Part Two

THE FAILURE OF CAPITALISM

After the egregious financial speculation, the stock market crash, and the deep economic recession of 2007-2009, even the most articulate and powerful believers in the ability of free markets to regulate themselves came to recognize that modern-day capitalism has failed our society. In a stunning admission, Alan Greenspan, former chairman of the Federal Reserve Board, conceded that he had found “a flaw in the model that I perceived as the critical functioning structure that defines how the world works.” An equally surprising concession came in a 2009 book from widely respected federal judge Richard Posner, a leader in the “Chicago School” of laissez-faire economics. Its title gets right to the point: A Failure of Capitalism.

I begin Part Two seeking to answer the question, “What Went Wrong in Corporate America?” In 2003, when I delivered this lecture at the Community Forum of the Bryn Mawr (PA) Presbyterian Church, the handwriting was on the wall: “stock market mania . . . the rise of the imperial chief executive officer . . . the failure of our (corporate) gatekeepers . . . the change in our financial institutions from being stock owners to stock traders. . . .” It turns out that the burst in the stock market bubble that I described in those remarks would, but five years later, be echoed in the burst of a real estate bubble that would lead to an even larger stock market collapse and the worst recession in the U.S. economy since the Great Depression. While I was belatedly aware of the mortgage mess, it was of a piece with the financial manipulation of corporate America that I describe toward the close of Chapter 6.

From the perspective of 2009, I examine the after-effects of the numerous failures in our system of free-market capitalism in Chapter 7, “Fixing a Broken Financial System.” I illustrate my main points with three examples: Alan Greenspan and his apologia; Bernard Madoff and his Ponzi scheme; and President Barack Obama’s articulate response to this failure in his inaugural speech, calling for “a new era of responsibility.” Despite the awesome question facing our society—whether we have enough character, virtue, and courage to reform the system—I strike an optimistic note on the financial crisis that America has endured: “This, too, shall pass away.”

The failure of capitalism is in large measure a failure of personal and professional values. When I was asked in 2007 to present a lecture at Princeton University on the subject of “vanishing treasures” in our society, I chose to illustrate the subject with the loss of “Business Values and Investment Values,” which is the title of Chapter 8. The main points are: (1) Modern-day business standards have come to overwhelm traditional professional standards; and (2) our once-triumphant ownership society has been supplanted by a new agency society in which our institutional investor/agents have placed their own interests ahead of those of their principals, whom they are duty-bound to serve. Unless we build a new fiduciary society that demands virtuous conduct and a return to traditional values, I conclude that the treasures that made American business the dominant force in our nation’s growth will indeed vanish. My 2009 op-ed essay in the Wall Street Journal—“A Crisis of Ethic Proportions”—concisely summarizes these views (Chapter 9).

In Chapter 10, I explain the failure of capitalism in part by the inevitable failure of the laws of probability when applied to the financial markets. As I examine the role of risk in the financial markets, I rely on the famous “Black Swan” formulation of the British philosopher Sir Karl Popper (1902-1994) to describe surprising events that are “outliers,” beyond the realm of our regular expectations. In “Black Monday and Black Swans,” published in the Financial Analysts Journal in early 2008, I draw the distinction between risk (an event with measurable distributions, such as a roll of the dice, even our mortality) and uncertainty (which is, simply put, immeasurable). The American economist Hyman Minsky (1919-1996) was right on the mark when he pointed out that rampant speculation in our financial sector inevitably flows over into our productive economy. In accord with his finding, I close by noting that “some surprising event . . . will surely come to pass . . . when it comes, [it] will be just one more Black Swan.” That view was promptly validated by the market crash that followed.

That we cannot seem to learn from our historical experience in market crashes is illustrated in Chapter 11. In “The Go-Go Years,” I go way back in time to describe the boom and bust in the wild and crazy era that began in the mid-1960s and essentially continued until the stock market collapse of 1973-1974. In this essay for a new edition of “Adam Smith’s” Supermoney in 2006, I described my role as a witness to, and a participant in, this era. My own involvement with go-go investing proved to be a personal and professional disaster, but ultimately led to the creation of the Vanguard Group as an antidote to the insanity. While I paid a heavy price in terms of my career, I learned from it, and gained the perspective that helped me anticipate, first, the market crash of 2000-2003, and then the market crash of 2007-2009. Investors will, I pray, learn from these painful lessons of financial history that have recurred over and over again for centuries.