Spitzer's New Deal
This year New York State Attorney General Eliot Spitzer has focused his attention on Wall Street and ending the spree of corporate crimes that have sprung up this year.
Spitzer has already reached a $100 million settlement with
Merrill Lynch & Co. over allegations that the firm privately criticized
stock while publicly praising the same stock to help maintain an investment
While it is a good thing that Attorney General Spitzer is trying to end this rash of corporate crime, he may-at the same time-be stifling the efficiency of the markets.
Although it is very true that the alternative (letting investment banks and CEO's lie about earnings and firm profitability) would have had a much worse impact on the markets and the economy as we are seeing now, an overreaction by prosecutors and regulators could have a profoundly negative effect as well.
An overreaction by prosecutors and regulators could cause analysts to be weary of giving firms positive ratings in the fear of being prosecuted for doing so without good cause. Furthermore an overreaction could cause CEO's and other executives to become extremely weary about taking chances with risky investments.
While it is true that both analysts and executives should be weary of the risks involved in both of these situations, it also true that an overreaction could cause analysts and executives to be too cautious. The down side of this scenario is that this could prevent capital from getting to the firms that deserve it, resulting in the misallocation of capital. The misallocation of capital, although due to improper information about companies, is the cause of our current and much more serious economic woes than an overreaction would cause.
Attorney General Spitzer should be acting out against people like former WorldCom CEO Bernie Ebbers. However, using ground breaking legal theories to do so may be a little dangerous. The conviction of different Wall Street figures, such as Martha Stewart, based on these radical theories could provide the legal precedence for further construal or interpretation of securities law that will make many analysts and executives very queasy about their decisions.
Right now investors are so uneasy about the state of corporate America that they jump at moments notice from stocks to the relative security of bonds. This is why we are seeing such high levels of volatility in the markets. This is one of the reasons the economy is still struggling. Granted, the conviction of corporate crooks will help soothe the worries of investors, but at the same time the daily news of more and more firms and employees being brought up on charges is as equally upsetting.
There is a very fine line to walk here. Prosecutors and regulators want to set a strong tone in corporate law that will hopefully prevent further corporate malfeasance, but at the same they should not go to far. In other words, people in the position of Attorney General Spitzer should not make the end of corporate corruption the backdrop of their political platform. This is the type of action that will lead to an overreaction, and most likely more economic troubles. Even if economic troubles resulting from an overreaction are less problematic than those that have resulted from corporate crimes, it does not mean that these crimes should be ignored.