A Lifelong Learning Lecture by John M. Miller
The Cypress – November 2, 2012
Should the federal government mandate that every car and truck manufactured and sold in America should have seat belts? Should states require that anyone riding a motorcycle within their jurisdiction must be required to wear a crash helmet? Should the Food and Drug Administration be empowered to inspect slaughterhouses for animals or poultry, and to give their approval to every drug sold in a pharmaceutical free market? Is it truly a free market if such regulations are imposed on private enterprises and on private citizens?
Why should seat belts or crash helmets or drug approvals be required by federal or state governments? Here is why: If people are not required to wear seat belts or crash helmets, ultimately you and I pay the added expense of their care when they have accidents. Our rates for both health and car insurance go up if some people refuse to protect themselves against the results of their own folly should they have car collisions or fall to the pavement on their motorcycles. Our insurance rates go up if drugs are sold which have unforeseen bad side effects, affecting thousands or millions of people over time. If food processing plants are not sterile, diseases can be passed on to our population, and we shall all pay the price of that contamination. We have a social contract, and regulations are an inevitable and necessary part of it.
Government regulations of private businesses are not some kind of perverse bureaucratic nonsense intended to make it even more difficult for businesses to succeed than is already the case. Government regulations protect the great majority of the people from the potential mistakes or abuses of the small minority. Government regulations are mandated to protect the public from either the misjudgments or the deliberate misappropriations of individual business people or corporations.
Most corporations and most individual owners and chief executive officers of corporations follow the unwritten ethical rules of proper business operations. That is probably even more evident for companies in the USA than for many companies in other parts of the world. Nation-states which only very recently have become democratic are much more likely to have nefarious business practices, because business often operates with minimal ethical standards in autocracies or dictatorships. Thus it is unrealistic to expect that countries like Russia or China or Viet Nam will have the same business standards of countries like the USA, Canada, Britain, France, Sweden, or Australia. The surprising thing about American capitalism is not how often it goes astray but how remarkably ethical are most business executives.
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All that having been said, however, there are numerous examples of why strict regulation of capitalistic enterprises is a necessity to ensure the smooth operation of our economy. That is especially true of banking and the financial industry.
The most notorious swindler in recent years was Bernie Madoff. He stole billions of dollars from his clients in an enormous and lengthy Ponzi scheme which went on for years. How he did not get caught sooner is one of the great mysteries of Wall Street, of which there are a great plenty. Had government regulators been more attentive much sooner, many of those investors would have lost little or nothing. But Mr. Madoff schmoozed his way to illegal success for a long time, and only at the very end did his house of cards collapse. Whistleblowers had tried to warn the feds, but to no avail. In the end, Bernie Madoff was sent to federal prison, from which he shall never emerge.
Sadly, there are many other investment moguls who are less infamous but no less guilty. Raj Rajaratnam was a billionaire hedge fund manager who built his fortune by carefully cultivating corporate clients. He was convicted on all fourteen counts of securities fraud and conspiracy in the biggest insider trading case of US history. The founder of the Galleon Group used wiretaps to gain insider information from various corporations. The government used wiretaps to break into his wiretaps, and thus he was apprehended. He was given an eleven year sentence. That says something about our jurisprudence system, although that has nothing to do with the regulations of capitalism. But some poor 25-year-old convicted for the third time of selling drugs goes to prison for the rest of his life, while Raj Rajaratnam serves eleven years and then is paroled for having bilked billions of dollars. But at least that’s the longest insider-trading sentence ever imposed.
Three other employees of the Galleon Group also were sentenced, but to less time, and for fewer infractions than their boss. Zvi Goffer, Emanuel Goffer, and Michael Kimelman were all securities traders.
A woman named Danielle Chiesi was sentenced to thirty months in prison for insider trading for her hedge-fund firm, New Castle funds. She got information from IBM and other corporations, and passed it along to Raj Rajaratnam, among others. She also agreed to pay a $450,000 fine. Her boss and lover at New Castle, Mark Kurland, also pled guilty to conspiracy and fraud, and was given 27 months.
A California expert-network firm called Primary Global Research has had nine employees who have pled guilty to insider trading charges. A man named Don Ching Trang Chu is the biggest fish to have admitted his guilt. The federal case against him was greatly assisted by Richard Choo-Beng Lee. A woman named Winifred Jiau also was arrested, but she has maintained her innocence.
I am not an investigative reporter, nor have I taken time to dig up where some of these folks were born. But by their names, some of them sound foreign-born. Could it be that where they came from, there was nothing like the Securities and Exchange Commission, the primary regulator of the financial industry? And might they therefore be less likely to comprehend why they should play by our rules? If the business culture in other nations is more lax, is it any wonder why people from those countries working in our country are perhaps more likely a) not to know our rules, b) not to agree with our rules, and c) are therefore more apt to try to bend our rules?
The culture of business is vital to a smooth and ethical operation. Left to their own decision-making, some people, happily a small minority, will try to avert the rules for their own personal gain. And when billions of dollars are being traded, that can represent enormous personal gain. For the safety of all of us, strong and clear regulations are necessary.
Barry Minkow was sentenced to five years in federal prison for defrauding the Lennar Corporation. He cost the home builder $580 million in market capitalization. As part of his sentence, he has to pay back that amount in restitution. Imagine trying to steal half a billion dollars from someone! Regulations are intended to protect American business and individual investors from such massive theft.
Listen to these fines and restitutions, as reported by the number one business newspaper, The Wall Street Journal. Angelo Mozilo, the former CEO of Countrywide Financial Corp., paid restitution of $45 million, and paid a fine of $22.5 million. David Sambol, former president of Countrywide, paid $5 million in restitution and a $250,000 fine. Michael Strauss, former CEO of American Home Mortgage Investment Corp., paid $2.2 million in restitution and a $250,000 fine. James Kelsoe, former portfolio manager of Morgan Asset Management, paid a $250,000 federal fine and an additional $250,000 state fine. The company itself agreed to $200 million in restitution. Brad Morrice, CEO of New Century Financial Corp., paid restitution of $540,000 and a fine of $250,000.
R. Allen Stanford was convicted of running a $7 billion Ponzi scheme for 20 years. He received 110 years in prison. Seven hedge-fund traders made $53 million on a single insider-trading deal. David Rubin of CDR Financial Products pled guilty to several charges having to do with municipal bonds. The government recovered $743 million from five different banks involved in the fraud. Rajat Gupta, a former head of McKinsey and Co., and board member of Goldman Sachs and Procter and Gamble, was recently convicted of fraud. Of 69 cases brought forward by US District Attorney for the Southern District of New York as a result of the Galleon fiasco, there have been 63 convictions, five cases are still pending, and one defendant has fled the country.
There are far more cases of illegal activities than just these I have cited, but these are some of the larger ones. Individuals with sticky fingers must be regulated. For the good of our whole society, that is a legal and moral necessity. Business people often complain that there are too many government regulations of business. Perhaps there are. None of us knows the scope or the complexity of all these regulations, but it is not necessary to be acquainted with all of them to know that they obviously serve a vital social purpose. If we didn’t have them, we would be a third-world kleptocracy, in which people on the inside would constantly be stealing from those on the outside who invest in what the investors assume are clean operations.
But it is not only individuals who are guilty of conspiracy and fraud. Major corporations also have been indicted and convicted of regulations violations.
The giant pharmaceutical company GlaxoSmithKline agreed to pay $3 billion to resolve federal criminal and civil charges arising from the company’s illegal promotion of some of its products, its failure to provide safety data, and alleged false pricing. It is the largest penalty ever paid by a drug company: three billion dollars.
For misleading investors, Goldman Sachs paid $550 million in fines, Citigroup $285 million, J.P. Morgan $154 million, and other banks $44 million, for a total of $1.03 billion in fines. These are some of our oldest and most admired financial institutions.
Wells Fargo Bank paid $85 million in a civil penalty for steering thousands of prime-mortgage borrowers into more expensive sub-prime loans. Ira Rheingold, the executive director of the National Association of Consumer Advocates, said the fine is “a pretty strong statement about the bad practices Wells Fargo has engaged in.” I guess so.
Bank of America agreed to pay $8.5 billion in refunds to investors who bought troubled mortgages that ended up going bad. This was part of the housing crisis of 2008-2010. The settlement amounted to 2 cents on every dollar loaned, with an original principal of $424 billion.
The US Supreme Court upheld a $300 million patent-infringement case against Microsoft. Non-technology companies like 3M and Johnson and Johnson supported the decision, saying that it is important to follow patent rules, but other tech companies backed Microsoft in the case, insisting that too strict an adherence to patent laws stifles technological innovation.
The Ford Motor company was forced to pay $2 billion to its 3000 dealers for overcharging them on commercial truck sales. This pattern continued over an 11-year period, the suit said.
Am I making too much of these legal judgments in which it has been found that rules and regulations were violated? Are regulations ignored as frequently as all of this seems to suggest?
A couple of years ago I used some airline frequent flier miles that were about to expire to subscribe to The Wall Street Journal. Frankly, I didn’t think I would like The Wall Street Journal. From what I knew of it, its editorial policies would probably not mesh with my political peculiar and particular prejudices and predilections. In that my suspicions were more than correct. However, The Wall Street Journal has outstanding domestic and international news coverage, and its business news coverage is second to none. I loved reading it. Nevertheless, I already was subscribing to two other newspapers and about a dozen magazines of one sort and another, so I gave it up. I just couldn’t spend that much time reading that much newspaper coverage every morning. Having subscribed, I felt duty-bound to read everything, and it was doing me in.
Nevertheless, I want to give you some stories of regulatory infringement from just one issue of the WSJ, dated Saturday and Sunday, March 19 and 20, 2011. Mind you, this is the premier business journal reporting on business skullduggery in one single issue. IBM paid $10 million in a civil charge of campaign bribery in Asia. The Galleon Group founder Raj Rajaratnam came out firing in the suit against him. (We heard earlier just how successful he was in his own defense.) Rajat Gupta sued the SEC in its case against him. (We also know how successful he was. If the best defense is a good offense, for him it wasn’t.) The New York Mets tried to get money back that they had foolishly invested with Bernie Madoff. As we learned after March 20, 2011, it didn’t work very well. Sergey Aleynikov got eight years for stealing the confidential computer code of Goldman Sachs. A Renault security employee turned over the name of the informer that prompted the French car maker to think it had been the victim of industrial espionage. They spent almost a million dollars to try to track down the allegation, only to find that nothing had been discovered by internal auditors. Remember, these stories were in just one edition of the WSJ.
2011 was admittedly a very good year for convictions on very bad regulations infractions. According to an AP story in The Island Packet, it was the worst year ever for court judgments against such nefarious activities. But the plethora of these news accounts point up the vital importance of government regulations.
The economic near-total-collapse of 2007-2009 was largely the result of officials in many of our biggest and most respected financial organizations bending the rules for their own purposes. On the other hand, some insiders in some of those companies were bending the rules for their own personal gain, unbeknownst to their superiors.
Adam Smith would be completely mystified by 21st century American capitalism. It is far, far more complex than anything the 18th century economic genius could ever have anticipated. In his day, capitalistic entrepreneurs were dealing with hundreds or thousands of dollars, which in today’s dollars would be thousands or tens of thousands of dollars. But banks and other financial institutions deal with tens or hundreds of billions of dollars every day, and if they are unregulated, there is bound to be chaos, inevitably followed by collapse. Regulations are as necessary to capitalistic enterprises as oxygen is to all animals, plants, and fish. We cannot survive, let alone thrive, without regulations.
Nevertheless, there is a constant hue and cry from conservative politicians and economists that we have far too many regulations. This has been a minor issue in this year’s presidential campaign. No doubt some of our regulations are ill-conceived and poorly administered. But until it is specified which regulations and which rules need to be obliterated or changed, the controversy over the very existence of regulations unfortunately shall continue unabated.
Who makes the regulations? Ultimately Congress does, the President signs them into law, and the courts decide whether or not they are constitutional. Obviously Congress itself cannot take the time to study all the issues behind all these regulations, so committees or commissions or congressional staff members are authorized to write them.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of July 1, 2010 was intended to address many of the systemic failures which led to the Great Recession. It was passed, barely as it turned out, to – quote – “Create a Sound Economic Foundation to Grow Jobs, Protect Consumers, Rein in Wall Street and Big Bonuses, End Bailouts and ‘Too Big to Fail,’ and to Prevent Another Financial Crisis.” On that last point, lotsaluck, as they say. No matter how good or how effective our regulations may be, they shall never permanently prevent all financial crises.
To accomplish these lofty goals, the following agencies and goals were established: a new financial consumer protection agency, under the Federal Reserve Bank, to assure clear and accurate information for borrowers; to end the possibility of taxpayers having to bail out banks deemed too big to fail by imposing much stronger limits on their lending practices; established an advanced warning system council to address very complex financial risks taken by banks, etc.; attempt to eliminate loopholes that allow exotic financial instruments to go unregulated; provide shareholders with more influence on executive salaries and bonuses; make tougher rules for credit rating agencies, in order to protect both individuals and businesses; and to create a Consumer Financial Protection Bureau. There is more to Dodd-Frank, much, much more, for a total of 850 pages.
Dodd-Frank was the primary means by which Congress chose to address the abuses which resulted in the Great Recession. Needless to say, with that many pages and that many new regulations and agencies, thousands of new federal employees are needed to be employed to oversee this massive effort.
Is Dodd-Frank overkill? Probably. Is it, or is something like it, necessary? Absolutely. The Great Recession occurred because too many individuals and too many corporations refused to follow the regulations we had, and because there were insufficient regulations to prevent it from happening. Capitalism cannot be self-regulating any more than society, without laws and statutes, can be self-regulating. If we don’t impose regulations, chaos shall be imposed on us. Good intentions are insufficient to insure a smoothly operating society and economy.
Conservatives almost always say we have too many regulations, and liberals almost always say we have too few. Neither side honestly confronts the issue. What kind of and how many regulations shall we have: that is the issue! Who shall make our regulations? How shall they be administered? What should be the penalties for non-compliance? Should there be a “death penalty” for egregious violators? I don’t mean that anyone might be executed, but that individual violators might be forbidden for life from participating in similar activities ever again, and that egregious corporations would be closed down permanently.
The level of greed which resulted in the Great Recession may have been greater than that which caused the Great Depression. Greed unfortunately is a factor in the behavior of too many persons and corporations. In my opinion, those who philosophically oppose most or all regulations are quasi-libertarians who have a decidedly defective understanding of human nature. For the good of society, we are obligated to create serious barriers for those who seek to beat the system. If we don’t, all of us will pay the price of that lack of oversight, and it is simply unfair to the entire body politic. We can’t allow everyone to make their own rules, because too many will choose rules which benefit only themselves while leaving the public holding their libertarian bag.
I have been saving clippings from newspapers and magazines for this lecture for well over two years. Because that is the case, I have far more material than can be reasonably utilized in a 45 or 50 minute lecture. I am going to skip altogether the 25 or 30 clippings I have about particular banking frauds, or the 20 or so clippings I have of other regulatory abuses in other industries. Nonetheless, I will note that as recently as Oct. 25, the was a story in USA Today which said that Bank of America is being sued by federal prosecutors for $1 billion-plus in a civil mortgage fraud lawsuit, whose details I will not take time to elucidate. The point is that banks and other corporations continue to break the rules even after new rules via Dodd-Frank have been set up presumably to stop malfeasance.
Therefore I shall now turn to that sub-set of clippings I labeled, in brief form, “Regulatory Problems.” Though we need regulations, there are some definite problems when we try to create and administer them. If we don’t have them, modern capitalism fails. And if we do have them, but we have the wrong kind, modern capitalism can be made too difficult to prosper.
The so-called Volcker Rule was to be part of the Dodd-Frank Act. Former Federal Reserve Chairman Paul Volcker wanted more stringent restrictions against banks engaging in what is known as proprietary trading. By it, banks take greater risks in making large loans, hoping thereby to gain more income for the banks themselves. Conservatives say that hampers the economy by stifling lending, and liberals say it is necessary to prevent the public from having to bail out the banks again when their bad loans threaten to destroy them. The liberals are supported in their thinking by the Federal Deposit Insurance Corporation (the FDIC) and the Commodity Futures Trading Commission, both of which are non-partisan agencies.
There has been so much resistance to the Volcker Rule by the banks that it has not been fully implemented, now two years after it was adopted by Congress. What this means is the biggest banks are still doing some of the same things they did which caused the Great Recession in the first place. Probably something needs to be done to improve the Volcker regulations. But in the meantime, Nero (the US government) fiddles while Rome (the US) continues to burn.
No one should suppose that Barack Obama is a great fan for more regulations, because he isn’t. He has been accused of being anti-business, and it is an accusation he wants to disprove if he can. In my opinion, he is succeeding in showing that he is very pro-business. Therefore two of his two chief regulators, Cass Sunstein and Bill Daley, have lowered air-quality regulatory standards which were directed against energy-producers. This is a political move which it is hoped will win some independent votes, but it is as likely to lose some votes in the Democratic base. Furthermore, relaxed regulations regarding the process of fracking to exploit new oil fields in the Northeast and Upper Plains may be leading to water pollution and other problems. Physicians in Pennsylvania have been prevented from reporting on increasing health concerns in areas surrounding fracking operations. The Obama Administration has chosen not to publicize these issues prior to the election, presumably for fear of losing votes. If Mr. Obama wins re-election, it will be interesting to see whether he starts to enforce regulations already in place, or he gives in to business pressures to ease the rules. But remember this: business pushes to do what is good for business, and not necessarily what is good for the nation or world. They don’t pay all those lobbyists all those millions of dollars for nothing. Business is important, but not all-important.
Some new freshman Members of Congress in the Class of 2010 are trying to roll back regulations. One of them is our own probable new Congressman, Tim Scott, who wants to bar the NLRB from restricting where companies can re-locate jobs. He specifically was upset when the NLRB tried, and failed, to keep Boing from building its new plant in Charleston because it did not need to deal with unions in South Carolina. Morgan Griffith of Virginia is behind an effort to delay EPA pollution rules for thousands of industrial boilers. The EPA says the new standards would save 2600 lives a year, avert 4100 heart attacks and 42,000 asthma attacks. How anybody can quantify that is anybody’s guess, but the controversy illustrates the difference between the good of corporations and the common good.
These are not new disputes. They have been fought for the past 150 years. Teddy Roosevelt’s presidency was built on breaking up monopolies, especially the oil companies. But the stakes now are much higher, because a greatly increased population creates far greater environmental concerns. Perhaps we can’t afford more regulations, but on the other hand, can we afford further to damage the environment in which we live?
Those kinds of concerns, however, are not the only matters facing us. John McCain once seriously suggested that no business executive should receive more compensation than the President of the United States, who is paid $400,000 per annum. The 30,000 employees of Goldman Sachs average $400,000 per year. That is of course misleading, because most of those employees would be well below that amount, and some far above it. But the political issue, even the election issue, is this: For the benefit of all of us should there be legal limits on the incomes of a small percentage of us? If there should be no legal limitations (which most of us would say there should not be), then how will corporations and other institutions, including sports teams, voluntarily put income limits into place? If three or five or ten million people are internally not allowed to make more income than the President (or whatever figure would be agreed on), wouldn’t some or most of those billions of dollars filter down to the rest of us? Is that a trickle-down which would truly benefit everyone?
Has the USA become either a plutocracy or a corporateocracy? This is an important question for which there is no clear answer. But it needs to be asked on a regular basis. Capitalism is obviously our economic system. Is it also to be the primary determinant for what our political system shall be? Or should our policies and our politics be governed by concerns that are larger than corporate concerns, as admittedly large and vital as they are?
You may recall that conservative Senators blocked Elizabeth Warren from being named the director of the Consumer Financial Protection Bureau. Thus she went back to teaching at Harvard, and now she is running for the US Senate seat currently held Ted Kennedy’s Republican successor, Scott Brown. How much do the interests of ordinary consumers, particularly those whose interests include banks and banking, come into the equation of the public good?
Prior to the Great Recession, there were 500 federal banking supervisors and their staffs. There are now slated to be 780. These are people who work full-time within our large banks, trying to oversee whether they are abiding by the new Dodd-Frank regulations. Nationally, there were 1,396 federal field bank examiners in 2006. In 2011 there were 1948. SEC chairman Mary Shapiro says her regulators were – quote – “stretched pretty thin, even before Dodd-Frank.” Can these people succeed in what the new regulations require of them? And in a time of government belt-tightening, are there likely to be more people inserted into these new positions?
The problems the regulations are intended to mitigate are so immense that it is impossible both to create the proper kinds of regulations and to supply enough qualified people to administer them. No doubt bad regulations have been adopted. It will take time to sort all that out. And in the meantime, the system will be gamed by those who are clever enough to succeed at gaming it.
Is the baby being thrown out with the bathwater? Maybe. Even likely in some cases. Regulations are a colossal pain the neck for those who are forced to try to adhere to them. But they exist for a reason. They exist because some individuals and some businesses and some entire industries will cheat if they think they can get away with it. We are a defective species, ladies and gentlemen; we truly are. For our own sakes, we need to keep a close eye on us. Regulations are one of the primary means for doing that.
The 14th Amendment to the US constitution was passed to guarantee equal protection under the law to former slaves. Initially it was employed solely for that purpose. However, from 1890 to 1910, 288 cases brought to the courts under its provisions were for the interests of corporations, and only 19 cases were to protect the interests of individual black Americans. American capitalism sometimes commands an inordinate amount of attention in America.
David Rothkopf is the author of Power, Inc.: The Epic Rivalry Between Big Business and Government – and the Reckoning That Lies Ahead. In an article in Time Magazine, he wrote, “Today’s contest is not so much between capitalism and another ideology but between competing forms of capitalism. The financial crisis, growing income inequality and faltering economic performance in the U.S. have tarnished American ‘leave it to the markets’ capitalism, which is being challenged by ‘capitalism with Chinese characteristics,’ Eurocapitalism, democratic development capitalism (India and Brazil) and even small-state entrepreneurial capitalism (Singapore, the U.A.E. and Israel). All these models favor a more significant role for the state in regulations, ownership and control of assets.”
Neither presidential candidate has clearly addressed the overall issue of business regulations. Given the nature of American political campaigns, perhaps that is inevitable. But whoever wins, that person can become a great President by breaking up the big banks, all of which are still “too big to fail.” If they aren’t broken up, like Theodore Roosevelt did with the oil companies, they shall certainly fail yet again, and we the people shall be stuck with the bill - - - yet again.
The Roman Republic also had problems with people or institutions pilfering money in such a way as to damage the body politic. So the Roman Senate passed regulations to curb theft. But a gnawing question arose which plagued them, and also us. Public records show that they asked themselves, “Who will regulate the regulators?” It’s a scary thought that they wondered about that more than two thousand years ago, isn’t it?
Regulations are an unpleasant, vexing, and frustrating reality. Without them, however, modern economics cannot function. We still have a great deal of work to do. Let us therefore seriously get to it, before it is too late.