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Wednesday, October 27, 2021

Economic Malaise: The Death of Trust


If we can’t rely on the best auditors, can we continue to trust the chartered accountants?
Issue Dated: February 22, 2009
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Economic Malaise: The Death of Trust Sin-ming Shaw

A former visiting Fellow in History at Oxford and Princeton universities.

Institute, and the author of C entral Eurasia – Prize or Quicksand?

A friend recently asked a seemingly naďve question: “What is money? How do I know I can trust that it is worth what it says it is worth?” We learn in introductory economics that money is a medium of exchange. But, why do we accept that? Bank notes are just pieces of paper with a number attached to them. We believe in bank notes because we collectively trust the government when it says that 100 is 100, not 10 or 50. Money, therefore, is about trust, without which no society can function.

Just as we obey our leaders’ orders to fight and die because we trust their judgment, we entrust our careers and our money to those who run Citigroup and Goldman Sachs and other such banks, because we believe their leaders will be fair to their employees and clients, and honourable in their business practices. We do not grow up wishing to work for crooks and liars. Once that trust breaks, bad things happen. Money ceases to have credibility. Leaders become figures of contempt or worse. As I write, inflation in Zimbabwe has reached an unimaginable (if not unpronounceable) level of more than 500 quintillion per cent. One quintillion is one million trillion. A year ago, inflation was “only” 100,000 per cent. This is what happens when trust vanishes.

Fortunately, Zimbabwe is not a country of real consequence for world stability. But, the Weimar Republic and China in the 1940’s were. One opted for Hitler and the other for Mao Zedong to restore trust. So the risks are clear. Are we now seeing an erosion of trust in America and in the United Kingdom?

The first warning sign surfaced in 2001, with the bankruptcy of Enron in the US. Its fraudulent accounts were certified by Arthur Andersen. Now, India’s Satyam, audited by PriceWaterhouseCoopers, is found to be missing billions. If we cannot rely on the best auditors, can we trust chartered accountants? Bond rating agencies have issued misleading ratings on companies in questionable health. Will we ever again be able to trust a triple A rating issued by, say, Moody’s?

Banks have been holding our money for safekeeping since the 14th century, when the Florentines invented the practice. The Royal Bank of Scotland, founded in 1727, has just become a socialist state-owned-enterprise, thanks to the bank’s incompetent leaders, who acquired overpriced banks filled with toxic assets. Citicorp, Bank of America, Goldman Sachs, Merrill Lynch, and other symbols of “excellence”, all would have collapsed but for public bailouts. And yet for decades, we thought that the people who were managing those firms were much smarter than we were. We grew up admiring leaders such as Robert Rubin, John Thain, and Henry Paulson. Rubin, a former US Treasury Secretary and ex-Chairman of Goldman Sachs, presided over the collapse of Citigroup while taking home $150 million in bonuses. Should he really have been rewarded at all for his “performance”? Recently, the technically bankrupt Citigroup’s senior executives were about to buy a new $50 million luxury French jet for themselves, until the White House stopped it. Thain, also a former president of Goldman Sachs, helped himself and his Merrill Lynch staff to $4 billion in bonus payments even after he had to sell the firm to Bank of America to save it from bankruptcy. After he was caught spending $1.2 million, even as Merrill Lynch disintegrated, to decorate his new office, Bank of America fired him to placate growing revulsion over Wall Street’s out-of-control culture of entitlement. Paulson, the outgoing Treasury Secretary and another Goldman Sachs veteran, left a loophole in his rescue package big enough for a truck to drive through. That loophole allowed his former friends and colleagues on Wall Street to get billion-dollar bonuses while keeping those firms afloat with taxpayers’ money.

The universities these men attended – Harvard and Yale for Rubin; MIT and Harvard for Thain; Dartmouth and Harvard for Paulson – have been magnets for the world’s finest young minds. The rest of us thought that these institutions could instill the wisdom, insight, and character of which we all wished we had more. Perhaps, parents all over the world should re-examine their obsessive craving for these “name-brand” universities, pushing their children as if an Ivy League degree was an end in itself. Now, we know that Wall Street’s titans were never all that smart, and certainly not very ethical, for they failed the only test that counts. All of the firms they led collapsed, and were saved only by money from those who could never get a senior job on Wall Street or a place at Harvard.

These Wall Street princes were smarter in one way, however, they managed to pocket a fortune while the rest of us are stuck with the mess they left behind. Bernard Madoff, who hailed from down market part of New York City and attended a middling university, will spend time behind bars, but none of the titans of Wall Street with blue-chip pedigree will ever do so. We need to save our economy from its abusers, or else.
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Issue Dated: Feb 5, 2017