The
Satyam saga gets more amazing by the day, with more
extraordinary revelations about the extent to which
the Raju family was apparently able to siphon money
out of the company they controlled. As the murky details
emerge, it is tempting to bemoan the poor state of industry
supervision in the Indian corporate sector, and see
this case as an example of how Indian regulatory standards
are not yet up to the standards set in the West. Indeed,
that is how several analysts both in India and abroad
have already interpreted it.
But the truth is that instances like the Satyam case
are neither new nor unique to India. Similar - and even
more extreme - cases of corporate malfeasance have abounded
in the past decade, across all the major capitalist
economies and especially in the US. And these were not
aberrations but rather almost typical features of deregulated
capitalist markets.
Furthermore, there is also quite detailed knowledge
about the nature of such criminal tendencies within
what are supposedly orderly capitalist markets. Four
years ago, at a conference in New Delhi, the American
academic Bill Black spoke of how financial crime is
pervasive under capitalism. He knew what he was talking
about: as an interesting combination of lawyer, criminologist
and economist, he had recently authored a best-selling
book on the role of organised financial crime within
big businesses.
This book (''The Best Way to Rob a Bank Is to Own One:
How corporate executives and politicians looted the
S&L industry'' by William R. Black, University of
Texas Press 2005) was a brilliant exposé of the
Savings and Loan scandal in the US in the early 1980s.
It received rave reviews, with the Nobel prize-winning
economist George Akerlof calling it a modern classic
and praise coming from all quarter including the then
Chairman of the US federal reserve Paul Volcker.
In his book, Black developed the concept of ''control
fraud'' - frauds in which the CEO of a firm uses the
firm itself, and his/her ability to control it, as an
instrument for private aggrandisement. According to
Black, control frauds cause greater financial losses
than all other forms of property crime combined and
effectively kill and maim thousands.
Such control fraud is greatly abetted by the incentives
thrown up by modern executive compensation systems,
which allow corporate managers to suborn internal controls.
As a result, the organisation becomes the vehicle for
perpetrating crime against itself.
This was the underlying reality in the Savings and Loan
scandal of the early 1980s that Black used to illustrate
the arguments in his book. But it has been equally true
of subsequent financial scams that have rocked the US
and Europe, from the scandal around the Bank of Commerce
and Credit International (BCCI) in the UK in 1991, to
the Enron, Adelphia, Tyco International, Global Crossing
and other scandals in the early part of this decade,
to the Parmalat Spa financial mess in Europe, to the
recent revelations around accounting practices of banks
and mortgage providers in the US in the current financial
crisis.
The point is that such dubious practices, which amount
to financial crime, flourish during booms, when everyone's
guard is down and financial discrepancies can be more
easily disguised. And this environment also creates
pressures for CEOs and other corporate leaders to show,
and then keep showing, good results so as to keep share
prices high and rising. The need becomes to maximise
accounting income, and so private ''market discipline''
actually operates to increase the incentives to engage
in accounting fraud.
This intense pressure to emulate peers in a bull market,
and deliver ''good'' results even if they are fake, is
a well known feature of financial markets, which intensifies
extant problems of adverse selection and moral hazard.
According to Black, ''This environment creates a ''Gresham's
Law'' dynamic in which perverse incentives drive good
underwriting out of circulation.''
Black further argues that the tendency for such control
fraud has greatly increased because of neo-liberal policies
that have reduced the capacity for effective regulation.
According to him, this operates in four ways: ''First,
the policies limit the number and quality of regulators.
Second, the policies limit the power of regulators.
It is common for the profits of control fraud to greatly
exceed the maximum allowable penalties. Third, it is
common to choose lead regulators that do not believe
in regulation (Harvey Pitt as Chairman of the SEC and,
more generally, President Reagan's assertion that ''government
is the problem''). Fourth, it is common to choose, or
retain, corrupt regulatory leaders. Privatisation, for
example, creates ample opportunities, resources, and
incentive to corrupt regulators.
Neo-classical economic policy
further aggravates systems capacity problems by advising
that the deregulation, desupervision and privatisation
take place very rapidly and be radical. These recommendations
guarantee that even honest, competent regulators will
be overwhelmed. Overall, the invariable result is a
self-fulfilling policy - regulation will fail. Discrediting
regulation may be part of the plan, or the result may
be perverse unintended consequences.
Neo-classical policies also act perversely by easing
neutralisation. Looting control frauds are guaranteed
to produce large, fictional profits. Neo-classical proponents
invariably cite these profits as proof that the 'reforms'
are working and praise the 'entrepreneurs' that produced
the profits. Simultaneously, there is a rise in Social
Darwinism. The frauds claim that the profits prove their
moral superiority and the necessity of not using public
funds to keep inefficient workers employed. The frauds
become the most famous and envied members of high society
and use the company's funds to make political and charitable
contributions (and conspicuous consumption) to make
them dominant.
In sum, in every way possible, neo-classical policies,
when they are adopted wholesale, sow the seeds of their
own destruction by bringing about a wave of control
fraud. Control frauds are a disaster on many different
levels. They produce enormous losses that society (already
poor in many instances) must bear. They corrupt the
government and discredit it. They inherently distort
the market and make it less efficient. When they produce
bubbles they drive the market into deep inefficiency
and can produce economic stagnation once the bubble
collapses. They eat away at trust.''
Black's analysis is extremely relevant for India today.
Not only because it shows how widespread the problem
has been in other countries, but also because it suggests
that it could be much more widespread even in India
than is currently even being hinted at. It is also very
important because it shows us how much of the problem
is essentially due to policies of deregulating financial
practices and implicitly encouraging lax supervision,
often as part of the mistaken belief that markets are
good at self-regulation and can control the ever-present
instincts of greed and the desire for individual enrichment
at the cost of wider social loss.
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