They inflated Enron's reported earnings and disguised its losses. They exposed the company to risks that they then kept secret. They buffaloed investors and the press with vague hype about the untapped potential of the Internet. Enron's accountants didn't tell its board all they knew, and its lawyers colluded in the whole process. Shame fell upon the financial analysts, too, who failed to investigate the company, yet puffed it brazenly to their clients.
Perhaps most egregious was Enron's meteoric rise toward the top of the Fortune 500. That business magazine is proud of its ranking of companies, based on "revenue, revenue, revenue." But Fortune failed to notice that Enron used peculiar energy-brokerage accounting standards that let it label as "revenue" what others in similar lines of business consider mere "trade volume." While Enron's stock price (and price/earnings ratio) soared to the skies, few were the voices that wondered how Microsoft-level profit margins could be wrung from a trading operation that was essentially a kind of NASDAQ for gas and electricity.
Capitalism is the most productive social system ever devised, one that has profoundly enriched the quality of human life. Yet it is regularly shaken by scandals, bubbles, crashes, and even crimes. Although security and prosperity are the rule of capitalist life rather than the exception, it is a fact of statistics that in a large enough population, even very unlikely events can happen often. We are not a society of burglars, for example, yet burglaries are committed every day. Thus it is with the scandals of capitalism: Enron and the Internet bubble today, Long-Term Capital Management yesterday, and no doubt some new disaster brewing for tomorrow.
The risk of business failures and price collapses cannot be eliminated from capitalism because capitalism is a system of individual initiative. Its institutions arise because individuals freely choose to create them—no law or mandate ensures their provision. We depend on free choice to bring us cars and airplanes, food and music, practically all the material necessities of life—and many of the spiritual ones, too. We also depend on private standard-setters to ensure the consistency and reliability of our transactions. One such organization is Underwriters Laboratories, which certifies the safety of mechanical and electrical products. Another is the Financial Accounting Standards Board (FASB), which provides the standard accounting practices that make it possible for investors to assess the financial condition of a firm with relative ease. Private journalists and analysts also gather information and provide evaluations that we don't have the time or expertise to undertake on our own. And, ultimately, we rely on market prices to reveal what seriously interested parties—those who put their fortunes at risk—think of a product or company. But despite these many people and services, we always run the risk that some individual will not perform as expected.
Normally, these risks are of limited effect. We can safely ignore a normal bankruptcy, for example. It may mean a reasonable risk that failed or may signal management incompetence, but it means little in the big picture to any who are not stockholders or employees of the failed firm. The failure of Enron, by contrast, is a wake-up call to all participants in the free market. When corporate structures fail investors, employment contracts fail workers, the FASB fails the accounting profession, accountants fail the stockholders who employ them, investment advisors fail their clients, and the press fails its readers, then we see problems that extend far beyond this one firm and affect the entire economic system. At a minimum, there is concern that unreported financial shenanigans may be widespread, and this is already sending jitters through the stock market.
These systemic problems should be of special concern to Objectivists, who seek to extend the principle of voluntary trade throughout social life. Under laissez-faire capitalism, a great many institutions now dominated by the government would need to re-emerge under a private aegis. For example, the government currently licenses drugs through the Food and Drug Administration (FDA). Under pure capitalism, there would be no FDA, but we would still need private organizations to provide reliable assessments of drugs and standards for reporting pharmaceutical research results, as currently the FASB provides standards for reporting financial results. Likewise, there would be no Social Security System nor pension regulations, but we would all need to save for retirement in some reliable manner.
The Left is using the collapse of Enron to confirm its view that business is a dog-eat-dog arena of swindlers and exploiters that must be kept firmly in hand by active government management. So it is clamoring for extensive new regulations of private business activities. Conservative politicians are cooperating, and a host of new measures is moving forward in Congress. These range from new regulations on 401(k) retirement savings to government oversight of the accounting profession, which had been self-regulating under a broad government mandate. None of these measures spells the present death of freedom, to be sure, yet a death of a thousand cuts must surely come like this, one by one.
These new regulations are not aimed at Enron employees or shareholders as such. They spring from a deeper well, from unease at the uncertainty and unpredictability of the market and moral disgust at the motive of self-interest that drives it. Underlying this is the vague expectation that somehow production will occur without independent decision-making. Leftists in particular seem to believe that money will be made without the incentive of the profit motive. Wise, angelic bureaucrats will supposedly keep watch over the economy, nurturing "sustainable" technologies and preventing all malfeasance. In sum, Leftists and their moral bedfellows on the Right yearn for wealth without risk, a Garden of Eden where all the fruits of knowledge will be ready to hand without any need to rely on the initiative of strangers or the exertion of one's own mind.
But the solution to the current crisis of capitalism cannot come by the means the politicians are promoting. If self-interested investors with money on the line and free professionals with their careers at stake could not plumb the mysteries of Enron, there is no way a panel of legislative appointees can be expected to do better. It is a shame that Enron's auditors let its obfuscatory accounting pass muster for several years. But many federal and state government agencies in America have gone for decades without following even the general form of standard business accounting. Enron is transparency and accountability itself in comparison to the Defense Department or the Department of Health and Human Services—it only took a few years for its corruption and bankruptcy to come to light. Furthermore, as the creep of government "oversight" and the addition of more and more mandatory requirements decrease the freedom of the market and the ambit of choice open to business, the heartbeat of industry slows and stills. Could the Left achieve its dream of a guaranteed, risk-less economic life, the result would be oppression and stagnation of Soviet proportions.
The framework for a solution cannot come from the moral foes of capitalism, only from moral friends who know that there is no freedom without responsibility. The problem here is not the market—it's what we do with the market. Insofar as regards our own risks and our own interests, it is only right that we ourselves take charge of correcting systemic biases when they appear in the marketplace, through the means of the marketplace: individual initiative.
But this isn't easy to do. In a division-of-labor society, none of us can master all the technologies, all the techniques, and all the information in the economy. Just as one cannot build an automobile entirely from scratch (in less than a lifetime), neither can one maintain an expert vigil over developments in every field from accounting to medicine. Of course, one way to eliminate risky social interactions is to drop out of society and head for the woods. But that would be to abandon free enterprise in the name of freedom and consign oneself to a primitive, miserable standard of living.
Fortunately, we can exercise our responsibility using the marketplace and the division of labor. It takes some conscious effort, but it is well within our powers. To deal with isolated risks, financiers have a simple therapy: Don't keep your eggs in one basket. Better diversification can make sure our retirement funds are well placed and insulate us from the kind of loss the Enron employees faced when their company stock evaporated from their retirement funds. However, diversification is itself no panacea, and companies may have good reason to encourage employees to own stock: For example, it harmonizes the financial interests of all parties involved. That is why we need the freedom to choose our own level of investment risk, and why we should make that choice prudently.
We can use the power of the purse to reward improvements in the institutions we depend on. In our magazine and newspaper purchases, we need to reward journalists who give us the truth and dig beneath the surface. We need to withhold our business from go-go brokers and look for advisors who tell us "sell" and "hold" as often as they shout "buy."
We can improve the climate through activism. We need to support shareholder initiatives to demand that corporate boards be truly independent. And we must push for accounting reform, through persuasion and rational argument. We don't have to do all of these things ourselves if we can find advocates who will undertake them for us. In fact, the power of the marketplace is already at work as big conglomerates like General Electric announce reforms to increase the openness of their books and financial analysts emphasize their independence from brokerage operations. But, in the end, we as individuals are the marketplace. It is up to each of us to safeguard his own interests. No one else can, and in the end no one else will.
A fiction exists in free-market circles that capitalism guarantees justice. In this view, markets are always "perfectly competitive" and always efficient; it is always for the best in this best of all possible worlds. The Objectivist view of freedom is less mechanical and its appreciation of business is more exalted. Efficiency is an achievement that requires endless effort and ongoing rational inquiry. A market is not a physical space or an unchanging Neo-Platonic ideal. It is a space made by humans, embodied in human institutions and human discoveries that lower transaction costs, extending the reach of information and the possibilities for trade. Markets are by their nature open and competitive, but that does not mean there are always many competitors producing in a given industry. It depends who has the knowledge, talent, and money to compete, and who exerts the effort as well.
Just as reason is a capacity of man that a great many fail to exercise, so the market is no guarantee of nobility or excellence. What is done with freedom depends on what we choose to do. And the lesson of Enron is that, like any other good, sound financial information is not guaranteed to be produced unless we make the effort to encourage its production.
This article was originally published in the March 2002 issue of Navigator magazine, The Atlas Society precursor to The New Individualist.