William K. Black describes the role that reputation played in Greenspan's distorted beliefs in his article in New Economic Perspectives.
Blankfein's reputation causes others to overlook behaviors such as the ones that contributed to the collapse of the mortgage market. While they were selling worthless CDOs based on sub-prime mortgages, Blankfein (and Goldman) bet against that same mortgage market and made billions by doing so. Goldman is viewed as exemplary, not because of its ethics and moral stance but because of its reputation for making big money consistently. What is overlooked is the billions lost by investors (pension funds, municipalities and savers) through fraudulent acts. Blankfein and Co. are blind to their conflicts of interest and seem unaware of the results of their frauds.
Others, too, are blinded by Goldman's flashy reputation. It is amazing to realize that clients still believe that Blankfein's reputation for making money is more important than his dicey outlook on frauds and his pushing the boundaries of legality.
Black points out that reputation as "the antidote to fraud" is a perverse belief that puts the lie to Greenspan's diabolical world view.
Greenspan's Laissez Fairy Tale
By William K. Black - New Economic PerspectivesWe continue to witness remarkable developments in the intersection of the related fields of economics, finance, ethics, law, and regulation. Each of these five fields ignores a sixth related field – white-collar criminology. The six fields share a renewed interest in trust. The key questions are why we trust (some) others, when that trust is well-placed, and when that trust is harmful. Only white-collar criminologists study and write extensively about the last question. The primary answer that the five fields give to the first question is reputation. The five fields almost invariably see reputation as positive and singular. This is dangerously naïve. Criminals often find it desirable to develop multiple, complex reputations and the best way for many CEOs to develop a sterling reputation is to lead a control fraud. Those are subjects for future columns.This column focuses on theoclassical economics’ use of reputation as “trump” to overcome what would otherwise be fatal flaws in their theories and policies. Frank Easterbrook and Daniel Fischel, the leading theoclassical “law and economics” theorists in corporate law, use reputation in this manner to explain why senior corporate officers’ conflicts of interest pose no material problem. The most dangerous believer in the trump, however, was Alan Greenspan. His standard commencement speech while Fed Chairman was an ode to reputation as the characteristic that made possible trust and free markets. I’ve drawn on excerpts from one example, his May15, 2005 talk at Wharton.I find Greenspan’s odes to reputation as the antidote to fraud to be historically inaccurate and internally inconsistent in their logic. Here, I ignore his factual errors and focus on his logical consistency.“The principles governing business behavior are an essential support to voluntary exchange, the defining characteristic of free markets. Voluntary exchange, in turn, implies trust in the word of those with whom we do business.Trust as the necessary condition for commerce was particularly evident in freewheeling nineteenth-century America, where reputation became a valued asset. Throughout much of that century, laissez-faire reigned in the United States as elsewhere, and caveat emptor was the prevailing prescription for guarding against wide-open trading practices. In such an environment, a reputation for honest dealing, which many feared was in short supply, was particularly valued. Even those inclined to be less than scrupulous in their personal dealings had to adhere to a more ethical standard in their market transactions, or they risked being driven out of business.To be sure, the history of world business, then and now, is strewn with Fisks, Goulds, Ponzis and numerous others treading on, or over, the edge of legality. But, despite their prominence, they were a distinct minority. If the situation had been otherwise, late nineteenth- and early twentieth-century America would never have realized so high a standard of living.* * *Over the past half-century, societies have chosen to embrace the protections of myriad government financial regulations and implied certifications of integrity as a supplement to, if not a substitute for, business reputation. Most observers believe that the world is better off as a consequence of these governmental protections. Accordingly, the market value of trust, so prominent in the 1800s, seemed by the 1990s to have become less necessary. But recent corporate scandals in the United States and elsewhere have clearly shown that the plethora of laws and regulations of the past century have not eliminated the less-savory side of human behavior. We should not be surprised then to see a re-emergence of the value placed by markets on trust and personal reputation in business practice. After the revelations of recent corporate malfeasance, the market punished the stock and bond prices of those corporations whose behaviors had cast doubt on the reliability of their reputations. There may be no better antidote for business and financial transgression. But in the wake of the scandals, the Congress clearly signaled that more was needed.The Sarbanes-Oxley Act of 2002 appropriately places the explicit responsibility for certification of the soundness of accounting and disclosure procedures on the chief executive officer, who holds most of the decisionmaking power in the modern corporation. Merely certifying that generally accepted accounting principles were being followed is no longer enough. Even full adherence to those principles, given some of the imaginative accounting of recent years, has proved inadequate. I am surprised that the Sarbanes-Oxley Act, so rapidly developed and enacted, has functioned as well as it has. It will doubtless be fine-tuned as experience with the act's details points the way.It seems clear that, if the CEO chooses, he or she can, by example and through oversight, induce corporate colleagues and outside auditors to behave ethically. Companies run by people with high ethical standards arguably do not need detailed rules on how to act in the long-run interest of shareholders and, presumably, themselves. But, regrettably, human beings come as we are--some with enviable standards, and others who continually seek to cut corners.I do not deny that many appear to have succeeded in a material way by cutting corners and manipulating associates, both in their professional and in their personal lives. But material success is possible in this world, and far more satisfying, when it comes without exploiting others. The true measure of a career is to be able to be content, even proud, that you succeeded through your own endeavors without leaving a trail of casualties in your wake.* * *Our system works fundamentally on trust and individual fair dealing. We need only look around today's world to realize how valuable these traits are and the consequences of their absence. While we have achieved much as a nation in this regard, more remains to be done.”Greenspan appears to have relied on the trump of reputation as the basis for causing the Fed to oppose financial regulation generally and at least five specific examples of proposed or existing regulation designed to deal with conflicts of interest. He supported the repeal of the Glass-Steagall Act despite the conflict of interest inherent in combining commercial and investment banking. He supported the passage of the Commodities Futures Modernization Act of 2000 despite agency conflicts between managers and owners of firms purchasing and selling credit default swaps (CDS). He opposed using the Fed’s unique statutory authority under HOEPA (1994) to regulate ban fraudulent liar’s loans by entities not regulated by the Federal government. He opposed efforts to clean up outside auditors’ conflict of interest in serving as auditor and consultant to clients. He opposed efforts to clean up the acute agency conflicts of interest caused by modern executive compensation. He opposed taking an effective response to the large banks acting on their perverse conflicts of interest to aid and abet Enron’s SPV frauds.Greenspan’s hypothesis: reputation trumps perverse incentivesGreenspan’s overall anti-regulatory hypothesis seems to be that laissez faire led to substantial control fraud, which gave business actors a strong incentive to avoid being defrauded. This caused them to care a great deal about reputation, which successfully prevented fraud. Indeed, the frauds “had to adhere to a more ethical standard in their market transactions, or they risked being driven out of business.”
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