I think most investors are like me. So this begs the obvious question: what keeps those CEOs from running off with all our money?!
The fact that I do invest shows I have remarkable confidence in our financial system. That confidence is based on history, the fact that firms and CEOs have been honest and transparent enough in their accounting and that, over the long run, the stock market has performed extremely well. The long sweep of history says I'm crazy not to invest.
But then I look at recent history and I wonder how the long history came to be. Honest and transparent are not adjectives that come easily to mind when looking at our modern financial system and events over the last decade.
This issue is in fact the lynch pin to modern capitalism. At a fundamental level what makes it all work is to having institutions that deal effectively with asymmetric information (the econ jargon). If one cannot see exactly what they are buying with their investment money, little investment will take place, and economies don't grow. So modern capitalism requires rock solid institutions that reduce information asymmetries and allow dollars to flow toward investments with the greatest potential returns.
This is why, back in 2002, Paul Krugman made what I think was his most polemic prediction ever:
I predict that in the years ahead Enron, not Sept. 11, will come to be seen as the greater turning point in U.S. society.Many, including me, thought this was a bit much, even if Krugman made some good points in that old column.
His column today, a tribute the naughties, echos similarly to his 2002 prediction. He quotes Larry Summers from over a decade ago:
If you ask why the American financial system succeeds... at least my reading of the history would be that there is no innovation more important than that of generally accepted accounting principles: it means that every investor gets to see information presented on a comparable basis; that there is discipline on company managements in the way they report and monitor their activities.So, in 2002 Krugman was worried about the collapse of our financial institutions and saw Enron as an omen. He must have figured if our finanical institutions were to collapse, that would be more ominous that the 3-4000 killed on 9-11. And if our finanical institutions didn't collapse, they would somehow have to be reinvented and made more sturdy, which would be a major turning point itself.
And here we are. Things didn't collapsed completely but it wasn't pretty. While we've begun to recover (barely) many problems still need fixing, particularly re-regulation of financial markets.
I still think Krugman overstepped when he made that prediction in 2002, not just because the Enron fallout blew over relatively quickly, but because the sweeping fallout of 9/11 has been so great. But today I do think there is a chance--a greater chance than I believed back in 2002--that Krugman's prediction might eventually turn out to be right after all.
But I've still got my money in stocks. Why? Because if things fall apart completely it won't matter where my money is sitting.