Risk & Other Four-Letter Words

Wriston, Walter B.


From Adam to George, from 1776 to 1984


All of us remember the old Charlie Chaplin film depicting a man caught up in a huge machine. Despite his best efforts, he became a cog in the turning wheels of the machine he was trying to fix. Those old machines are gone now, but they have been replaced by a new kind of dilemma. The mechanical machines are now electronic, and instead of running around with a wrench and an oil can, we are condemned to filling out endless forms replete with warnings of dire consequences concerning entry of false data. While this is part of modern life, I would pose two questions: First, what is it we are really trying to do? Second, does what we are now doing help us achieve the desired result?

To put those questions in context, it is necessary to recall that there are still only two basic models of human organization: the authoritarian in its many guises, and the democratic. In its simplest terms: power from the top down or the bottom up. That thread of political evolution is inextricably linked with economic theory and practice in the nations of the world.

In our political evolution, Americans drew heavily on the ideas of British thinkers, especially John Locke, and, in a sense, went even further by adopting a Constitution based on the


accuracy of Lord Acton's dictum that "power corrupts and absolute power corrupts absolutely." That belief led to the explicit division of powers among our President, our Congress, and our courts.

This constitutional separation of powers gives us a few bad moments from time to time. The orderly formation of policy sometimes appears to be frustrated. Our system is untidy, it is difficult, and it is further confused by the fact that the media occasionally anoint one or another arm of our government and proclaim its ascendancy. Everyone remembers reading about the imperial President, or the primacy of the Supreme Court when President Roosevelt claimed progress was being blocked by nine old men. Most recently, Congress was accused of running five hundred and thirty-five State Departments. But with it all, the main purpose is achieved individual liberty in America has been not only preserved but enhanced. There are few countries on earth that have enjoyed that experience.

It was more than a matter of luck. The political concepts we imported from England happily coincided with the economic ideas of Adam Smith and together they provided the basis for the remarkable growth of the American nation in the nineteenth century. By coincidence, Smith's was published in Scotland in the same year as our Declaration of Independence was proclaimed in Philadelphia.

The name Adam Smith is probably best known today as the pseudonym of a popular writer and television commentator on financial matters, so it is worthwhile to recall that the original Adam Smith was a somewhat eccentric Edinburgh professor of Political Economy and Moral Philosophy, as the dismal science was called in those days. Though he was apt to walk in the rain without his umbrella or start for his lecture hall not fully clothed, Adam Smith's intellect was crystal-clear. He viewed the dawn of the Industrial Age and grasped its potentials while the conventional wisdom of his era was still wedded to restrictive mercantile principles. Smith sensed, long before


others, that free markets could unlock a torrent of economic expansion leading to a better life for all, in stark contrast to the static mercantilist partnership of state and business that set limits for products, production, prices, and profits and distributed the benefits to a favored few. Though a devoutly religious man, Adam Smith was a pragmatist who had few illusions about his fellow man's altruistic instincts. His opinion of businessmen was particularly realistic, to say the least:

He generally . . . neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain and in this as in many other cases, is led by an invisible hand to promote an end which was no part of his intention .... [But] by pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it. I have never known much good to be done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

My friend Professor George Stigler, one of our Nobel laureates in economics, has observed that "unfortunately, in a rare display of reticence, Adam Smith failed to tell us what those few words are."

The truth is that the Father of Capitalism did not have a high opinion of capitalists. What he understood was that multitudes of human beings pursuing their own best interest will ultimately produce a sort of common denominator from which we all have a chance of getting the best available deal at the moment. This state of affairs also has a way of liberating a great deal of human energy, directing it toward finding better or cheaper ways of doing things. He also understood that the diffusion of power, both political and economic, could and


would create the conditions for human freedom and economic innovation. All power, no matter how derived, either from the bottom up or the top down, can be arbitrary. Only in the multiplicity of power is there safety.

Smith's desire to keep government's hands off business had nothing to do with protecting business from government. On the contrary, it was his knowledge that whenever business and government walk hand in hand, the inevitable result is to afford some businessmen the opportunity to keep others out of the marketplace. He did not consider this to be in the interest of the consumer-or, as Smith might have said, the common man. What it gets you is higher prices and less innovation, and there are plenty of examples of that right up to our own time.

Smith didn't think much of governments' proclivities to tax, either. He noted that "there is no art which one government sooner learns of another, than that of draining money from the pockets of the people." That observation is some two hundred years old but it still has a certain validity.

The link between free markets and free men and women has been apparent to all who would look, because a directed economy must, in the end, be backed by governmental edict to function at all. Absent such force, markets will let individuals decide how to allocate their own time and money, and this will often be at variance with the central plan, or whatever euphemism for it is in vogue at a given moment.

Any central economic plan involves choices because resources, no matter how large, are still finite. Since few of these choices can be put to a majority vote, more and more are assigned to experts, who then substitute their judgment for the market. It is a poor trade. The market is the greatest data processor in existence. It adjusts for things seen and unseen in a way no single person can perceive. Its ability to sift through the mass of data and arrive at a conclusion on everything from the dollar-yen cross-rate to the price of a given product is frustrating to people who believe a particular professional discipline should have more influence on prices than it has.


The fact that the market makes judgments at variance with what you and I might regard as the "correct judgment" based on our perception of the "facts" in no way alters the reality of the efficient market.

The alternative is a world in which, as Milton Friedman has said, "whatever is not compulsory is forbidden."

In our democracy, public policy results from the complex interaction of what people think an economic and political system should be and what they believe it to be at the moment. It is the disparity between what they conceive of as the ideal and what they perceive as real that fuels the engine of social change. Both concepts, the ideal and the real, have always been influenced by the pamphleteer or his equivalent, which nowadays may range from a respected think tank to a rock composer.

The difference between then and now is that the scholarly ideas of Adam Smith or the incendiary words of Thomas Paine were read by a few hundred people, but the staged demonstration at a nuclear plant enters fifty million living rooms on the evening television news with devastating effect.

The impact of this continuous flow of fact, fiction, data, information, and misinformation has had a profound effect on American society in general and on business in particular. We have become the first human society to live in a state of what the late George Gallup called "a continuous audit."

The power of the computer has played no small role in creating this unlimited proliferation of data. Consequently, it is always possible to look back and find a piece of the data somewhere in the memory banks to prove that somebody knew something years ago and failed to act upon that information responsibly or acted in violation of some law or regulation. As long as the trail is wide and long and prolix, which the computer assures it will be, commentators, lawyers, and regulators can dig through a billion pieces of paper, or their electronic equivalents, as they did in the long-playing International Business Machines and American Telephone and Telegraph antitrust suits, until it becomes statistically inevitable


that any given proposition can be after the fact.

That one item may range from the presence of a Russian brigade in Cuba that appears and reappears like the Cheshire Cat, sitting on an international limb, to a loan or an investment that goes bad, thereby proving to the critics that it should never have been made in the first place. This continuous audit cannot fail to have a significant and inhibiting effect on the way we conduct our affairs.

Just as we find it increasingly difficult to determine we know something, so it is also more difficult to decide we know, for the line has been blurred between random information and the reality about which we need to be informed. Indeed, it can be argued that the importance of the legal and regulatory paper trail has made the manual of procedure more important than the act itself. We resemble the line from , when Professor Higgins says that "the French don't care what you do, actually, so long as you pronounce it properly." We have become so entranced with pronouncing it properly in our electronic data entries that we sometimes forget what it is we are trying to do. The production of statistics and reports has become an end in itself, and threatens to lead us into a new form of mercantilism in electronic disguise. Adam Smith would have no trouble in seeing where the miles of printouts lead.

It might add to our perspective a bit if we reminded ourselves where we got the word "statistics" in the first place. It was given to us by a Scottish gentleman named Sir John Sinclair, who imported it from Germany in 1791 and used it in the title of his book, . The German term, he tells us in his preface, did not quite describe his own purposes. Sir John was interested in "the quantum of happiness enjoyed by the inhabitants and the means of its improvement," but in Germany the word Statistik was confined to matters concerning the political strength of the state. A case can be made that the original German concept of statistics is now working its way into our country on the back of the technologically driven data explosion.

Underlying the whole process is, of course, the revolution that began with the first electronic computer in 1945. Every item in business today leaves an electronic trail-of research, development, design, manufacture, distribution, marketing, and accounting. We find the laws and regulations concerned more with assuring a clearly marked trail than with the final results. A single number, which appears to be finite, is itself the end result of many guesses and can be, and often is, communicated worldwide in minutes. We have reached the point where the statistics of the gross national product or the composite index of leading indicators can cause a major rally or slump on Wall Street when released. In that situation, the index is not a statistical report what is happening in the world. Publication of the statistic the happening, even though the number probably will be revised in a few weeks.

Governments have fared no better. There is more than a little truth in the remark of a former British Chancellor of the Exchequer that there was no balance-of-payments problem in the nineteenth century because there were no balance-of-payments statistics. In fact, nobody ever attempted to work out the statistic before the 1930s. The old-time policymakers only dimly realized that it might theoretically exist. They looked instead to the movement of gold reserves, and if that was creating a problem, it was usually something that could at least wait until after lunch.

Today, any government in the world that announces a change in its fiscal or monetary policies can find out in a matter of minutes what the world thinks of the development by watching the exchange rate on its currency, which alters almost instantly in the money markets in London, Zurich, or Tokyo. The old gold exchange standard of yesterday has been replaced by an electronic information system that can be more or less harsh than the gold standard but, in the end, is just as sure and just as certain.

The incessant production of new data and its instantaneous communication throughout the world thus creates a paradox: Information, which we have always viewed as the thing that


eliminates uncertainty, now increases everybody's feeling of insecurity because of the failure to convert data into knowledge.

That feeling of insecurity, in turn, creates an insatiable demand, both in public opinion and in the halls of government, to "get things under control." If we subjected our health to the same process, we would take our blood pressure every hour. That drumbeat of data could lead us to the conclusion that we are very sick men and women when in fact we are only measuring the normal rhythm of life.

The resultant hypochondria is providing a ready market for the peddlers of miracle cures in bottles of all shapes and sizes. What they have in common is almost always a label that reads "to be taken with large doses of government intervention."

Under the banner of protecting the small investor, the Securities and Exchange Commission now requires reams of data that are so comprehensive no small investor could possibly get anything out of them. The requirement to produce these data clearly is part of an effort to control the governance of American business, rather than arising from any concern to protect the small investor.

One of my Walter Mitty dreams was to be allowed to keep the books of Citicorp the same way for two years in a row so we, and our stockholders, would know how we were doing. That never happened; each year brought mandated accounting "improvements," which supposedly had a sound conceptual base but, nevertheless, changed the numbers in greater or lesser ways, making it difficult to interpret results on a consistent basis. While consistency may be the hobgoblin of little minds, as Emerson said, it also has its uses. Disclosure, the touchstone of investor protection, became stylized like a Kabuki dance while information presented in other formats was regarded by some as offering no real protection. This point of view reached its level of when a legislative committee of New York State held hearings to imply that bankers did not make full disclosure about what


they knew about New York City's finances. At a hearing, I held up the front page of the New York , a newspaper that then had the country's largest circulation. The headline, covering the entire front page, read "City Broke." I argued-not unreasonably, I thought-that a paper read by millions of people constituted full disclosure. And yet some people, with straight faces, advanced the notion that since it was not in fine print in a prospectus, this was not true disclosure. In the end common sense prevailed, but it was a near thing. If the purpose of disclosure is to warn and inform the investing public, certainly the front page of the is at least as effective as a 10K. On the other hand, if the goal is not really to inform but rather to conform to a requirement for completing a form devised by lawyers in a certain way, it is inadequate. So we return to the first question I posed: What are we trying to do? It seems to me what we should be trying to do is to produce reliable, timely, informative data within an understandable framework that allows people to make informed judgments.

Clearly, we must have a set of standards if we are not to have chaos. At the same time, statisticians, accountants, and the regulators who have the power to mandate reporting rules must come to grips with the question of what information is relevant for decision-making. I would suggest that they use the old adage "Less is more" as their guide. Our ability to discern what is important and what is not may be impaired if one is inundated by a sea of numbers. Too many numbers may make the decision-making process harder, not easier.

All of life is the management of risk, not its elimination. We can have too much exercise, or too little; too much food, or too little; too much medical attention, or too little; take too much risk with our investments, or too little. Increased disclosure may help reduce ignorance-induced risk but can never protect against the natural risks inherent in decision-making. When I started out as a credit officer, I used to go down the street to a lending officer at another bank and ask him, "Is company X's credit any good?" He would say "Yes" or


"No." And that was a credit check. The assumption today is that more and more statistics make life less dangerous, but the high number of loan write-offs and bankrupt companies fail to prove the case.

Of more significance is the fact that the mere production of all these data is pushing business back to a discredited form of economic policy that has been dressed up in new fashions which appeal to some modern business managers. It was packaged most attractively by a former President of the United States, who once referred to it in a State of the Union address as a partnership between government, business, and labor.

For such a partnership to exist, we would have to adopt the view that business has become a separate class with interests independent of those of its owners and employees. We would also have to accept the proposition that the almost three million workers in the federal government are no longer the servants of the citizens, as envisioned by our Constitution, but also have become a separate estate, with interests distinguishable from those of the people they are elected or appointed to serve.

Once one swallows that premise, logic would suggest that there has been a separation of ownership and management of the American corporation. That, in turn, is used to make the argument that the corporation has a life of its own, independent of its owners and their interest. Doubt is thus cast upon the corporation's legitimacy. Data are then produced to show to the prosecutor's satisfaction that the corporate power to influence output, employment, and the income of millions of Americans is growing year by year. The historical justification for private ownership of the means of production-namely, that it would produce via the force of competition in the marketplace the highest social product-appears to have been undermined. The length of the road we have come can be measured by two incidents: first, the flap caused in 1953 when Charlie Wilson supposedly said that what was good for General Motors was good for America, and second, when the Ninety-sixth Congress bailed out the Chrysler Corporation


and thereby repealed the right to fail as public policy.

Private ownership has become so subverted that the employees-including the professional managers-have become wards of the state. Indeed, the bailout of the Chrysler Corporation by the federal government, as a denial of the right of private owners to fail, logically leads to the denial of the right to succeed. If all this is accepted, it becomes clear that so-called excess earnings are now justifiably claimed by government. The chain is complete in which the government has transferred the wealth of savers and equity holders to others in our society. Since markets cannot be fooled over time, this massive income transfer is reflected in the fact that the real rate of return on the Standard and Poor common stock index has been negative since 1967.

The litany of what we have done to effect this transfer of wealth from the saver to the spender would make the old mercantilists green with envy.

It all adds up to a kind of modern mercantilism in electronic clothing that is packaged as partnership. However flattering this partnership role might seem, and it is very attractive to some businessmen, there are at least two things wrong with it. First, it contradicts the basic American principle that our society is a collection of individuals, not institutions, and that the basis of our political liberty is individual liberty. Carried to its logical conclusion, this view of society must ultimately replace the idea of the individual as the center of our society with the notion of the . The second thing wrong with the partnership concept is that to the extent that it succeeds, it will be an economic disaster. It replaces economic competition among various entities with political competition. It creates an environment in which a corporation's well-being depends less and less on its ability to produce a salable product or service and more and more on its ability to secure a favorable interpretation of some obscure subparagraph in the .

Corporations are the economic agents of the people just as surely as governments are their political agents. The failure to


preserve this distinction between the proper roles of economic agents and political authorities threatens to politicize all economic decision-making. To the extent that occurs-and, in fact, it already has begun to occur-it will impair fundamentally the capacity of the business system to provide jobs and raise productivity. Once the economic marketplace is replaced by the political process, what Franklin Roosevelt called "the great arsenal of democracy" will be replaced by a shrinking pie with special-interest political groups fighting over their share. The state will become the receiver in bankruptcy of impotent individual responsibility.

In the short run, some corporate managers are tempted to participate in the political game to curry favor, and many have done so in the belief that the survival of their enterprises depends on it. But the longer-term result of this business political strategy is to bring all decisions concerning output, employment, and resources allocation to Washington. Once that is achieved, one of its worst effects-resulting from a flood of regulations, laws, and publicity-is the creation of a powerful incentive to avoid risk of any kind.

The process tends to nullify the capital value of organizations designed to make economic decisions on economic grounds. Although there are undoubtedly many reasons for the significant decline in the real market value of American corporations, this phenomenon surely has to rank as one of the most important.

We have revived Colbert's ancient and disastrous system of "restraint and regulation" from the court of Louis XIV with an efficiency beyond anything he could have dreamed or imagined. Today, it is even more dangerous because we have something Colbert lacked. We have computerized data. The combination of mercantilist ideas with the torrents of information that inundate American society may be a greater threat to the survival of our system of democratic capitalism than the Great Depression or World War II.

Oliver Wendell Holmes once remarked that there are times when "we need education in the obvious more than


investigation of the obscure." What needs to be made obvious today is that the solutions concocted by Colbert and Louis XIV will not work any better on the floppy disks of computers than they did in the Hall of Mirrors at Versailles.

What needs also to be made obvious is that you and I who have enjoyed that rarest of commodities, economic and political freedom, have a responsibility to preserve and protect it for our successors as our forebears did since 1776. More than two hundred years have elapsed since John Locke and Adam Smith laid the foundation for the benefits we enjoy today. Those benefits are not enshrined in a perpetual contract but rather in one that requires continual renewal. George Orwell reminded us of that necessity in his gloomy view of a future society, dominated by Big Brother, in which there was no freedom, no privacy, no individuality. He wrote:

The party . . . sought power because men in the mass were frail, cowardly creatures who could not endure liberty or face the truth, and must be ruled over and systematically deceived by others who were stronger than themselves. That the choice for mankind lay between freedom and happiness, and that, for the great bulk of mankind, happiness was better.

As it turned out, Orwell was wrong-at least in his timing. The year 1984 came and went and although Big Brother is uncomfortably pervasive in our lives, he is being held at bay. Part of the reason the grim society Orwell predicted did not materialize is that a free economic system and political freedom go hand in hand.

Adam Smith's invisible hand still produces more for most people than the heavy authoritarian hand of George Orwell's Big Brother.