TCS Daily


Reform Follies

By Pejman Yousefzadeh - July 18, 2002 12:00 AM

Democrats and Republicans are agitating for new laws and regulatory regimes, claiming that such "reforms" are the only way to prevent future Enrons, Global Crossings, WorldComs and ImClones. However, this headlong rush for new regulations-in the midst of an election year, a time when clear thinking is usually in short supply-could potentially cause more troubles than it proposes to cure.

At the risk of upsetting the plans of politicians and pundits to further regulate our capitalist system, it is time that we hewed to tough guidelines about whether new regulations are necessary, and whether there are creative alternatives out there that aren't receiving the attention they deserve:

  1. Are new laws really necessary? A new law, or series of laws, would make the most sense if corporate CEOs have engaged in clearly unethical behavior that nevertheless would not bring about any significant punishment for those CEOs. On the face of it, it appears doubtful that this is the case. Any violations of securities laws are amply covered by the Federal Securities Act of 1933, and by successor acts and amendments. The civil portions of the Racketeering Influenced and Corrupt Organizations Act (RICO) are themselves tremendously elastic, and capable of covering a whole series of offenses. The justice system has proven itself capable of punishing alleged corporate malfeasance-witness the recent conviction won against Arthur Andersen and its partners. If any new laws are proposed to deal with the perceived problem with corporate corruption, the authors of such laws should be required to show just how the current regulatory system is supposed to be deficient.

  2. Will new laws be more effective than the current market system? With the revelation of each and every financial scandal, an immutable truth is proven over and over: Government and regulatory regimes cannot come close to matching the speed with which the markets respond to scandals. While politicians expressed outrage and indignation in public pronouncements and congressional hearings, the markets reacted swiftly to the disclosure of any corporate shenanigans by seeing to it that the stock of the corporations at issue dropped precipitously. Those stock losses serve as a more effective market enforcement mechanism in the short and medium term than any regulatory device or legislative scheme that is dreamed up by the political establishment. As certain astute observers - such as Charles Krauthammer, Robert Bartley, and Radley Balko -- have all pointed out, the markets have reacted more quickly, and more efficiently, to disclosures of financial irregularities than all the legislative proposals being currently debated. Unless new laws can improve upon the self-correcting nature of a vibrant and vigorous free market (and it is doubtful that they can), those laws will in all likelihood be superfluous and meaningless.

  3. Don't neglect more innovative reforms. One of the best methods of deterring accounting irregularities (other than a strong and negative market reaction) has been proposed by Professor Roman Weil, who teaches at the University of Chicago Graduate School of Business. He calls for audit committees to exercise the power that the Securities and Exchange Commission has already given them, rather than seeking new powers through new legislation as the first resort. Additionally, Weil proposes the idea of audit committee term limits. A new audit committee would replace a predecessor after five or seven years. This ensures that the old auditor understands that no matter what its performance, it would be replaced after a given time. As such, it would behoove that auditor to be scrupulously honest and rigorous in its analysis, lest it be made to look bad by a successor auditor. Conversely, the successor auditor would have a strong incentive to go over the findings of its predecessor with a fine-toothed comb, thus ensuring the presence of continued rigor and honesty in the analysis of financial transactions, balance sheets, and accounting statements. Auditors could come back to perform services for a particular company, but mandating their replacement-if only for a temporary period-will help bring about greater honesty in accounting practices.

  4. Leave the partisan politics at home. Democrats are salivating over the chance to make corporate corruption an issue going into the 2002 midterm elections, and perhaps use it to cut into President Bush's stubbornly high approval ratings in anticipation of the presidential election in two years. Someone should remind them that those who live by the sword, die by the sword. Democrats are more vulnerable than they realize on this issue. Two of the loudest Democratic critics of President Bush and the Republicans have been Terry McAuliffe, the chairman of the Democratic National Committee, and Richard Gephardt, the House Democratic leader. McAuliffe was heavily involved in Global Crossing, one of the companies whose financial irregularities have captured public attention. Additionally, it was revealed last week that McAuliffe was responsible for awarding an unsecured loan to Gephardt in the 1980s. The loan was through a bank that McAuliffe founded-a bank that was later determined to have used suspect practices by federal regulators. To top matters off, the loan was made while McAuliffe served as financial director of Gephardt's political campaign, thus perhaps violating federal election laws.

    Making the Democrats' task even more difficult politically is the fact that the corporate abuses they seek to pin on Republicans and the Bush Administration, actually started under the administration of President Clinton. Democrats accuse Republicans of having passed supposedly deleterious deregulation legislation that allegedly enabled corporate corruption. But as the Fox News' Fred Barnes points out Democrats voted for the legislation as well, and in large numbers. At no time during the Clinton Administration did Republicans hold veto-proof majorities in either chamber of Congress. Additionally, it was the policies of the Clinton Administration that helped some of the worst corporate malefactors currently dominating press attention. Duane Freese of TechCentralStation highlighted the incredible degree to which Enron benefited from the environmental policies of the Clinton Administration, as did Bill Lickert and Christopher Morris. The point is clear: Democrats have been at least as complicit as Republicans, and the Clinton Administration was at least as involved as the Bush Administration, in cozying up to big business. A clever Republican media guru can make this point easily in a 30 second ad-thus eliminating any partisan advantage.

  5. It's the economy, stupid. At the risk of dragging out this tired and shopworn slogan for yet another rhetorical go-around, public officials would be smart to remember that while the economy continues to grow out of recession, its growth is somewhat limited. The economy can easily fall back into recession if the markets and market actors lose confidence in the actions of public officials. Again, despite the fact that this year is an election year, public officials should take care to be responsible and careful with the proposal of new laws. Over-regulation will only serve to calcify economic growth, doing more harm than good in the long run. The purpose of the current debate over corporate malfeasance is to renew confidence in the economy and in the market system. If the economy ends up double-dipping into recession because of ill-conceived new regulations that stifle capitalist creativity, it will represent the ultimate failure of the political system in attempting to ensure market honesty.


The economy is not an issue with which public officials should toy. Economic matters affect the lives and livelihood of millions of American families. The political class should approach the management of economic issues with the greatest trepidation-remembering always that the capitalist system works best when it is at its freest. If there must be new legislation in the wake of reports of corporate malfeasance, the political class should carefully consider its actions along these and other guidelines. A headlong rush to legislate will only make for nice political theater. It will do nothing to restore investor or market confidence. And it will fail utterly to stop corporate malfeasance, while further harming economic performance. Style should not be allowed to triumph over substance, especially on an issue as important as the American economy.

 

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