Federal Reserve Chairman Alan Greenspan certainly has been crammed into a box labeled "interest rates."
The news media and Wall Street analysts are so obsessed with his thoughts on interest rates that they are forever dissecting and parsing his speeches, and even his appearance and demeanor, for clues as to his intentions.
Despite what Wall Street thinks, the U.S. economy does not live on interest rates alone. Greenspan is aware of that, and his position and experience give him a unique perspective on the American economy.
At the recent Financial Markets Conference hosted by the Federal Reserve Bank of Atlanta, for example, Greenspan gave a brief speech — not about interest rates, but about trust and its role in markets and, ultimately, our economy.
"To be sure, a market economy requires a structure of formal rules, for example, a law of contracts, bankruptcy statutes, a code of shareholder rights," he said. "But rules cannot substitute for character."
And, as he points out, character and trust are essential to efficient markets.
"Even when followed to the letter, rules guide only a few of the day-to-day decisions required of business and financial managers," Greenspan said. " The rest are governed by whatever personal code of values managers bring to the table."
Greenspan dips into American economic history to show that "reputation and trust were valued assets in freewheeling 19th-century America." And he notes, "J.P. Morgan marshaled immense power on Wall Street in large part because of his widespread reputation for fulfilling his promises."
Morgan, in fact, on two occasions saved the U.S. Treasury, and therefore the economy, by assembling capital to bolster confidence and add liquidity to the market — precisely the kind of thing the Federal Reserve would later be created to do.
There is no doubt that Greenspan is correct. At an absolute minimum, a decline in trust would create a barrier to efficiency in the form of paperwork — certifications, third-party guarantees and similar documents. Much of today’s domestic and global trade is so time-sensitive that this type of paperwork is usually too cumbersome.
Even though banks have improved the efficiency of letters of credit, for example, they remain a relic of a time when the world of commerce moved at a more leisurely pace. Today’s trade finds us relying more and more on reputation rather than documentation.
He is also correct when he says we should not be overconfident about the effectiveness of laws and rules in promoting trust and honest behavior. He notes that our reliance on government regulations has risen at the expense of the "market value of trust."
"But corporate scandals of recent years have clearly shown that the plethora of laws of the past century have not eliminated the less savory side of human behavior," he adds.
While his observations are accurate, Greenspan’s anticipation that "trust and integrity will be amply rewarded in the marketplace as they were in earlier generations" is questionable.
Markets are good at sorting out post facto failures of trust, but whether this process would actually encourage and expand trust, as it did in the 19th century, is doubtful given today’s moral climate. The invisible hand in the market can deal with self-interest; self-absorption is another matter.
The nature of trust is simple, but its interrelationship with reputation, regulation, retribution, education and prevailing moral values is not something we understand all that well. And if there is anything to be learned from the failure of Enron and the near-failure of Long Term Capital, it’s that markets are not very good at dealing with things that are hard to understand.
We need trust for efficient markets, and we know that rules and regulations have limited effectiveness. So if we don’t buy into the idea that markets will take care of the problem on their own, what’s the alternative?
The honest choice is to recognize that the price of moral decay is no longer an intangible — something that can safely be left up to TV evangelists to worry about. We can now see it and tally it up in the financial damage done to specific individuals and to all of us as we clean up one mess after another and markets become less efficient.
What the solution will look like in the end is difficult to say. But what it must look like in the beginning is our acknowledgement that we have a problem, and that the answer will not be found in the Securities and Exchange Commission, in Congress, in the New York State Attorney General’s Office, or on the floor of the exchange. The market will not place a high price on doing the right thing unless we do.
James McCusker is a Bothell economist, educator and consultant. He also writes "Business 101," which appears monthly in The Snohomish County Business Journal.
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