The Fraud Problem

Most of the moral ills that people attribute to capitalism can probably be traced to the problem of fraud. This, I think, is the major distinction between “capitalism” railed against and resisted and the “free enterprise” of the idealist. It’s a question of freedom. In the classical Smithian form, a free buyer and free seller come together and strike a bargain that does them both good. The problem arises when one of the parties enters into the arrangement with bad faith. Stiglitz, Akerlof, and others have written some fascinating stuff on the concept of information asymmetry , the idea of how a transaction is affected when one party has important information that the other does not. In the long run this kind of thing should (used to?) work itself out as the withholding party ruins his reputation for straightforwardness and no one is willing to do business with him anymore. No one wants to deal with a swindler.

So why are there so many people out there that haven’t gotten this essential idea? What is it about climate / culture / education that leads the Enrons and Providians to try again and again to profit from dishonesty? If all of the spin and advertising in the world couldn’t save Detroit (and the city too, for that matter,) is it ever reasonable to believe that the same doesn’t hold true across the board? I wonder if this can be tied to an excess of competition (in the Vince Lombardi win-at-all-costs sense,) in the messages received growing up. Long-term enterprise, after all, is fundamentally cooperative; Deming proved that to all of us. An organization that doesn’t have at least internal trust (Enron again) is doomed to fail in the medium to long term.

This, I suspect, is also at the heart of the decline of the Republican Party. The Goldwater message of individual freedom that resonated with so many and reached apotheosis in the Regan revolution was hollowed out by late comers mouthing similar-sounding rhetoric but missing the essential point. A “market solution” is no solution if the market is rigged (i.e. not transmitting information properly.) Feeding tax dollars back to selected business isn’t at all the same as people spending the money individually – it’s actually closer to fascism. (Defined as central control with industry held privately.) The lesson here is people don’t viscerally respond to empty phrases any more than they recall pleasant memories. As soon as enough history sullies the phrase from the memory: game over.

So why so much institutional fraud? From Merck to Citibank to AT&T to the electric company (cf the TXU buyout) some of the most trusted institutions of commerce seem to have adopted all of the integrity of the street hustler. Moral failing of short-sighted baby boomers? A problem of ever-increasing scale making personal reputation and repeat business less important? Increased commerce filling the air with so much noise that the word-of-mouth signals of old have been drowned out? (Don’t take my word for the trend, read Elizabeth Warren )

There’s something deeply resonant here about how the species organizes itself. Cheater detection was a well–developed skill of the hunter-gatherer. Whole forms of civilization coalesced around finding and avoiding fraud. What’s the modern answer?

It all makes one wonder.