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Where's a Real Villain When You Need One--Skeel

Almost a year into the subprime crisis, we still haven’t seen any major reforms. The Enron and WorldCom scandals six years ago, by contrast, prompted sweeping reforms in Congress and on Wall Street. Why the difference?

I increasingly think the most important difference is the lack of a clear villain– a person and company that serve as a posterchild for everything that is wrong and needs to be fixed with American finance.

America’s most important corporate regulation has always been passed (or so I argued in a book called “Icarus in the Boardroom”) in response to scandals that are identified with particular individuals, starting with the 1873 collapse of Jay Cooke, a Philadelphia banker who failed when his railroad, the Northern Pacific, failed; continuing with Samuel Insull (a utility magnate) and Ivar Krueger (the “Swedish Match King”), whose 1932 failures inspired the federal securities laws and other New Deal reforms; and with Enron’s Ken Lay and WorldCom’s Bernie Ebbers, whose misbehavior gave us our most recent major corporate reforms. With the subprime crisis, no individual or company stands out in the same way. Perhaps Angelo Mozilo of Countrywide comes closest; but he’s simply no Samuel Insull or Ken Lay.

This same point can be made in a slightly different way. Americans tend to divide their business crises into two categories: they’re viewed as scandals when there’s a clear villain, but as a common disaster when no in particular seems to be to blame. A great deal of dubious behavior went into the subprime crisis, but so far Americans seem to view it more as a common disaster like a hurricane or tornado, than as a scandal. If this remains the case, we may see some kind of bailout (the usual response to a common disaster), but we aren’t likely to see any important systemic reform, say, of the bankruptcy laws or of our financial regulation. Only if a flesh and blood villain emerges is subprime likely to be seen as a true scandal, and to inspire more extensive reform.


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Comments ( 7 )

The junk-bond and S&L crises produced actual villains like Boesky, incompetents like Charles Keating, and sharp but controversial players like Michael Milken. They all made decent villains, yet the S&L industry was bailed out and the junk-bond market survived (regulation preceded and perhaps precipitated the crash). This may not invalidate your theory -- perhaps it was a villain-response on steroids, when Milken and Drexel paid a billion-dollar fine for offenses that were rarely prosecuted, and which usually merited fines of less than half a million dollars.

Many thanks for this comment, Byrne. I actually think S&L and Milken are consistent with the thesis, especially the S&L crisis, since lots of S&Ls were shut down and the regulatory framework was quite significantly changed. Milken is more complicated, since (as you note) the government went after him personally but didn't really change anything. My own view is that not enacting a lot of new regulation in response to Milken et al was actually a good thing.

Follow the money. The Mortgage Broker (as well as the bank loan officer) sell what the market produces. Follow the money! Wall street set up this shell game and until we realize that it is off the sheet games like this one, the dot com mess and the laddering effect that were all set up by wall street will we be able to find a solution. The basic problem with the subprime mess was simple. Wall street told investors that this bond (mortgage backed security) had an initial interest rate around 6 percent, but in two years it would go to 12 percent. Great buy! Until you realize that at the other end the Mortgage Broker was telling the client that he would refinance him out of this loan at two years so he wouldn't have to pay the 12 percent interest. The buyers of these mortgage backed securities were being dupped. And they were being dupped by the same people who did it with the Dot com and others. Wall Street and those who can figure out another way to make not just a buck but a big buck. I wonder if the run up in commodities is the next trick in their bag.

"...Enron’s Ken Lay and WorldCom’s Bernie Ebbers, whose misbehavior gave us our most recent major corporate reforms..."

I guess I'm being picky, but that seems a little un-nuanced. I've been under the impression that Ken Lay's guilt has been cast further and further into doubt with the passing of time, although nobody's going out of his way to exonerate him. Even the WSJ (not just the editorial page, but the much more pro-regulatory newsroom) and Economist have seemed to suggest that Enron's collapse had causes similar to Bear Stearns'. It at least seems that there was misconduct on the part of prosecutors.

But you almost certainly know more about this than I do. I'd just hesitate to write a dead man off as a wrongdoer when there's so much doubt currently cast on his conviction, he hadn't exhausted his appeals, and he was so widely respected both for his accomlishments and for his service to others.

Thanks a million for this comment, Joe. Your view on Ken Lay is one that is held by a lot of people, particularly now. It strikes me that one could plausibly conclude that he didn't deserve criminal prosecution, but I don't think one can fairly conclude that he wasn't in any sense a villain. He clearly had some idea what was going on at Enron, even if he wasn't directly responsible for the worst of the
wrongdoing. And he seems to have willfully ignored warnings. I don't think Sherron Watkins was quite as much a hero as she was portrayed at the time, but she did flag some of the corruption within the firm and he essentially brushed her off. And I do think there was a great deal of corruption within Enron, of a sort I haven't seen evidence of at Bear, Stearns.

Can you email me a summary of Kenneth Lay's villainous deeds at Enron? I was too young to know the details although I did see him on the nightly news.

Thank you.

Margaret Harrison

I would recommend reading a book like "The Smartest Guys in the Room" (the inspiration for the Enron documentary of the same name). The role of Lay personally seems to have been that of a facilitator (or having looked the other way), rather than actively committing Enron's worst misbehavior himself.