I've been working away on a draft symposium piece for the NeXus Journal at Chapman where I present a model of deregulation that explains banking deregulation in Sweden leading up to that country's financial crisis in 1990.  The model may also help us understand how the deregulation of Freddie & Fannie, the repeal of Glass Steagall, and bank OTC derivatives trading contributed to our own financial crisis. 

The piece is called Deregulation Pas de Deux: Dual Regulatory Classes of Financial Institutions and the Path to Financial Crisis in Sweden and the United States and can be downloaded here.  Here's the abstract: 

This article presents the following model of two regulatory classes of financial institutions interacting in financial and political markets to spur deregulation and riskier lending and investment, which in turn contributes to the severity of a financial crisis:

1) Regulation creates two categories of financial institutions. The first class faces greater restrictions in lending or investment activities but enjoys regulatory subsidies, such as an explicit or implicit government guarantee, while the second class is more loosely regulated and can make riskier loans or investments and earn additional profits.

2) These additional profits leads to calls for deregulation to enable the first class to participate in lucrative lending or investment markets.

3) Deregulation allows the first class of institution either to compete with the second class in formerly restricted markets or to invest in the second class, in either case, while retaining its regulatory subsidy.

4) Deregulation spurs additional lending in two ways:

i) subsidy leakage, which occurs when the first class can use subsidized funds to make riskier investments (including investments in the second class) without regulation compensating for moral hazard; and

ii) displacement, which occurs when subsidized competition pushes the second class into riskier market segments.

5) Additional lending increases leverage in the financial system and fuels a boom in an asset market.

6) Asset prices collapse and threaten the solvency of financial institutions.

This model explains financial deregulation in Sweden in the 1980s, which led to a 1990 bank crisis. The model also provides a framework for scholars to examine whether deregulation in the United States involving the following dual classes of institutions contributed to the current crisis:

¶ GSEs (Freddie Mac and Fannie Mae) and sponsors of “private label” mortgage-backed securities;

¶ Commercial and investment banks with respect to the Glass-Steagall repeal; and

¶ Banks and hedge funds with respect to OTC derivatives.

The model would support the premises of the proposed Volcker Rule, which would restrict investment activities of banks, but suggests that imposing those restrictions may not be sustainable in the long run.

Comments are welcome!

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For the first time in history, the New Orleans Saints are Superbowl Champs!  Today I was more than happy to cheer the Saints on to victory--and not just because I am a Patriots fan and like to see the Colts lose!  Given Katrina, it is just great to see some good news come to New Orleans.  To be sure, we did get the expected record snowfall in the DC area.  Hence we not only have been snowed in, but we also were without power for a while.  So I almost did not get to see the victory.  Hopefully my power will stay on long enough for me to watch all the postgame coverage!  But even if it doesn't, it looks like Mardi Gras came early to New Orleans. . .   

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New Mexico is looking to hire a visitor to teach in our transactional clinic in the Fall.  The ad is below.  My colleague, Nathalie Martin (martin@law.unm.edu) would be happy to answer questions.

The University of New Mexico School of Law ("UNM") seeks a Visiting Professor of Law to teach in its nationally-recognized clinical law program during the fall of 2010. The candidate hired will teach and supervise students in UNM's Business and Tax Clinic, who represent clients involved with small businesses and non-profit corporations with a variety of legal issues, as well as other clients with consumer, debtor-creditor, tax, and home mortgage issues. JD and admission to a US bar are required. Preference will be given to candidates with experience practicing law in the areas in which we assist clients, as well as experience teaching and supervising students in a transactional clinical setting. For best consideration, submit applications by February 24, 2010. The position will remain open until filled. However, UNM intends to fill this position by March 31, 2010. To apply, visit the UNMJobs website: https://unmjobs.unm.edu/. Please reference Posting Number 0805063. The University of New Mexico is an equal opportunity/affirmative action employer and educator. You also can call Nathalie Martin at (505) 463-9051.

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On Friday, I attended and moderated a panel for an extremely interesting Symposium at Brooklyn in honor of our former dean (and Eastern District Court Judge) David G. Trager.  The Symposium was entitled, "Sharing the Blame: The Law and Morality of Punishing Collective Entities."  We heard from panels of psychologists and moral philosophers in the morning. In the afternoon, I moderated a lively roundtable discussion (with Jim Fanto, Len Orland and Peter Henning) regarding some of the problems that arise in regard to corporate criminal liability. 

The psychologists focused their attention on the concept known as "entitivity." (In some quarters, its called entatitivity; I think I like the shorter version better).

I'll do my best to summarize the findings (some of which admittedly were in conflict):

1.People have little trouble attributing "intention" to groups.  In fact, the attribution of intention to groups seems to be engrained.

2. People tend to view tightly knit groups (ie, groups with higher levels of entitivity) more negatively than less focused groups.

3. Groups organized for an economic purpose (corporations) have high entitivity. 

4. [Tom Tyler's point] We may have trouble distinguishing the character or fairness of the entity from the character of a given person whom we associate with the entity.  This arose from a study of employees who were asked questions about their employer and their supervisor.  If I understood this part right, the negative character inferences about the supervisor seemed to trump the feelings about the organization's overall policies and structural decisions.  I took this to mean that when we ascribe negative "intention" to certain entities (Goldman? Enron?), we are in fact transferring negative character inferences about a given individual we associate with that group (Lloyd Blankfein, Ken Lay, Jeffrey Skilling, etc). 

As I later explained during the third panel, when it comes to corporate criminal liability, the law pretty much removes the messy business of distinguishing "bad" individuals and the groups that employ them.  That is, we do not, as a legal matter, need to distinguish between the inferences we make about a corporate officer's character and intentions, and the corporation's "character" and intentions.  The law pretty much allows us to treat them as equivalent, thereby imposing liability regardless of whether the "group" truly is a reflection of the individual's character or intention. 

Now, I have criticized corporate criminal liability as far too broad, particularly because groups are not nearly as "entitative"(?) as the public would assume them to be.  Nevertheless, what I learned from the psychologists is that this "entity" approach may be more or less engrained.  This got me thinking.  Ordinarily, we might think that a corporation would respond to the "entitivity" problem by trying to debias the public of its "groupness."  In other words, you might try to fight the public's intuition to punish by educating the public on how you're really an aggregation of multiple groups, some of whom may have no control over others.

On the other hand, if the desire to ascribe blame to groups is engrained and intuitive, maybe the better strategy for corporations is to embrace their "entitivity" and cast blame on some other entity - namely the government.  In this vein, consider Steve Bainbridge's claim on how the corporation acts as a buffer between individuals and an all-powerful state (true, he was talking about political participation by entities, but I assume those feelings transfer over to questions on how to assign blame).  If I am right, and corporate defense counsel realize this as well, we may begin to see the coalescing of a strategy whereby corporations deftly cast blame back on government entities that have already had a hand in regulating them.

   

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Over at the Faculty Lounge, Jacqueline Lipton asks whether audio books are worth the candle.  Meanwhile, Bainbridge links to a really boring, but usefully concise, audio report on the SEC's proxy rules.  It all is a reminder that one way to manage a bit of knowledge acquisition in the midst of all the rest of the multitasking is through one's iPod.  I can attest that there's nothing quite like a little 3 AM Niall Ferguson or Jean Bethke Elshtain while walking a very small child up and down a corridor.

But as I have noted before, audio really isn't the best way to catch up on the current literature.  For one thing, not much of it is on line, and even if you could get your fancy new Kindle to read it in computerese, audio takes a lot of time.  Still, the uChannel podcasts can keep you broadminded, EconTalk has a great roster of economists, and the occasional Planet Money or Fresh Air interview can be really useful financial crisis coloratura.  As for audiobooks, the classics are crushingly difficult for me to finish, and really, most fiction doesn't work unless it is very abridged, and very action-packed.  I like histories, particularly short histories, and I admit I haven't yet found the perfect law related audiobook.

So that's how I use audio, and between commutes, snow shoveling, and so on, I use it often.  Always looking for more recommendations, though (I even subscribed to AudioFile for a while, where every audiobook is reviewed, and they are all above average).  If you have some, do put them in the comments.

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Senator Dodd just announced that efforts to broker a bipartisan reform bill in the Senate have sputtered and the Democrats will go it alone.  Does this mean that the Democrats will try to push a populist bill through by summer and paint Republicans as obstructionist and protecting Wall Street?  My guess is yes.

Will it be politically successful?  Part of the problem is execution -- particularly the President's self-created image (and possibly his temperment) of being the great uniter.  Can and will he shift from the "let's have beers at my place and talk it out" to the LBJ "I'll bury you and your grandma" style of politics? 

Will any bill that comes out be good policy?  As I mentioned before, I have serious reservations about the bank risk tax.  (Don't get Christine started).  As I'll post later, the Volcker Rule may be better, but so far all we have are very vague outlines of what it will look like concretely.  (The White House seems like a scholar that is really polished at writing abstracts for papers, but has yet to actually get something published.  Good luck with the tenure vote). 

As I mentioned before, I don't fully understand politically why the Obama Adminsitration did not lead off with financial reform.  In the comments to my post, Brett McDonnell and Elizabeth Brown questioned my premise that financial reform would have been a net gain of political capital for the Obama Administration.  They made some compelling points that the Administration was dealing with dissent from independent agency heads and did not have as clear an idea of what they wanted to do with financial reform as they did with health care.

I'm still not so sure financial reform is not an easier sell.  Among agency heads, only Sheila Bair at the FDIC has built serious political clout during the crisis.  And since when did politicians wait to have a clear sense of the problem before legislating?  It is true that the Democratic base has been dreaming about health care and that it was a centerpiece of Obama's campaign.  Perhaps the Democrats gambled that it was better to get the more ambitious program through first before they got bogged down in mid-term elections and then the next Presidential campaign.  That worked really well.   

Elizabeth made a good point that it is hard to overcome small cohesive groups with large stakes in a political fight.  That likely explains part of why credit rating agencies have escaped any serious reform efforts so far.  (But I think that same logic applies to healh reform.  HMOs, Big Pharma, the AMA, AARP, all have well-run political machines). 

There is something to be said for going slow (see Posner, Feibelman & Omarova, Cunningham & Zaring) with major reform and getting it right.  But the political attention cycle will turn.  And there is nothing to be said for doing nothing. 

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I've just posted a paper on SSRN:  Pay for Banker Performance:  Structuring Executive Compensation for Risk Regulation.  The basic idea is to include banks' public subordinated debt securities in bankers' pay packages in order to curb excessive risk taking.

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Just a heads-up on upcoming business-related events at Emory:

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We here in the DC region are preparing for what a Washington Post meteorologist has called  "Snowmageddon," with others referring to the coming snowstorm as "Snowpocalypse."  Metereologists are predicting over 1 to 2 feet of snow, and that we will see "a high-impact storm any way you cut it.  Heavy wet snow. . may lead to numerous power outages," bringing " wind and near-blizzard (or even blizzard) conditions."  The Washington Post warns to "be prepared to be stuck where you are for at least 24-48 hours, if not longer."  Which of course means that everyone was in the grocery store today, emptying out many shelves.  I had the pleasure of spending an entire hour in line, though I am never quite sure what I am stocking up on.  In any event, snow is predicted to start accumulating around 9 a.m. tomorrow and not let up until Saturday.  If the predictions are correct, meteorologists say that "a historic event is in the cards."  I'll let you know how we weather the snowmageddon.

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In January, the United States Sentencing Commission released proposed amendments to the Sentencing Guidelines, which included amendments to those guidelines that relate to the sentencing of organizations accused and convicted of criminal wrongdoing (ie, the "Organizational Sentencing Guidelines"). 

When companies are actually charged and convicted of a federal offense, the Organizational Sentencing Guidelines (Chapter 8 of the United States Sentencing Guidelines) guide the sentencing court in its decision on how to impose penalties.  Because the collateral costs of indictment are so high for many companies (think Arthur Andersen), most regulated entities seek a Deferred Prosecution Agreement in lieu of any indictment. For that reason, one might reasonably conclude that the Department of Justice's charging guidelines are far more important than the OSG.  Nevertheless, to the extent the OSG casts some "shadow" over the negotiating process, we should care about its contents.

Since there are several proposed changes, I'm going to break this up into several posts.  For now, I would like to focus on the Application Notes that follow Section 8B2.1.  (The official text of the Proposed Amendments is here.) This Section defines an "Effective Compliance Program" - or rather, it provides minimal requirements companies must meet for getting credit for having an "Effective Compliance Program."  Some of these requirements are (and always have been) extremely vague.  (For example, "The organizational shall exercise due dilligence to detect and prevent criminal conduct."). 

This year, two of the Commission's proposed amendments focus on document retention policies.  I find this interesting for two reasons. First, the OSG's focus on document retention policies confirms claims I have made here and here that the government's interest in corporate compliance is not driven by some desire to improve governance culture for the sake of shareholders or other stakeholders, but rather by a desire to reduce the costs of corporate policing. It's easier to police firms if they have internal guidelines in place that make it harder to destroy documents.

more ...

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As I have noted in other post, many so-called activist hedge funds engage in charitable giving.  Interestingly, these funds also bring their own management and investment style to their charitable giving practices.  As one article notes, such funds rely on the same kind of rigorous research and strong oversight that they bring to other portfolios they manage.  Hence, the article explains that one fund "uses a private-equity strategy of placing a portfolio manager with each grantee to ensure it extracts the highest return from each programme, measuring the impact on children's health, psycho-social well-being and educational attainment, then 'calibrating' scores against other potential investments."  Is this kind of approach good for charities? 

Apparently some charities find the approach "threatening."  And others have concerns about intentions;  or perhaps they are concerned about whether aggression and charity go hand-in-hand.  And yet, charities are certainly in need of donations, even if they would rather that such donations came with no strings.  Then too, charitable organizations are not immune from charges of mismanagement and self-dealing. Thus, it is certainly not the case that such organizations have perfect management structures.  Perhaps the approach some hedge funds bring will provide, even in a small way, better or more efficient oversight to charitable organizations and projects.  Who knows if that is the case, but it is certainly something interesting to consider.  And of course it also will be important to consider if this management/investment style raises other concerns about which charities should be mindful.  Of course, as this Wall Street Journal story  indicates, the economic downturn has meant that hedge funds have had to make considerable adjustments to protect their charitable endeavors against losses.  Thus, it is likely that the real concern is not about how these organizations manage, but rather about whether they can continue their giving in this current financial environment.

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By way of White Collar Crime Prof Blog, I recently read an account of a sentencing of a securities dealer who received a relatively light sentence (five years’ imprisonment) for fraudulently marketing auction-rate securities, but who was blasted by Judge Jack Weinstein for, among other things, being part of an “industry beset by avarice that has been allowed to run rampant by regulators and negligent supervisors alike.”  Strangely, the Judge’s view of the industry seems to have worked in the defendant’s favor. 

 

Judge Weinstein (of Eastern District of New York fame) begins the opinion by saying:

 

On August 17, 2009, Eric Butler was convicted by jury verdict of all counts of a three count superseding indictment. His trial laid bare the pernicious and pervasive culture of

corruption in the financial services industry. The blame for this condition is shared not only by individual defendants like Butler, but also by the institutions that employ them, those who carelessly invest, and those who fail to regulate. Supervision is seriously negligent; greed and short-term gain are so enormous that fraud and arrogant disregard of others’ rights and of ethics almost encourage criminal activities such as defendant’s.

 

Despite the fact that the defendant allegedly was facing a substantial sentence under the (now advisory) United States Sentencing Guidelines, he was sentenced to a term of five years’ imprisonment (plus the standard three year term of supervised release) because:

[F]irst, defendant’s young child and loving wife suggest the desirability of defendant’s early presence at home, working and supporting his family economically and psychologically; second, a strong supportive network of extended family, friends, teachers, and potential employers, as well as defendant’s positive reaction to supervision since his arrest, indicate a high probability of rehabilitation. Supervised release will encourage rehabilitation; violation of supervised release will result in further incarceration.

 

Regardless of how one feels about white collar sentences for corporate offenders, I think it’s fair to say that Judge Weinstein is basically guessing here. 

more ...

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WaPo has a story describing the extinction of some traditional French cheeses:

Dozens have been lost since World War II, and experts say another dozen or more are considered at risk of extinction. No one has a precise count of how many cheese types France produces, but the country has long prided itself on having a different one for every day of the year.

Why is this happening? You had to know that Americans are at least partly to blame. Other villains: law and big corporations.

Many blame the Americans, saying they habituated the French to pasteurization, to the detriment of raw-milk cheeses -- an ironic claim, considering that the germ-killing process was invented by a French hero of science, Louis Pasteur. 

Other big forces are also in play: the creeping homogenization of the global palate, food-safety regulations imposed by the European Union, and the increasing weight of the food industry, which churns out just a handful of blockbuster varieties.

In the end, however, the French have no one to blame but themselves. No one is forcing them to eat commodity cheese. A few pieces of self-loathing from the French:

"The French have forgotten what real cheese is," said Veronique Richez-Lerouge, who heads the Association Fromages de Terroirs, a group aimed at protecting France's cheese culture.

"Buying cheese has become like buying a box of detergent," said Richez-Lerouge, whose association publishes a calendar featuring bikini-clad pinups straddling hunks of Saint-Nectaire, Savarin and Rocamadour from family farms.

And this from a cheesemaker:

"Little by little, the others got old and retired or decided it wasn't financially worth it to them," Marmottan told The Associated Press. "A farm has to be viable financially and the product we make has to interest people or we can't in good faith continue. It's too hard a job."

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According to the WSJ Blog (which quotes the Washington Times), the SEC may have had some oversight problems of its own.  Apparently, some employees found ways to get around the SEC's computer filters and view pornography sites - a lot.   

I can't say I am extremely surprised.  An entire cottage industry of consultants exists to help companies identify this type of thing, not simply because of moral or legal concerns but because they don't want their employees to waste company time. (Nice example of how the corporate interests actually coincide with societal ones).

I should add, we have no idea how the SEC stacks up to other agencies (or private companies for that matter) in terms of employees who access porn sites on work computers.  (Time for a new OIG report?) Nevertheless, the mini-episode does tell us something about culture, norms and enforcement: despite the fact that these folks worked for a well-known government agency, knew their computers were being monitored, and that they were wasting government time and resources, they still continued with their course of conduct.   Clearly, there are impulses that drive people to commit wrongdoing, regardless of how organizations structure themselves.       

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here.  (Oscar nominees, that is.)

There are ten Best Picture nominees, but only five each for the acting categories.  Hmmm.  So "Up," a movie which I really didn't like, is nominated twice, once for Best Picture and once for Best Animated Film.  I wouldn't hold my breath for a twofer, given the other nine choices for Best Picture.  Who was shunned?  I would say Sherlock Holmes and Robert Downey, Jr. specifically.  I just hope James Cameron comes up with a better acceptance speech than "I'm king of the world (universe?)!"

BTW, the Oscars could be confusing this year -- Up and Up in the Air?  A Serious Man and A Single Man?

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