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November 3, 2002
David Warsh, Proprietor


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Short Takes

Slipping out the door of the Justice Department all but unnoticed some day this month will be the key figure in the last act of the Microsoft drama, Charles James. As assistant attorney general for antitrust, James threw the company a softball settlement pitch last year, even though the government had won the most important part of its case on appeal.

The attorneys general of nine states rushed to court to overturn his deal. On Friday, Federal District Court Judge Colleen Kollar-Kotelly declined to give them what they wanted. Microsoft got away with the commercial equivalent of murder — in this case, the Netscape browser.

Had Netscape been allowed to prosper, its browsers — programs known as middleware, loosely defined as the / in the ubiquitous client/server relationship ushered in by the Internet — would have and made the computer environment far more open and competitive, and rendered Microsoft’s proprietary operating systems far less profitable.

 

Granted, the 2000 presidential election was a cliff-hanger. You cannot blame George Bush for wanting to put behind him the Justice Department’s epic battle with the world’s richest man. Still, there was still something alarmingly spineless about the government’s retreat from a case in which Bill Gates repeatedly had sought to deny the government’s very authority in a variety of ways, including lobbying Congress to cut the budget of the antitrust division.

How lacking in self-confidence is the White House when it comes to economic regulation? They weren’t afraid to walk away from the bad Kyoto treaty. And they did well enough when Enron failed. But the debacle at the Securities and Exchange Commission (next item) is a disturbing sign. The real test of its stewardship will come with the appointment of the next chairman of the Federal Reserve Board.

Meanwhile, antitrust chief James, whose supporters boast that he successfully challenged 20 of 21 lesser mergers during his brief tenure (15 months), is off to his reward. He’ll become general counsel at Chevron Texaco. In antitrust circles he’ll be remembered mainly as the man who quietly folded the government’s pretty good hand.

* * *

There are three strikes now against poor Harvey Pitt, chairman of the Securities and Exchange Commission. We won’t know whether he is out until after Tuesday’s election.

It should be noted, however, that he had a master tormentor in Stephen Labaton, a talented reporter for the New York Times. Labaton tagged him all three times

The first strike came back in Early Enron Times, earlier this year, when someone slipped the reporter a memo in which Pitt argued within the administration that the SEC chairman should be elevated to a bureaucratic par with the chairman of the Federal Reserve Board and the lot of his staff improved. Alan Greenspan was still riding high in those days. The Times put the story on page one. A wave of ridicule followed.

The second time Pitt suffered at Labaton’s hands came last month when the reporter scooped the chairman on the pending appointment of pension fund chieftain John Biggs’ to head a newly-created oversight board for the accounting profession — before it had been signed off upon, much less officially announced. The story was widely interpreted as an example of Biggs’ strenuous lobbying for the job. As noted at the time by reporters Michael Schroeder and Cassell Bryan-Low of the Wall Street Journal, the story angered Pitt (who had been supporting Biggs), polarized the commission, galvanized industry opposition, sabotaged Biggs’ chances and left Pitt with no strong candidate.

The third strike came last week when Labaton disclosed that William Webster, the squeaky-clean former FBI and CIA director to whom the administration had retreated after Biggs’ candidacy collapsed, recently had been chairman of the audit committee of a company that had failed and been sued for fraud. He had told Pitt about his involvement, but Pitt hadn’t told his fellow commissioners before they voted late last month to appoint the 78-year-old former judge. His colleagues were, predictably, outraged. Privately, Pitt flailed back at the Times

The first two times Pitt had a point. The SEC has suffered from politically-motivated Congressional budgetary stringency for years. Even with recent raises averaging 14 percent, its employees make far less than their counterparts at the independent Fed. Its chairman lacks the proverbial “chair at the table” of the administration’s inner circle. And in the Biggs case, nobody wants to be dictated to by an aspirant leaking news of his impending appointment to a friendly reporter. A newspaper with more concern for fairness than the New York Times would have treated both stories differently.

Now Pitt has been undone by the pressure. The Bush Administration probably won’t decide how to respond to the most recent embarrassment until after it has seen what sort of Congress it will be dealing with for the next two years. But barring something unforeseen, then it will be time for Pitt to go — and probably Judge Webster, too. Lacking an accounting background, Webster was a stretch in the first place. There are many regulators who can do the job. A superb securities lawyer, Pitt will be harder to replace.

* * *

Anybody who wonders how former Enron Corp. chief financial officer Andrew Fastow got himself indicted on a 78-count federal criminal complaint should make a beeline to What Went Wrong At Enron by Peter Fusaro and Ross Miller.

Fusaro runs an energy consulting firm. Miller established the quantitative finance research group at General Electric before going into business for himself. Their shared sense of what constitutes an explanation is as sharp as that of the government’s lawyers — and a lot easier to read.

Their story begins with a description of the relationship of Enron’s founder Kenneth Lay with financier Michael Milken. (Lay viewed Milken as a role model, the authors say, and invited him to a private meeting in 2001 designed to enlist support for Lay’s solution to the California energy crisis., along with actor Arnold Schwarzenegger and Los Angeles Mayor Richard Riordan.) The book ends with a series of internal memos, e-mails, letters, suicide note, etc., faithfully reproduced. Their appeal is almost pornographic

 

But the real highlight, at least for those who like economics, is the passage in which the authors explain that Ken Lay, with his PhD in economics from the University of Houston, failed to understand the work of Ronald Coase. True, nobody loved markets more than Lay. And Coase was famous for the argument that many of the most perplexing problems — pollution, the allocation of scarce resources such as the electromagnetic spectrum — easily could be solved if the government simply assigned property rights and let the market work.

But “The Problem of Social Cost” was only half the reason that Coase was awarded his Nobel Prize. In “The Nature of the Firm,” in 1937, the economist argued that certain kinds of transactions, especially those involving cooperation and coordination, are too costly to assign to the market. The moral of Coase’s other story is that “Corporations, families and other social institutions are able to achieve things within their protective shells that the market mechanism, at least in its current form, simply cannot,” write Fusaro and Miller.

Like what? Like creating and retraining an honest and trustworthy workforce. Enron did its entry-level hiring in a series of “Super Saturdays,” during which candidates were grilled for 50 minutes by each of eight different interviewers with a single ten minute break. Around half of those attending were offered jobs. But having been hired, staffers were ranked every six months on the same criteria. Fifteen percent were let go every six months, and substantially more put on notice.

So from top to bottom, Enron employees were forever setting themselves up for their next job — and never mind what might happen in Houston headquarters after they were gone. “Enron’s blind adherence to a misguided notion of how to apply market discipline to its internal operation would contribute greatly to its downfall,” conclude the authors.

* * *

Ten leading New York banks last week agreed under pressure from regulators to create an independent third-party research house to distribute disinterested advice to retail investors. At first blush the scheme looks like an industry marketing board.

The banks have agreed to pony up $50 million to $100 million each for the next five years. Instead of funding research on how best to grow walnuts and sell raisins, the new institution they create will use the money to hire analysts whose work will be overseen by a blue-chip board and distributed free to the public.

Will it work to eliminate research at the banks? Probably not — no more than public television has eliminated commercial cable and broadcast TV. But it will add one more interesting voice to the chorus.

The impulse to hang onto the best information is very strong, especially in investment circles. The best analysts, enjoying the best access to the companies they cover, will continue to work for the banks. Doubtless they will find better ways of persuading investors to pay for their services.

Paying analysts out of the profits of underwriting is the practice that led to outrageous boosterism in the first place. The wave of the future probably is to be seen in Citigroup’s decision last week to put its analysts under a new boss reporting directly to the chairman, rather than to the head of investment banking.

Shallow confidence will return to markets quickly, hastened by the “All Clear” customarily intoned at the completion of this kind of mechanism design. Deep confidence, however, will require that a new generation of sophisticated regulators grow into positions of responsibility.

* * *

 

The University of Chicago is holding a conference next week to honor Milton Friedman on the occasion of his 90th birthday.

Among the scheduled speakers are John B. Taylor on monetary policy in the years after World War II; James Heckman, Martin Feldstein, Assar Lindbeck and Robert Moffitt on incentives and public policy; Caroline Hoxby on educational choice and school vouchers; Costas Meghir and Thomas Sargent on the permanent income theory; Ben Bernanke, Robert Lucas and Anna Schwartz on depression and recovery; and Gary Becker on Friedman’s philosophy of economics and public policy. The doughty professor himself will speak as well — as often as he likes.

The Friedman story is a complicated one. Jurg Niehans has noted that the Chicagoan’s narrow contributions to economics are difficult to pin down. Yet in the second half of the twentieth century, Friedman’s place bears some resemblance to that of Adam Smith two centuries before. “Inasmuch as economics is an art,” writes Niehans in his magisterial A History of Economic Thought: 1720-1980, “he represents it in all its diverse facets.

“He knows how to use theory as a guide to action, he is decisive as an army commander, as lucid as a teacher, and as articulate as a lawyer. He has a legislator’s understanding of institutions, a statistician’s respect for figures, and an econometrician’s ability to draw inferences. He derives lessons from the past, as a historian does, can talk the language of the small businessman, and has the social vision of a missionary.”

Happy birthday, Milton Friedman.

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