The Decline of American Capitalism

Neil Weinberg, executive editor of Forbes, delivered the McGowan Center for Ethics and Public Life lecture at King's College in Wilkes-Barre, Pennsylvania. Weinberg lectured on March 26, 2009 in the Burke Auditorium on the college campus.

In May 2008, Weinberg became director of personal finance coverage for both the magazine as well as the website Forbes.com. He is also in charge of investigative reporting at the business magazine. Weinberg is a frequent contributor on CNBC, Fox News and other media outlets. He received an MBA from the American Graduate School of International Management.

Before he was editor, he gained real world experience as an investigative reporter for "Forbes" magazine. His articles were about controversial practices in politics and business. He published articles on corporate, pension, and mutual fund scandals, and executive pay excesses. He also published articles on the possible collapse of private equity and hedge funds, and the controversial issues involved in whistle blowing.

Weinberg co-authored the book "Stolen Without a Gun: Confessions from Inside History's Biggest Accounting Fraud - The Collapse of MCI WorldCom. The book was co-written with convicted felon Walter Pavlo, Jr., and is used by universities as they teach accounting, business ethics, and other related subjects.

King's College was the ideal setting for this lecture. Bill McGowan was a small town boy from Northeast Pennsylvania who graduated from King's College and founded MCI. McGowan symbolizes the old capitalism; prudent, cautious, fair, and ethical. This is the system that made America the greatest country in the world, the system that allowed everyone to contribute and enjoy an undeniable hope that tomorrow will be better than today.

The new capitalism destroyed the American Economy as well as the optimism and spirit of the American People. The new capitalism is the exact opposite of the old, as it is wild and reckless, unethical, and maximizes profits at any cost.

The title of his lecture was "Stolen Without a Gun: Paying for Failure, How Wall Street Got Hijacked And How To Win It Back." Weinberg had a simple yet dynamic explanation for the decline of American Capitalism. He said if you pay people to do bad things they will and that is precisely what happened. The speech began by repeating the Forbes motto which is "The Capitalist Toll." He supports free markets and capitalism and is very concerned because people are saying we need more government. Capitalism is a twin edge sword. It will produce great wealth, but it also produces excesses especially in income distribution.

How The System Failed. Under the old ethical system of capitalism the housing industry was fairly simple. Twenty years ago, if an individual wanted to buy a house the bank made sure the individual could afford to pay the mortgage and they had a suitable match. The buyer had to make a substantial down payment, and the mortgage was based on a conservative appraisal of the value of the house. When the system broke down and the buyer could not afford to pay the bank took the loss. This system minimized the number of foreclosures and America prospered.

The new housing market is a reckless disaster. Buyers put very little down. In accordance with Weinberg's theory appraisers were paid to inflate the value of the house and that is exactly what they did. Bankers ignored the suitability of the buyer to the mortgage and were not very concerned if the buyers could not make the actual payments. They wanted to sell as many inflated mortgages as possible and maximize their profits. When the buyers could not make the payments they did not take the loss, they sold them to Wall Street.

Of course, Wall Street was not going to be left holding the bag, and they were determined to make their money in the system. So they packaged the mortgages into securities. In another dynamic example of Weinberg's theory, the rating agencies were paid to rate these securities and that is exactly what they did. They gave these miserable securities excellent ratings and the investors blindly bought them. The downward spiral began.

Overpaid Executives Add Fuel to the Fire. Coupled with the housing and securities disasters, overpaid executives ruined much of what was left of the system. Beginning in 1980, executive pay skyrocketed. In 1980, corporate CEOs were paid forty times the average workers pay. By 2007 that number had ballooned to 433. Believe it or not, in 2007, CEOs made 433 times what the average worker made.

In the past CEOs enjoyed a good reputation in America. They were seen as the "Captains of Industry" that ran American Industry and developed jobs for everyone. Now they are seen as greedy, incompetent fools that ran American industry into the ground, yet managed to get paid millions and millions of dollars in the process.

The doctrine of unintended consequences made the situation worse. The tax code states that corporations that pay executives more than a million dollars a year must pay taxes on it. To avoid this tax, companies paid CEOs with stock options.

The second issue is that CEOs are treated much better than they deserve. They are corporate employees just like everyone else but they are treated like investors who were taking serious risks. Consequently, they were given the opportunity to make millions and millions of dollars.

Obviously, the CEOs took major risks to radically increase the value of the corporate stocks. This produced a serious moral hazard. If the CEO is successful he makes a lot of money and if he fails the stockholders take the loss. Now we have a double moral standard. If companies fail they now ask the Federal Government for a bailout.

The Board of Directors in these companies could have stopped this insanity but they did not act. The board of directors system is broke as most directors come from the same "Good Old Boy Network" and contribute very little to corporate America. Often they are friends with the very corporate executives who run the companies into the ground, or have no expertise in the industries they direct.

Solutions. Fixing corporate governance will be a difficult and challenging project. First, we need a philosophical change. We need to get back to the old ethical, prudent capitalism and away from the reckless philosophy that has ruined the system. The "Good Old Boy Network" that run the board of directors system needs to be replaced with a professional system where knowledgeable and professional people are appointed to these boards. Finally, we need simple pay packages for corporate executives who should be treated as corporate employees, and not investors. Their pay should be based on long term corporate and stock performance.

Sources:

1. Monarch Notes, Published by the King's College Public Relations Office, March 23, 2009

2. Neil Weinberg, A Lecture Entitled "Paying for Failure" March 26, 2009.