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Smith vs. Thoreau Smith: We hear much these days about the sins of the marketplace. We hear much about the sins of market-makers: their greed, their lack of integrity, their misconduct. No doubt some of what we hear is true and that is most unfortunate. We must be vigilant in our efforts to do better. But these regrettable sins of the free marketplace do not represent the whole story, nor do they even represent a significant portion of the story.
For lost in all this negative rhetoric is something so fundamentally important about free markets, something so priceless, something so valuable, that lest we occasionally stop to remind ourselves, we might allow irreparable injury to occur. We might someday, in a thoughtless moment of sanctimonious folly, allow someone or something to take from us the most precious gift we possess: the markets of America and the unyielding force on behalf of human rights that these markets represent. The financial markets are color blind. They know no distinction between races, they know nothing about ethnic origin, and they are indifferent to gender.
What matters are price and quality. In the financial markets, the trophy goes not to the Catholic or to the Jew, not to the White or Black not to the male or female, but to the one who understands the economic principles of supply and demand. Personal pedigree, family origin, physical infirmities, and gender are meaningless when measured against one's ability to determine the customer's needs and how to market your product. Little else matters.
The market rewards you when you are right and punishes you when you are wrong no matter who your father was, no matter what he did for a living, and no matter where he came from. No other private sector establishment, entity, or apparatus is freer of human prejudice and less concerned with race or religion than the American free market structures. It established that an economic system could succeed only in an environment that permits individuals to freely pursue their own objectives for purely personal gain. As a consequence of such pursuits, the individual, when taken in mass, will be led by an invisible hand to promote an overall social good. That is why I hold that Enron management was acting in a way that should not be condemned by any means, and should not be a subject to any sort of accusations. They were using the tools of the free market, therefore the legality of their, and which is more important, the morality of their actions is unquestionable to me.
Thoreau: As I see it, the problems the scandal reveals are systemic. The individuals involved may have been uniquely greedy and unethical, but they were empowered by a system that exalted greed as it diminished ethics and accountability. The most basic issues of Enron are system issues. These come down to two, not unrelated truths: 1) the ideal of the unregulated free market is flawed, and it's time we said goodbye to the invisible hand; 2) managing a company solely for maximum share price can destroy both share price and the entire company. These are foundational flaws in theory, flaws in how we conceive of markets and how we define business success. They are system design flaws.
For beyond the juicy tales of villainy at Enron, the deeper issue is why the system lent so much power to villainy, and why there were so few checks and balances to stop it. We need checks and balances not only on the side of shareholder value, but on the side of public accountability. That means changing the system design. What a new design might look like is explored at length in The Divine Right of Capital, but the concept most appropriate to Enron is the idea of graduated penalties for unethical conduct. Firms caught cooking the books, for example, might lose all government contracts.
A federal contractor responsibility rule could prohibit the government from contracting with egregious corporate law-breakers. Such a rule was put in place by President Clinton as he left office, but was overturned by President Bush. It should be reinstated and made permanent through legislation. As though under mass hypnosis, we have denied what we know in our gut: the theory of laissez- faire is bankrupt.
It's a hoax. Why were there so few checks and balances to stop the villainy of Enron? Because we pretended we didn't need them. We believed the hucksters who sold us the elixir of unregulated free markets. Of course, unregulated markets are never really unregulated. Complex economic interactions need rules.
The question is who makes those rules: elected representatives serving the public good, or a financial elite serving only itself. With Enron, the rules were made by folks like CEOs Kenneth Lay and Jeffrey Skilling, and chief financial officer Andrew Fast, as well as the financial powers entangled with them. Like all elites, they preferred to run things without public oversight. This is why the invisible hand keeps rising out of the grave. To me, it appears that the free market mythology is a smokescreen that disguises the real nature of elite power -- much like the divine right of kings. It allows elites to run our economy to suit themselves, without interference, and with a veneer of legitimacy.
Which brings us to our second question about Enron: Why did the system design lend so much power to greed? Because doing so was in the interest of the financial elite, including Enron executives and Wall Street. Lay and Skilling both were "laser-focused" on shareholder gain, which led to their own option gains. They succeeded at this so well -- with annual gains of 40, 60, 90 percent -- no one asked questions. Those who did were brushed aside, like Sharon Watkins and her memo to Lay.
Why disturb the goose laying so many golden eggs? In the wake of Enron some have called for a close alignment between executive and stockholder interests. But this close alignment was itself the problem. When we define business success as maximum share price, a soaring price makes it impossible to see problems. What could be wrong? The business is succeeding beyond anyone's wildest dreams.
We fail to recognize that managing a corporation with the single measure of share price is like flying a 747 for maximum speed. You can shake the thing apart in the process. It's like a farmer forcing more and more of a crop to grow, until the soil is depleted and nothing will grow. It's like an athlete using steroids to develop more and more muscle mass, until the body itself is destroyed. The problem with Enron was not a lack of focus on shareholder value. The problem was a lack of real accountability to anything except share value.
This contributed to a kind of mania, a detachment from reality. And it led to a culture of getting the numbers by any means necessary. Smith: Nevertheless, it has to be admitted that the problem is not with the laissez-faire management, it is people from the management that caused the problem. We should not confuse here, the individual motivation with the market system.
I do not see flaws in the system, but rather flaws in the individual thinking that led to the scandal. Thoreau: Dear Adam, the problem with your approach is obvious to me. You have formulated a doctrine of free markets, however, the notion of your invisible hand should not assume the notion of invisible individuals crowding the market. First of all, we have to deal with mentality of people who participate in the market. Any economic model is not worth that much unless it has a solid foundation based on the group psychology of the given class of population that is being into account. That is why I believe the position of Enron management cannot be justified with your theories.
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