How does the present situation compare to other crises in American capitalism? Are we witnessing excesses on a par with the '20s, the '80s ...?

It's a pattern that we've had frequently, and it's often associated with what I would call deregulation episodes. The savings and loan debacle, for example, where the U.S. government had to bail out [banks] to the tune of several hundred billion dollars, was basically the same thing: misreporting, trying to claim as income things that weren't income. So in fact there is a pattern here, and that pattern continually reminds us of the need to have some kind of oversight, if we're going to make the market economy work.

But the pains of the '80s seemed to disappear relatively quickly. There was a minor recession in the early 90s, but the economy recovered. Will that happen again, or is this problem on a much larger scale?

Eventually, it's going to bounce back. I have absolute confidence in that. The American economy is very, very strong for the long run. But this may, and quite likely will, extend the recovery and slow it down.

The timing couldn't be worse. The fiscal mismanagement of the current administration -- leading to a change in the fiscal position of the United States over the past year -- is absolutely phenomenal; going from huge surpluses to huge deficits and the deficits are probably going to be larger than people anticipated. That means that foreigners are already losing confidence in the United States because the United States had earned a reputation for sound fiscal management -- and now that reputation is being destroyed. The United States had a reputation for the best accounting standards in the world; now people are saying, we don't know.

The last time excessive doubt in the U.S. economy occurred -- during the Depression -- new regulation followed. How will this episode affect the structure of capitalism, here in the U.S. and abroad?

It is an important warning. The view of capitalism in the late '90s was of a particular form; American capitalism was triumphant. The view was that you don't need regulations -- just let it rip. Now people are becoming much, much more cautious. They're looking at what America said at that time with a lot more circumspection. There's a recognition that there's a downside. And just like the lesson of the Reagan era -- the excessive deregulation of banks -- led most countries to recognize the importance of sound financial regulation, I think that this episode is going to lead people to say there ought to be sound accounting regulations, sound regulation on corporate governance, things that were insufficiently talked about before.

It's also going to mean that the premise that American accounting standards are better, say, than European standards, is no longer going to be convincing. People are going to say let's look at alternatives. There isn't one way, there are alternatives. Sometimes the American way is best but sometimes Americans ought to learn from others, and the accounting standards in Europe may in fact be a better system for dealing with the complexities of the current world.

Is that a sign of progress -- moving away from an American-centric economic worldview?

Yes, I think it is.

You mentioned that the Bush deficit isn't helping matters, but in terms of future policy, what needs to be done and do you think that Bush will do it?

What is interesting is how slow they've been to recognize the problems. We're now beginning to recognize the broader set of issues, what you might call conflicts of interest. Merrill Lynch brought those issues out into the open; that if a firm is trying to sell a stock through its brokerage houses, trying to get business through its IPOs, those conflicts of interest can lead to bad decisions.

But if you could name a list of things -- 1, 2, 3 -- that Bush and Congress could do to reinstill confidence in the markets and economy, what would they be?

We need to begin to think much more carefully about these issues of conflicts of interest, which are pervasive. We saw it in the accounting area, where the accountant firms have conflicts of interest between their role as consultants and their role as accountants. In the 1930s, the Glass-Steagall Act was passed, which talked about why we needed to separate out investment banks from commercial banks because of the potential conflicts of interest. I think another mistake that was made in the '90s was the repeal of that. The point was made that people were getting around it, and that was used as an argument against it. Well, there were two strategies: Do you try to limit the ability to get around it, or do you abandon it. I think they made the wrong choice.

Part of the reason they made that choice was because of Wall Street lobbying. Even now, post-Enron, most attempts at reform have been stalled due to opposition from Wall Street. How can anyone who wants to reform the system overcome such a powerful force?

It will be overcome when there is enough popular support, and when the problems begin to rebound seriously enough against the industry. Let me go back to another example. At the end of the 19th century, it was the food industry -- the meat industry -- that asked for government regulation. Why? Because as a result of Upton Sinclair's book "The Jungle," people said we don't trust meat. And they said, we'll trust the government if it starts inspecting the meat. So the industry demanded regulation to restore confidence.

Do you really think that will happen?

Henry Paulson [chairman of Goldman Sachs] has begun talking about the problem and you have to think that it's partly because of a recognition that if investors lose faith in American firms, they're going to put their money elsewhere. And that is going to be very bad for Wall Street. There are going to be two sources of concern: one, voters; secondly, investors.

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