<http://www.forbes.com/forbes/2002/1223/234_print.html>
Forbes - 85th Anniversary issue - December 23, 2002
The Confidence Game
Why I trust the most disgraced chief executive more than I do the most reputable public servant.
George Gilder
Why do I trust Gary Winnick and Jeffrey Skilling--nefarious former chief executives of notoriously bankrupt companies--more than I trust Senator John McCain of vaunted valor in prison camps or David Broder of Pulitzer fame or Senator Joseph Lieberman of famously flinty integrity? Why do I trust Kenneth Lay of Enron (otc: ENRNQ - news - people ) and Bernard Ebbers of WorldCom (otc: WCOEQ - news - people ) more than I trust Justices William Rehnquist and Antonin Scalia, the stalwart intellectual leaders of a nominally conservative Supreme Court, or even George W. Bush, that most trusted of Presidents?
Why do I trust General Electric (nyse: GE - news - people ) chief emeritus Jack Welch or AT&T (nyse: T - news - people ) Chief Michael Armstrong more than I trust the entire scientific and environmental coverage in the New York Times and all the venerable editors of the increasingly political Scientific American? Why do I trust Martha Stewart and ImClone (nasdaq: IMCL - news - people )'s Sam Waksal far more than I trust the crusading journalist James B. Stewart or New York State Attorney General Eliot Spitzer, trustbuster deluxe, as they righteously seek to banish moneylenders, marketmakers and conflicts of interest from the temples of Wall Street?
The reason I trust disgraced executives more than politicians, judges and journalists is the same reason that I trust physicists more than I trust sociologists. The answer comes from the eminent philosopher of science Karl Popper: falsifiability. In science, falsifiability means that a hypothesis is presented with sufficient rigor to be proven wrong, that is, falsified. It is the condition of trust. By contrast, the sociologist deals in broad propositions--such as "ethnic diversity improves educational outcomes" or "patriarchy causes war"--that, by sinking into a mush of definitions, defy disproof.
Except when conducting trials of identifiable crimes such as murder or assault, judges are no more truthful than politicians or journalists. They all adhere to the "ring-true" standard of sociology rather than the falsifiable standard of physics. Most of the time, as physicist Wolfgang Pauli put it in another context, they are not even wrong. Their statements lack the rigor to rate as lies and swim in the ontological soup of the verb "to be." From such a soup, no enduring truths can evolve.
Like a physical experiment, every entrepreneurial venture embodies and tests a hypothesis about products or markets. Intel is currently preparing to test the hypothesis that computer companies will choose a microprocessor that runs at 3 gigahertz, or 3 billion cycles a second, and will buy it in sufficient volumes that Intel can profitably manufacture it in a plant that costs $2 billion to build and equip. Samsung is testing whether people will buy a cell phone that takes digital photographs. Ebay (nasdaq: EBAY - news - people ) is testing whether it can move beyond Web auctions of used wine openers to Web auctions of $20,000 antique cars, and to TV programs. The presence of such testable hypotheses distinguishes investment from both gambling and government planning. A true gamble does not test a refutable principle. Therefore it cannot produce valuable knowledge. Likewise, a nationalized business with guaranteed markets cannot yield falsifiable information.
Knowledge emerges not from chaos, or fixity, but from conditions of uncertainty. Under capitalism power flows to precisely the people who are willing to stake their money not on gambles or sure things but on testable hypotheses, thus generating knowledge and wealth for society. Entrepreneurs are trustworthy because they accept a moral code of testability and falsifiability rather than one based on sentiment, sanctimony, good intentions, good press, good luck, good looks or guarantees.
Bankruptcies play the same role in economic progress that falsifiability plays in the progress of ideas. Both sciences and businesses advance as much by disproof as by affirmation. Every capitalist investment has the potential for a dual yield: a financial profit and an epistemological profit. One without the other is sterile. Economies progress when the process of investment is informed by the results of previous investments. What makes the entrepreneur uniquely trustworthy is that he combines in one person these two yields of enterprise. If his venture succeeds, he also gains the power--through profits--to make further investments, further experiments in light of his initial venture. If his venture fails, he and other investors who shared his confidence in the business may well lose wealth, and the project will sooner or later be halted, no matter how commendable and morally uplifting it is. But even as money is lost, epistemological profit is gained, distilled through the learning effects of direct experience.
I trust chief executives because they deal in projects that can go bankrupt. They cannot repeatedly or consistently lie about their companies because the truth will out in a relatively short time. Even at Enron, Lay and Skilling could deceive themselves and the public only for a matter of months. Skilling got skittish--and got out. Lay maintained his faith through no fewer than 14 margin calls that he had to meet by selling Enron shares. Both Enron stars learned their lessons (about off-the-books subsidiaries and financial engineering, for example), and they taught them to the world.
Gary Winnick and his serial executives at Global Crossing (otc: GBLXQ - news - people ) also submitted to the crucible of experience. Building a unique global network of optical fiber, they learned the perils of debt in a deflationary market. Selling a quarter of his shares at a $600 million profit, Winnick also signaled a belief that they were fairly valued or even overvalued. Many other shareholders did not trust that signal, though they should have. Now politicians want to banish such information from markets altogether in the name of making them more transparent and trustworthy. But most business information is uncertain most of the time. Which means that bans on insider trading make markets more treacherous, since prices will not move until outcomes are sufficiently certain to be announced. Insider trading rules make the executive personally liable for getting things wrong, though much of what any chief executive--or any person--thinks at any particular time is wrong. Thus the law bars all the guesses and intuitions of people closest to the company from influencing the price of the shares.
While executives can be trusted to face reality and learn from it, even if it means bankruptcy, no such corrective faced the politicians and judges who allowed the bankruptcies of some 35 onetime producers of asbestos on account of preposterous claims of "potential illnesses" from this mostly safe and useful material. No such edifying gauntlet faced the government officials and politicians who brought down 70 telecom companies through a series of egregious policy errors of telecom reregulation and monetary deflation.
Politicians are indignant about bankruptcy. They deem it a crime, rather than a punishment. But they would never tolerate the equivalent outcome for themselves. To prevent such a catastrophe, incumbent politicians such as McCain and Lieberman, who want us to trust them, have been busily enacting campaign-finance rules that bar anyone without a personal fortune from displacing them. But even the loss of an election does not require the abnegation faced by a bankrupt entrepreneur, or the recanting expected of a scientist whose findings have been falsified. Coming from an entirely different culture, politicians and journalists are baffled by enterprise and science. But the most crucial reason to distrust nearly everything said by politicians is their defiance of truth and reality on issues of science.
Example: In one of the most brazen chemophobic claims in the history of science and government, politicians around the world are now condemning carbon dioxide (the air that we breathe out and plants imbibe) as a dangerous pollutant. Seeking new controls on the global economy, Greens urge implementation of the Kyoto Protocol on global warming, which would cost $500 billion a year to apply, reliably causing a Third World holocaust of famine and poverty. Citing a nonexistent consensus of scientists, the political choirs ignore all evidence that temperatures today, though admittedly warming up from the "little ice age" of the last millennium, are cooler than their average in the human era. By many paleochemical calculations, corroborated by historical record, global temperatures were several degrees warmer 1,000 years ago, 3,000 years ago and 6,000 years ago, long before humans began using fossil fuels. Rushing to justify new government powers over the global economy, journalists and politicians simply do not deign to consider the available data on the history of weather.
Politicians get away with denouncing reality and blaming it on executives and other private-sector powers. But driving most of the misrepresentation in business is the labyrinth of laws through which the chief executive has to guide his company, following the advice of lawyers and accountants and sharpie chief financial officers. Since corporate tax laws and securities regulations make no sense, executives do not bother to learn the details, leaving interpretation of the cabalistic codes to highly paid experts with many years of training and specialized degrees. Journalists who would never dream of filling out their own tax returns deride executives who claim they have no clear idea of the contents of thousands of pages of mandated forms and accounts that remain unread by anyone, including the government bodies that mandate them--until bankruptcy or recession lends 20-20 postmortem clairvoyance to press, politicians and prosecutors. Depreciation rules that assign lives of 15 years to telecom switches that grow obsolete in 15 months make "the capitalization of expenses" a mandatory part of telecom business. Mandatory, that is, when the government mandates it. Otherwise, as in the case of WorldCom, it becomes felonious. As the President put it, "Corporate accounting is not necessarily black and white."
What makes these accounts so critical to politicians are insider trading regulations that try to create a level playing field for both a taxi driver and Warren Buffett. With all other information pushed beyond the pale, politicians want to believe that the quarterly numbers are meaningful and sufficient guides to investment. But without inside information of material significance, investment loses its falsifiable basis and becomes a form of gambling. Buffett or the executives of General Electric or the masters of Silicon Valley's venture capital would never think of staking their funds without inside knowledge unavailable to hoi polloi. Inside knowledge is perfectly legal for all these players, who sit on multiple boards, read hundreds of for-their-eyes-only business plans, and shuffle capital among hundreds of companies under a corporate umbrella or within a portfolio.
The law denies inside information only to the layman, who is expected to invest on the basis of technical analysis (the voodooistic interpretation of past trading patterns), Keynesian economic astrology, quarterly earnings reports known to the world and other trading trivia. While investigators pore over tomes of paperwork to ferret out the possibly inside provenance of information about ImClone--which had already plunged the stock ten points when Martha finally sold--the rest of the world is left to contemplate the baffling challenge of finding any shred of actionable data about a company that cannot be deemed an inside tip. The idea of a level playing field of information is ridiculous on its face, since information is defined as a deformation of the level. Outside analysis is mostly useless to investors--because it is outside, and thus widely known and already reflected in the prices of shares.
Chief executives understand that it is impossible to banish insider trading without crippling the markets themselves. They grasp that conflicts of interest are ubiquitous in life and that intelligent people take them into consideration when appraising a particular report, tip, argument or analysis. But politicians rule a realm where rhetoric trumps reality, where they imagine they can guarantee corporate purity with Chinese walls and chastity belts among analysts and bankers, forced recusals by "interested parties," mandated "independent" board members, executive seals and signatures on all accounts, back-checks and other fake remedies imported from the world of law and politics. Amid the fun-house mirrors of insider trading rules, we now live in a world where the only investors free of suspicion are people who channel their money into companies they know nothing about. Approved by politicians everywhere, the best investment by this measure is a state-run lottery or, more significantly, an all-market index fund from which all useful inside information has been excluded. If people are not allowed to put their money in companies they understand, capitalism loses its advantage over socialism, since what makes capitalism succeed is the assignment of capital to the insiders who earned it--and thus learned how to invest it profitably.
The insanity of our securities laws, and even our tax laws, is nothing compared with the sand thrown into capitalism's gears by American antitrust law. Based on the idea of perfect competition, where the market is omniscient, this code is as unenforceable as the insider trading rules. Now coming forward with treble-damage antitrust claims are the likes of class action attorney William Lerach. Under the rules, companies today can set any price they choose for their output, as long as it is not too high (gouging), too low (predatory dumping) or just right (collusion). At present Micron Technology (nyse: MU - news - people ) and other producers of dynamic random access memory chips for computers--one of the most competitive industries on the planet--are confronted with charges from the Justice Department that imply all three pricing offenses at once.
No government program has ever gone broke, which is why politicians need never face the inconvenience of weighing the truth or falsity of their claims while they calibrate them to the resonant frequencies of their audiences. Republicans were cruelly unfair to Bill Clinton, whom they assailed as dishonest, when in fact he was fully honest to his trade as a Democratic politician. Republicans are scarcely better. They adopt a different idiom, oriented toward people in businesses, churches, constabularies and intact families, rather than toward single mothers, academics envious of others' success, union members, government workers, criminals and professional Greens or grievance groups. But politicians in neither party tell the kinds of truths espoused by physicists.
When a politician breaks the pattern and speaks the truth--normally in a crisis too sudden to permit the conducting of a public opinion poll--he gains instant beatification, as Rudy Giuliani and George W. Bush discovered after Sept. 11. The public reels in amazement and admiration, as if their dog had begun to sing Schubert lieder. After a time, though, the politician wishes to discover what it was that elicited the public enthusiasm. He takes a poll.
Chief executives trust the personal opinions of their customers, who voluntarily and authoritatively choose what to buy with their own money. Politicians collect the money of others in order to spend it on public purposes sanctioned by figments of aggregate opinion.
In a profession offering a limited number of powerful slots--100 senators, 50 governors, 1 President--politicians live in a zero-sum world, where the gains of one necessarily come at the expense of others. In an election, one candidate wins and the other loses. In a zero-sum world, you may envy or blandish others, but you cannot trust them, because you can assume they are seeking to aggrandize themselves at your expense. Thus politicians necessarily distrust one another and the public. It is natural for them to tax and regulate people coercively.
By contrast, chief executives know that their success is dependent on grasping a reality that they can never comprehend in its fullness themselves. In order to win they must trust others and collaborate with them. Their success depends on the successes of others; their own enrichment relies upon the enrichment of their customers and collaborators; their own profits stem from the dignity of voluntary personal choices, rather than coercive appropriations. Their entire enterprise is ultimately founded on trust. That is ultimately why I trust them. They trust me.