in the 1980s, traces the problem to the decision by many investment banks to convert from partnerships to public corporations.

In a partnership, individuals are responsible for the losses of the firm, making them more wary of risk. In a corporation, risk is borne by investors. Gambling is always easier with other people’s money. (Emphasis added.)

The point about CEO bonuses is apt, even though Bradley ignored much of the need for laws to protect investors from bad information, and actual regulators. As I said here previously, we are expecting firms' executives to work for profits for the firm, but that has not been rewarded as much as the short-term gains that trigger the big money bonuses. Sometimes those can come at the expense of overall health, as in the case of excessive SUV production in the face of inevitably rising gasoline costs.

The public interest has been revived in the coming administration, and a return to actual representation of our laws will be a real change. I am hopeful that oversight can be a saving grace for the country's business as well.

When we can see even the free marketeers admitting that their ideas were wrong, oh sorry, that the people they expected to use their ideas to do the right thing failed, MISSION ACCOMPLISHED.

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