It would be understandable at this point for investors to feel betrayed by Corporate America and distrustful of anything that executives told them. And it would be equally understandable if investors withdrew their money from equities, fearing the next revelation of corporate malfeasance. After all, the fraudulent behavior seems to be getting more and more blatant. Every time we think we have seen it all, a worse example comes along.
But people need to remember something very important: One of the great virtues of the U.S. economy over the past 20 years has been its ability to successfully deal with a wide variety of seemingly intractable economic and financial problems. The list starts with the runaway inflation of the early 1980s, vanquished far faster than economists expected. It includes the savings and loan crisis, the threat from foreign competition in the '80s, the 1987 stock market crash, the 1997 Asian financial crisis, and the 1998 failure of Long-Term Capital Management. Each time, there was a recognition--perhaps delayed--that there was a serious problem. That was followed by a willingness, on the part of both the private and public sectors, to do what needed to be done.
Today's crisis is following the same pattern. It took a while for regulators, politicians, and corporate leaders to realize the depth of the problem with corporate lying and fraud. But gradually there has been action, with the New York Stock Exchange, the Securities & Exchange Commission, Standard & Poor's, and the Conference Board all putting forth or about to promulgate new standards. Congress is seriously considering accounting reform. And the issue is finally getting on the radar screen of the Bush Administration. President George W. Bush said on June 26 that he was "deeply concerned about some of the accounting practices that take place in America."
None of these steps will have an effect overnight. But cumulatively they're changing the ground rules for corporate behavior. CEOs are being put on notice that the sort of immoral and illegal behavior that pervaded Enron and WorldCom will no longer be winked at. More scandals from the '90s may still emerge, but it will be far less likely that companies make aggressive accounting a key part of their financial strategy, as these companies did.
While the short term may be rocky, there's little doubt that the U.S. economy--and the stock market--will not only survive the current crisis but will thrive in the long run. The economy is showing good fundamental strength, with productivity growth strong and manufacturing recovering. And while the market may not be at bottom yet, over the long run stocks will rise if the economy does well.
The big danger is that investors who displayed irrational exuberance in the 1990s will swing the other way and surrender to irrational negativism. Skepticism is appropriate, but withdrawal isn't. The U.S. economy has a resilience that should not be underestimated.