William Black - How Flawed Economic Theories Fail to Account for Financial Fraudsters
January 20, 2012 We continue to witness remarkable developments in the intersection of the related fields of economics, finance, ethics, law, and regulation. Each of these five fields ignores a sixth related field – white-collar criminology. The six fields share a renewed interest in trust.
The key questions are why we trust (some) others, when that trust is well-placed, and when that trust is harmful. Only white-collar criminologists study and write extensively about the last question. The primary answer that the five fields give to the first question is reputation. The five fields almost invariably see reputation as positive and singular. This is dangerously naïve. Criminals often find it desirable to develop multiple, complex reputations and the best way for many CEOs to develop a sterling reputation is to lead a control fraud. Those are subjects for future columns.
This column focuses on theoclassical economics' use of reputation as “trump” to overcome what would otherwise be fatal flaws in their theories and policies. Frank Easterbrook and Daniel Fischel, the leading theoclassical “law and economics” theorists in corporate law, use reputation in this manner to explain why senior corporate officers' conflicts of interest pose no material problem. The most dangerous believer in the trump, however, was Alan Greenspan. His standard commencement speech while Fed Chairman was an ode to reputation as the characteristic that made possible trust and free markets. I've drawn on excerpts from one example: his May 15, 2005 talk at Wharton. I find Greenspan's odes to reputation as the antidote to fraud to be historically inaccurate and internally inconsistent in their logic. Here, I ignore his factual errors and focus on his logical consistency.
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