Capitalism will self-correct
From Today's Times (London)
American Account - Irwin Stelzer: Capitalism bounces back stronger after its excesses
FRIDAY’s strong first- quarter growth figures reminded me that the amazing thing about American capitalism is its ability to profit both from its excesses and the subsequent reforms. This explains its durability, and the inability of rival ideologies to win more than marginal attention from the American public.
In the latter part of the 19th century the so-called robber barons built the railroads and established the giant, vertically integrated companies that came to dominate the steel, oil and other industries. These free-wheeling entrepreneurs and empire builders over-reached, manipulating share prices, playing games with balance sheets, squeezing out competitors with anti-competitive tactics and, if necessary, physical violence.
The result was Teddy Roosevelt, a trust-busting president who brought to heel what he called “the malefactors of great wealth” by pushing the Sherman Antitrust Act through Congress. As a consequence, American capitalism entered the 20th century with two huge assets: highly efficient refineries, steel mills and other factories, knitted together by a superb rail system, and reforms that quieted discontent and put the economy on course to become the world’s most competitive.
When the Great Depression and unsound banking practices and monetary policies almost brought capitalism down in the 1930s, a time when the competing systems of national socialism in Germany, fascism in Italy, and communism in Russia were gaining adherents, another Roosevelt, Franklin, rallied a coalition to reform banking and financial markets. Again, American capitalism was the winner, ending up with the world’s most efficient capital markets, reformed to eliminate the excesses of the Roaring Twenties.
Now we are in another wave of reform, this one jointly driven by government and the market. The collapse of internet and other technology shares, combined with the failure of Enron, are reshaping American capitalism every bit as much as the two Roosevelts did in their time.
Corporate governance is suddenly a front-burner issue, perhaps more so than at any time since 1936, when two scholars, AA Berle and Gardiner Means, predicted that dispersed share ownership in large companies conferred unchecked power on managers, enabling them to stuff their pockets with perks without consulting the real owners of the business.
This is just what happened. It took Mike Milken to bring that party to an end by making credit available to thrusting entrepreneurs who cleaned out the corprocrats and refocused America’s companies on what businesses are supposed to be about — making money for their owners by lowering costs and improving their products. Once again capitalism self-corrected, leaving America with an enormous asset — companies that could drive up productivity and participate in a long-running, inflation-free period of economic growth.
Now we are in the middle of another correction. The internet bubble has burst, but the productivity-enhancing technologies it wrought remain. Enron is gone, but the nation is left with a more competitive energy sector — and with a set of reforms that promise to make capitalism more efficient than ever.
Audit firms are finding that it is no longer acceptable to be soft on their clients in the hope of winning large consulting contracts. This, combined with government regulations, will give investors a truer picture of the financial state of America’s companies. One of the first things to go may be share-option schemes that have not been recorded as expenses by the managers who vote themselves these generous salary supplements.
Company audit committees and outside (non-executive) directors are now wary of being co-opted by management, and are likely to be given new powers and resources with which to protect shareholders rather than directors.
Business is in a race with governments to get reforms on the table. In Britain, the CBI will propose reforms to the way companies are governed, rather than wait for the government to come up with what may be less realistic suggestions. Then there are the stock-pickers who have helped their investment-banking partners win business by recommending the shares of undeserving companies — or, at least, by failing to scrutinise balance sheets with the care that investors expect of highly paid professionals.
Thanks to the discontent of those responsible for investing the funds of millions of shareholders, and the aggressive attack of Eliot Spitzer, New York attorney-general, on Merrill Lynch analysts who in private e-mails described as “s” companies whose shares they were touting to investors, these conflicts of interest are headed for severe regulation or, with luck, the dustbin of history.
Not even Rudy Giuliani, who has been hired by Merrill Lynch to defend it, can head off big changes to the current system. So the day may be dawning when investors will be able to base their decisions on appraisals from analysts who have no conflicts of interest — and on information from rating agencies that have in the past been slow to downgrade the credit rating of falling angels but are now rushing to put their ratings in line with financial reality.
The improvements in corporate governance, the greater integrity of auditing and financial reporting, and more honest analyses by professional share-watchers have led to another benefit. They have forced companies to shake up their operations. Those with loss-making subsidiaries and off-balance-sheet debt can no longer conceal their errors. They must correct them. Investments that have gone sour are being written down to market value; operations that make no sense when properly accounted for are being closed.
The result: a 21st century-model capitalism that is outperforming the economies of dirigiste euroland and unreformed Japan, economies that many thought would overtake America’s by the end of the last century. Those wishful thinkers had not counted on the ability of American capitalism to self-correct, and then get on with the business of making Americans still richer.
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