The Founding Fathers is the name we give to the leaders who signed the US Declaration of Independence and participated in drafting the Constitution. They set up a system of governance based on the principle of separation of powers under which the state is divided into different branches, each with separate and independent powers and areas of responsibility.
Critical to the success of this style of governance is a system of checks and balances, whose purpose is to prevent any one branch of government from becoming too powerful at the expense of the others, and to induce them to cooperate in getting things done. The notion of checks and balances has become embedded in the culture of the country, not just as it applies to the federal government, but also to the balance of powers between federal, state and local governments.
It has proven to be a brilliant system of government. Not only has it endured for over two centuries, but it has done so while adapting to the vast changes that the country has undergone during that time, including its massive growth in size, population and power; the vast diversity in the composition of its people; and the highly different political beliefs, social mores and market conditions it has experienced through all that time. Its success is largely due to its built-in flexibility to adapt to vastly varying conditions. If any part of the system becomes too prominent, the other parts react to limit its powers and bring the overall system back in balance.
Getting the system back in balance has not always been easy. It has led to major confrontations, as was the case with the Civil War, when eleven Southern states declared their secession from the US central government, leading to a brutal war that resulted in massive destruction and human loss. The civil rights movement of the 1950s and 1960s is another important example in our history, where the federal government had to intervene and remind the states that the Constitution guarantees that all citizens are indeed created equal and have equal rights. A final example are the confrontations that, to a greater or lesser degree, most administrations have had with Congress concerning the limits of presidential powers.
The system of checks and balances is particularly applicable in today’s highly complex and fast changing economic environment. It is a critical factor in the relationship between government and the private sector. I think that by now, extreme, ideologically-driven positions have proved to be largely irrelevant when applied to the economy. Those on the extreme left who advocate a very strong role for government in managing the economy and a weak role for the private sector, have seen their views discredited with the implosion of communist states twenty years ago, as well as the sorry state of Cuba and the handful of remaining communist economies. Those on the extreme right advocating a minimal government role in the economy have seen their views equally discredited by our serious economic crisis.
A pragmatic system of checks and balances is clearly the answer. While most of us view the US economy as an open, free market economy, it is in fact a mixed economy, combining elements of government planning and regulations within an overall system of capitalism. To a greater or lesser extent, this is the case with just about all countries that we view as having a market economy.
Our ongoing economic upheavals offer some very important lessons in what happens when the system of checks and balances between the public and private sectors stops working.
Potential causes of the financial crisis
Many have said that the underlying cause of the financial crisis is greed. That is way too simplistic an answer. Greed has always been a part of the human condition. Powerful Darwinian forces drive the human quest for money and power, - especially in highly competitive environments like Wall Street.
In a very good article, The End in Portfolio magazine, Michael Lewis dismisses the notion that greed is the cause of the financial meltdown because, he observes, "Greed on Wall Street was a given—almost an obligation." He further says in a later OpEd, co-written with David Einhorn in the January 4 New York Times that “Greed doesn’t cut it as a satisfying explanation for the current financial crisis. Greed was necessary but insufficient; in any case, we are as likely to eliminate greed from our national character as we are lust and envy. The fixable problem isn’t the greed of the few but the misaligned interests of the many.”
Others have said that the problem was the bonus system of Wall Street, which enabled people to make huge sums of money when they have a good year, without having to worry about the impact of their short term actions on their clients, companies or society in later years. While the focus on short term results may have been more extreme and rewarding in financial companies than elsewhere, this has long been identified as a problem that afflicts all public companies.
Many studies have warned that the obsession with short-term results by investors, asset management firms and corporate managers comes at the expense of strategic value creation and can result in the demise of the company. Yet, executives of public companies continue to encounter significant short-term pressures from an increasingly transient investor base that cares little whether the company survives or not as long as they can make money from their investments – or rather - their bets.
The aforementioned Times OpEd points out that “What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term . . . But if any one of them had set himself up as a whistleblower - had stood up and said “this business is irresponsible and we are not going to participate in it” - he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.”
Given that greed and short term temptations and pressures are pretty much inevitable, you would expect that counterbalancing forces outside companies and markets would rise up to watch out for the interests of the community and society at large. This is what checks and balances should be all about. Our Founding Fathers would have expected, I believe, that the appropriate government agencies and regulatory bodies would act on behalf of the long term well-being of the public when such an imbalance occurs.
Our financial crisis seems to have been a result of a massive systemic failure in our financial systems and the checks and balances that are supposed to keep things running smoothly. Why did this happen?
Why did it happen?
It is very hard to understand the causes of a major event when you are still in the eye of the storm. But I believe that future experts will focus on two key factors as having had a big influence on this economic crisis.
Over the past three decades, the mood in the country has been anti-government. Politicians, including some at the highest level, have run for office by putting down the very government they want to be part of. In his first inaugural address in January of 1981, Ronald Reagan uttered the now famous phrase "Government is not the solution to our problem; government is the problem," a phrase as ingrained in a large segment of our country and its political leadership as JFK’s "Ask not what your country can do for you; ask what you can do for your country" from his inaugural address twenty years earlier.
Many have embraced this anti-government ideology. They must assume that there is something new out there that enables free markets to operate smoothly and self-correct as needed with minimal oversight. Alan Greenspan, who served as Chairman of the Federal Reserve for twenty years, - one of the top and most respected officials in the country charged with overseeing the financial system, - re-iterated as late as March of 2008 his conviction that the lax regulations of the last thirty years were fine, because market flexibility and open competition on their own where our most reliable and effective safeguards against cumulative economic failure.
Finally, in Congressional testimony on October 23, 2008, Greenspan acknowledged that he was partially wrong in opposing regulation and stated "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity - myself especially - are in a state of shocked disbelief."
I am a very strong believer in free markets - not out ideology, but out of pragmatism. I believe that while free markets are often chaotic and unrestrained, they generally produce the right results. But, free markets cannot possibly work unless they are open and transparent. And, as we have been learning, our financial institutions still don't know what assets they own, let alone the value of the complex products they sold over the last several years.
This is not the way market economies are supposed to function. In the last few years, our financial markets have been as open and transparent as a swamp. You would think that those charged with overseeing the smooth functioning of the financial systems would have noticed this lack of transparency and would have done something to correct the problem. Clearly, the anti-government, anti-regulatory ideology caused the checks and balances pendulum to swing too far toward one end.
Personally, I view the highly disruptive nature of our global markets, business environment, and technological infrastructure, as further proof that we are in the middle of a historical transition from the industrial age of the last couple of centuries to something else - perhaps a knowledge-based or information age. We should not be surprised that given the massive changes accompanying such transitions, they are truly disruptive to the many people and institutions that came of age in decades past. It takes time - many years - to get used to and successfully adapt to all those changes. Perhaps we have to wait for coming generations now growing up for society to be fully comfortable in these new environments.
One thing is clear. As per the famous Chinese curse, we are indeed living in interesting times.