Frauds are a cancer destroying capitalism

My previous post described a comment by Sam Antar during his CPE session that the fines arising from of a long list of financial fiascos are essentially a tax on illegal behavior.

He made another comment in that session that I wanted to describe in detail. He said these frauds are a cancer destroying capitalism.

I had opportunity to visit with him a few weeks ago and asked him to expand on this idea. I will summarize what we discussed.

This discussion is cross-posted from my other blog, Attestation Update, since it directly affects freedom, capitalism, and morality.

Cancer destroying capitalism

He indicated the foundation of capitalism is reliability of financial information. If you can trust financial information you read then we can do business with each other.

He says the extent of frauds we have seen are leading people to lose faith in financial information. That leads to loosing faith in their counterparties. Therefore people have less trust. In financial terms that means the risk premiums for transactions go up. The interest rate built into a transaction increases and the return drops.

Perhaps repeating that point or perhaps expanding it, I would add that in any transaction we are now seeing higher risk premiums built-in regardless of whether that is directly reflected as an interest rate adjustment.

He says the problem in falling trust and increasing interest premiums eats away at the economy. It undercuts our economic vitality.

After the financial meltdown, the fraud premium increased. He believes the premium has dropped because of an incorrect perception that the risk of fraud has fallen.

He thinks we are in big danger of another meltdown because of endemic fraud. He is concerned there’s another credit card fraud on the scale of Target or Home Depot that is in progress but just been discovered or publicized yet. (Hmmm. Since we visited, the successful hacker attack on J.P. Morgan hit the paper. Maybe there are several cooking right now.)

I perceive there are still several more rounds of major financial settlements to hit the headlines. Some of those were taking place after the meltdown.

Combine all the headline financial scandals, add to them the credit card breeches and you can easily see there is something seriously wrong, which is what he refers to as a cancer.

It is causing hidden damage (again the cancer analogy).

The effect is to slowly undercut our capitalist system.

Unfortunately, I agree.

I would argue the foundations of capitalism are actually items other than reliability of financial information. I believe the key factors forming the foundation of free enterprise capitalism are private property rights, a just legal system, and a functioning democracy. Maybe a couple of other items, but that will do for the moment.

However, if we were to substitute my suggestions for his comment of the reliability of financial information, it would only be necessary to rephrase his arguments slightly to explain that the frauds we are reading about are dangerously undercutting capitalism.

Consider just a few of these frauds: cooking LIBOR and facilitating systemic tax evasion as an intentional client service for a century (Credit Suisse comes to mind). Add more as you wish.

Those fiascos are tearing down property rights. See previous post describing why the frauds are leading to a mockery of the justice system. It is not healthy for democracy when settlements are resolved behind closed doors, with no visible rationale for the size of settlement, and with evidence either not revealed or not tested in court.

So I guess after arguing with his starting premise I still agree with his conclusion.

This is not okay

Mr. Antar says we can’t pretend everything is okay. We can’t pretend our way out of the mess we are in.

Again, I agree.

To get out of this mess and reinforce the foundation of capitalism, we need to acknowledge our current mess and then figure out some way to deal with it.

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