Tuesday, January 27, 2009

The Economics of Satyamisation.

The following article by Jayati Gosh explains the Phenomenon of Satyamisation – of 'Control Fraud', that is a fact of the capitalistic economy with less or ineffective regulations, as excerpted from Mr William Black's book.

The Indian scene offers two pictures in contrast of the now surfaced 'Satyamisation'.

On the one side, the question looming large in our minds is whether Satyam is a lone aberration? With corruption having come to stay in endemic and epidemic proportions, can we say that one is honest only as long as he is not caught? If we start looking at other major business houses, will there be anyone left to throw the first stone at the offender as Lord Buddha told? The phenomenon of "control fraud", eclipsing modern business practices lends credence to this question.

On the other side, we have corruption of mammoth proportions of the politically powerful. The 8,000 crore Satyam scam pales into insignificance, in the face of 80,000 crore Spectrum scam. Atleast in the case of Satyam, there is some solace that it was a by-product of a business, where the money had gone into growing business, in generating employment and revenue. But where has the Spectrum scam money gone? How many jobs it generated? How much revenue it brought for the country? And there is another question, are we living in a world of two types of corruption, positive corruption of the Satyam kind (of Business class) and negative corruption of the Spectrum kind (of Political class)? Should we not ask these questions too??


Related post on horoscope of Ramalinga Raju:-



Markets don't regulate, they abet 'control fraud'


Jayati Ghosh


THE SATYAM saga gets more and more amazing by the day, with extraordinary revelations about the extent to which the Raju family was apparently able to siphon money out of the company they controlled. As the murky details emerge, it is tempting to bemoan the poor state of industry supervision in the Indian corporate sector and see this case as an example of how Indian regulatory standards are not yet up to the standards set in the West. Indeed, that is how several analysts, both in India and abroad, have interpreted it.

But the truth is that instances like Satyam are neither new nor unique to India. Similar — and even more extreme — cases of corporate malfeasance abounded in the past decade, across all the major capitalist economies, especially in the US. And these were not aberrations, rather typical features of deregulated capitalist markets.

Furthermore, there is also quite detailed knowledge about the nature of such criminal tendencies within what are supposedly orderly capitalist markets. Four years ago, at a conference in New Delhi, the American academic William R. Black spoke of how financial crime is pervasive under capitalism. He knew what he was talking about: as an interesting combination of lawyer, criminolo gist and economist, he recently authored a bestselling book on the role of organised financial crime within big businesses.

This book — The Best Way to Rob a Bank Is to Own One: How corporate executives and politicians looted the S&L industry — is a brilliant exposé of the savings and loan scandal in the US in the early 1980s. It received rave reviews, with the Nobel prize-winning economist George Akerlof calling it a modern classic and praise came from all quarters including the then chairman of the US federal reserve, Paul Volcker.

In his book, Mr Black developed the concept of "control fraud" — frauds in which the CEO of a firm uses the firm itself, and his/her ability to control it, as an instrument for private aggrandisement. According to Mr Black, control frauds cause greater financial losses than all other forms of property crime combined and effectively kill and maim thousands.

Control fraud is greatly abetted by the incentives thrown up by modern executive compensation systems which allow corporate managers to suborn internal controls. As a result, the organisation becomes the vehicle for perpetrating crime against itself.

This was the underlying reality in the savings and loan scandal of the early 1980s that Mr Black used to illustrate the arguments in his book. But it has been equally true of subsequent financial scams that have rocked the US and Europe — from the scandal around the Bank of Commerce and Credit International (BCCI) in the UK in 1991, to the Enron, Adelphia, Tyco International, Global Crossing and other scandals in the early part of this decade, to the Parmalat Spa financial mess in Europe, to the recent revelations around accounting practices of banks and mortgage providers in the US in the current financial crisis.

The point is that such dubious practices, which amount to financial crime, flourish during booms, when everyone's guard is down and financial discrepancies can be more easily disguised. This environment also creates pressures for CEOs and other corporate leaders to show, and keep showing, good results so as to keep share prices high and rising. The need arises to maximise accounting income and so private "market discipline" actually operates to increase incentives to engage in accounting fraud.

This intense pressure to emulate peers in a bull market, and deliver "good" results even if they are fake, is a well-known feature of financial markets which intensifies extant problems of adverse selection and moral hazard. According to Mr Black, "This environment creates a 'Gresham's Law' dynamic in which perverse incentives drive good underwriting out of circulation".

Mr Black further argues that the tendency for such control fraud has greatly increased because of neoliberal policies that have reduced the capacity for effective regulation. According to him, this operates in four ways: "First, the policies limit the number and quality of regulators. Second, the policies limit the power of regulators. It is common for the profits of control fraud to greatly exceed the maximum allowable penalties. Third, it is common to choose lead regulators that do not believe in regulation (Harvey Pitt as chairman of the SEC and, more generally, President Reagan's assertion that 'government is the problem'). Fourth, it is common to choose, or retain, corrupt regulatory leaders. Privatisation, for example, creates ample opportunities, resources, and incentive to corrupt regulators".

"Neo-classical economic policy further aggravates systems capacity problems by advising that the deregulation, desupervision and privatisation take place very rapidly and be radical. These recommendations guarantee that even honest, competent regulators will be overwhelmed. Overall, the invariable result is a self-fulfilling policy — regulation will fail. Discrediting regulation may be part of the plan, or the result may be perverse unintended consequences." "Neo-classical policies also act perversely by easing neutralisation. Looting control frauds are guaranteed to produce large, fictional profits. Neo-classical proponents invariably cite these profits as proof that the 'reforms' are working and praise the 'entrepreneurs' that produced the profits. Simultaneously, there is a rise in 'social Darwinism'.

The frauds claim that the profits prove their moral superiority and the necessity of not using public funds to keep inefficient workers employed. The frauds become the most famous and envied members of high society and use the company's funds to make political and charitable contributions (and conspicuous consumption) to make them dominant." "In sum, in every way possible, neo-classical policies, when they are adopted wholesale, sow the seeds of their own destruction by bringing about a wave of control fraud. Control frauds are a disaster on many different levels. They produce enormous losses that society (already poor in many instances) must bear. They corrupt the government and discredit it. They inherently distort the market and make it less efficient.

When they produce bubbles they drive the market into deep inefficiency and can produce economic stagnation once the bubble collapses. They eat away at trust." Mr Black's analysis is extremely relevant for India today. Not only because it shows how widespread the problem has been in other countries, but also because it suggests that it could be much more widespread even in India than is currently even being hinted at. It is also very important because it shows how much of the problem is essentially due to policies of deregulating financial practices and implicitly encouraging lax supervision, often as part of the mistaken belief that markets are good at self-regulation and can control the ever-present instincts of greed and the desire for individual enrichment at the cost of wider social loss.

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