Thank you to our Masters for a provocative first forum on what should be the business law agenda for the House, Senate, and President during the 112th Congress. You can read all the posts here.
Look out for more Masters forums (fora) coming soon.
Bailouts of megabanks preserved our financial system-for better and for worse. Next time around, Dodd-Frank allows winding down of big firms that cause systemic threats. But as I far as I can tell, the Act doesn’t require any liquidations—it’s up to the Treasury Secretary to decide whether to appoint the FDIC as receiver, (and up to the FDIC to pass the actual rules ). So it’s not clear whether there will be political courage to use this power in a future crisis; likely there will be bailouts again.
The obvious solution to the too-big-to-fail problem is to start breaking up the too-big ones that almost failed last time, and to prevent any more from getting that big. Then we can see a little creative destruction now and again. [How to do it? Luckily, I don’t have to bother with that part, since this forum is about the next two years and this is so not going to happen any time soon (if ever).]
Monetary policy: [Yes, I know this is mostly Fed policy, not legislative]
One has to wonder: the economy almost self-destructed because of easy credit, and the solution is…to ease up on credit?
I understand, and generally sympathize with, demand-side economics, and it may be the only way to mitigate the current pain of job losses. And I find it hard to believe there’s currently a real danger of inflation in the near term (those who claim to be worried about these days are probably most concerned about bond prices). But in the longer term, economic growth based entirely on expanding domestic demand seems like a snake eating its own tail. Is it prudish--or radical--to suggest there’s something wrong with our culture of consumption? If it needs fixing, punishing savings with low/negative interest rates ain’t the way to start. I don’t profess to have a palatable alternative. Maybe that’s the point—it’s time to take the nasty medicine….But I have tenure, so it’s too easy for me to say that.
Looks like I'm not the only wishing I'd written Dave Hoffman’s post, but since he got there first, let me polish the apple a bit: Instead of passing new laws, how about actually enforcing the laws already on the books? Oh, yeah, enforcement is the job of the executive branch. Then how about Congress just refrains from obstructing the enforcement of the ones it just passed? [Edit: Underbelly has more juicy stuff on this.] Just a thought.
Like Chris Brummer, I think the government will look to foreign agreements to get things done in financial regulation. There will be plenty of domestic rulemaking as well. But otherwise, I've predicted gridlock on legislative fronts, and it's not hard to see it coming if the Senate minority leader is already calling for the president's ouster.
What could happen? Dodd-Frank could be fixed a little. Maximally this might include a reorg that coordinated the SEC and CFTC more (merging them seems like a pipe dream at this point), minimally Congress could give American regulators a more definitive agenda for their international agreements, rather than simply asking them to pursue them (which to be sure, counts for some legitimacy).
I think the challenge for the House will be oversight. Congressional oversight usually looks terrible, with yelling Congressmen and bland administration officials, and it all looks rather pointless blamepointing. It's a bit less - if only a bit less - pointless when you can threaten the appropriations of the agency you are yelling at. But when you can't really pass legislation, and when you can predict that the agencies will be active on the rulemaking front, managing oversight it tricky. If the House has committee leaders who can sound smart, make their points, and do some dry eviscerating, then it will have learned some elegant new tricks. But if it becomes the simple House of no, I find it hard to see how that will be appealing.
To: Freshman Senator/Member of Congress
Re: Making your mark
¡Felicidades! Maybe, like Robert Redford at the end of The Candidate, you find yourself asking “Now what?” How will you make your mark in the 112th Congress? Senior legislators are likely to give you some sage advice: focus on one or two important issues and become the master of those topics. It will show the seniors in the class that you are serious, deferential, and a resource for the party, rather than a dilettante and an egotist (you don’t want to be the first one of those on Capitol Hill). The more technical the issue, the less competition you’ll have and the less of a threat you’ll be to the old barons and baronesses.
Although technical (some would use the perjorative “boring”) issues may be a hit with the party bosses, you may be concerned that they won’t win you points with your public. But that depends on which issue you pick. One strategy – that also meshes well with your deeply ingrained sense of public service – is to find policy issues where the public is seriously underestimating the risk of problems and start raising the alarm. Do so in a sober way, of course, or risk becoming chicken little. (Just between the two of us, for all your jeremiads against the “elite”, I know you are secretly a wonkish egghead like me. Accordingly, you’ll be interested in some rich scholarship on the political opportunities that come from the gap between objective risk and public perceptions of risk. See Amitai Aviram).
Bearing this general strategy in mind, if you want to focus on financial regulation, there are three routes you can take: First, you can reach into the grab bag that was the Dodd-Frank Act and take an active role overseeing one of the major regulatory projects under that act.
As noted many times before, the last Congress delegated to federal agencies the task of putting the meat on that statute’s skeleton. There are lots of high profile rulemakings to choose from including the Volcker rule and the authority of the SEC to impose fiduciary duties on broker-dealers. But those two fields are likely to be crowded, so consider the host of other issues that are harder to understand, but no less important. Derivatives present a motherlode of important, but complex issues. For example, the “swaps pushout” requirements under the Act, which create push banks and other regulated entities that receive “federal assistance” to move their derivatives trading operations to affiliates that don’t receive that assistance. The politics of this regime can be clarified – should federal taxpayer dollars subsidize risk-taking on derivatives that might require a federal bailout? But the economics of this issue – measuring cross subsidization from one affiliate to another, determining when entities with an obscured subsidy compete unfairly with those that don’t – are hard. As are the legal issues of an agency writing rules to make sure that any subsidies from deposit insurance don’t leak even to “pushed out” affiliates. Bottom line: hire some experiences regulatory and transactional lawyers on your staff and reach out to economists.
You can go even deeper and ask about the unintended consequences of Dodd-Frank rules. For example, Dodd-Frank has numerous provisions designed to push over-the-counter derivatives to trade on exchanges and to be cleared through clearing companies. The intentions behind these provisions are good – to move derivatives to institutions where pricing is transparent and where counterparty risk (the risk that one party to a derivative contract will default, increasing the risk of a domino effect of defaults (the reason given for the bailout of AIG)) can be centralized, measured, and mitigated. But the risk of centralizing counterparty risk in clearing organizations is that we may be creating the mother-of-all-counterparty risks. This means that close attention will have to be paid to the rules for derivatives clearing organizations, including things like position limits and margin rules. Of course there will be plenty of experts in the agencies and in the private sector weighing in on these boring topics. However, one lesson from the financial crisis that should linger is the dangers of excessive reliance on technocratic experts to handle the boring stuff. Even technocrats are flawed and selfish, Principe/principessa.
A second approach is to focus less on the roadmap in Dodd-Frank and more on those factors in the global financial crisis that Dodd-Frank largely fails to address. I can think of many, but here are two starters.
One: the repurchase markets in which banks and other financial institutions borrow vast sums – often overnight. When lending in these “repo” markets (no – Emilio Estevez was not involved in this disaster) dried up, the credit system froze. Some economists liken the effect to a modern-day bank run. Dodd-Frank does too little to address repos.
Two: much of the complex financial transactions were a rhyme (not a repeat) of the type of off-balance sheet games we saw in the Enron era. Perhaps not the same shenanigans nor the same intent, but the effects were worse – assets were often moved off bank balance sheets even though the risk remained with the banks. Leverage was hidden. Bank regulators will tell you that they carefully look at off-balance sheet liabilities when examining financial institutions. Bologna! We’ve seen what a great job they’ve done with that. So let’s add an accountant to your list of committee staffers or outside advisors.
A third and final approach is to forget fighting the last war and focus on fighting the next one (nota bene: military and sports metaphors will get you far in your line of work). As I’ve written before, beware of a crisis in municipal finance. If underfunded government insurance programs are your thing, move past social security and consider the Pension Benefit Guaranty Corporation – a government corporation that assumes responsibility for certain private sector pension plans when the sponsoring companies are in financial “distress.”
Hope this is helpful. Mucha suerte con todo! Oh, and about those personal e-mails imploring me to donate to your campaign -- I think you mean the Erik Gerding who used to work at Cleary Gottlieb.
Dave Hoffman’s initial post in this Masters Forum on when nothing is good enough got me thinking about the effects of doing nothing in the area of law I’m most familiar with, federal taxation. As is well known, an odd thing about our current Internal Revenue Code is that, if Congress takes no action, the tax law will change in some major ways on January 1, 2011. To hit some highlights, absent Congressional action, the following provisions are among those that will change:
– Income tax rates: The 10% bracket for individuals will be eliminated, so the first bracket will be 15%. The other brackets will all increase, with the top bracket increasing from 35% to 39.6%.
– Capital gains rates: The maximum capital gains rate for individuals will increase from 15% to 20% and the capital gains rate for individuals with a top marginal rate of 15% will increase from 0% to 10%.
– Dividends: Individuals’ dividends will return to being taxed at the same progressive rates applicable to other forms of ordinary income, rather than at a maximum rate of 15%.
– Estate tax: In 2009, the maximum estate tax rate was 45%, and decedents received an estate tax exemption of $3.5 million. Currently, those, like George Steinbrenner, who die in 2010, face no estate tax. However, unless Congress changes the law, 2011 decedents will return to the law prior to the Economic Growth and Tax Reconciliation Act of 2001, meaning a $1 million exemption and a top rate of 55%, with a 5% surtax applying to estates between $10 million and $17.184 million.
Given the election results, extension of the sunsetting tax cuts is on the table, and repealing or decreasing the scope of the estate tax no doubt will be, too. If changes are made in 2011, gaps could be eliminated by making the legislation retroactive to January 1.
The CBO found that all four options it examined for extending the tax cuts would increase income and employment during the next two years, compared to letting the cuts expire. However, the CBO also found that, in the longer term, each of the four options would likely reduce income because of the increase in federal debt they would occasion. The CBO concluded that other temporary tax cuts (such as reducing employers’ payroll taxes) or increased government spending (such as aid to the unemployed) would get a bigger bang for the buck.
The United Nations recently published its 2010 Human Development Rankings. Introduced in 1980, the rankings represented "a new way of measuring development by combining indicators of life expectancy, educational attainment and income into a composite human development index." The those initial rankings, the US was first. In the new rankings, the US is fourth, trailing Norway (aka The Motherland), Australia, and New Zealand.
When you look at the component parts of the HDI, the US is fairly on GDP per capita. We cannot compete with Liechtenstein and Qatar, but we come in ninth on this measure, trailing mostly small countries with lots of oil. Where we lag significantly is life expectancy and years of schooling.
What may be more newsworthy is the fact that the US drops to 13th place when the rankings are filtered for inequality. According to the UN: "Under perfect equality the HDI and the IHDI are equal. When there is inequality in the distribution of health, education and income, the HDI of an average person in a society is less than the aggregate HDI; the lower the IHDI (and the greater the difference between it and the HDI), the greater the inequality."
What does all of this have to do with the 112th Congress? What we know is that House Republicans claim that they want to cut spending, but they have neither the power nor the courage to follow England's example. Cuts on that scale would touch Medicare, Medicaid, and Social Security, and that's not happening in the next two years. If Congress wants to attack the deficit when the required budget cuts are off the table, the only other option is growth. The problem is that strong incentives for short-term growth are likely to be found in tax reductions for businesses and investors, which will produce more inequality.
Eric Cantor is making his pitch to the American people by contrasting his growth agenda with "the Administration’s anti-employer agenda." Cantor mentions the possibility of tax reductions for small businesses ("give private-sector job creators an incentive to hire by exempting small businesses from 20 percent of their tax liability"). Otherwise, his big idea is not much of an idea at all:
Conduct an immediate and comprehensive review of existing and proposed government rules, regulations, and statutes that impose additional, unnecessary costs on employers and job creators.
If I had a nickel for every time I have heard this proposal.... If this happens at all, we won't see any results until after the next election, which is mighty convenient. And I suspect that it won't happen at all, which is probably just as well.
The inconvenient truth is that government is playing on the margins when it attempts to promote entrepreneurship in the US. We already do very well in entrepreneurship compared to other countries, so new ideas for government action end up seeming a bit silly.
On the other hand, governments can do a fair amount of harm to entrepreneurship. It's hard to imagine an environment more destructive of entrepreneurial incentives than one in which the government is lurching from one major new policy initiative to the next. Robert Higgs coined the term "regime uncertainty" to describe the depressing effect of Roosevelt's New Deal on business investment, and the analogy to the Obama adminstration seems apt. Thus, I am very sympathetic to David Hoffman's suggestion that "nothing is good." It seems rather uninspiring, and I suspect that it won't appeal to many elected officials, but it may be Congress' best bet for a growth agenda.
UPDATE: We aren't the first to hop on the "do nothing" train or to peg regime uncertainty as a modern problem. For example, see here.
Plenty of challenges await the new Congress and the President, but I think it is clear that politicians, along with financial regulatory authorities and agencies, should not lose sight of the need for continued, robust international cooperation in financial market regulation. Sure, as an international financial reg scholar I’m biased: The 2008 agenda ushered in by the G-20 helped to spark unprecedented efforts to coordinate financial regulatory policy, not only in the high profile field of bank capital adequacy, but also in areas as diverse as credit rating agency oversight, executive compensation, and derivatives oversight.
But there is still much more to be done: regulatory initiatives for many cooperative efforts remain vague and indeterminate, and significant gaps remain in such key areas as shadow banking regulation, too-big-to fail, and cross-border resolution cooperation. Plus the monitoring of countries' compliance with international best practices and standards, though recently strengthened by the IMF, is still all too often weak.
As a result, even assuming US political actors can reach consensus on national regulatory strategy, broader international gaps persist such that Dodd-Frank reforms can potentially be mooted where, as Chris Dodd recently noted, foreign countries with weak supervision provide “safe harbors” from strong regulatory oversight. Even in an age of increasing isolationist retrenchment, financial authorities and political elites must, as a result, continue to acknowledge and engage the still growing interdependence of not only financial markets, but also financial market regulation.
This will be difficult to do in the absence of agreement or consensus at the local level of US politics. Still, there are broad areas of agreement such that the US positions as already articulated in the Dodd-Frank Act should provide either the basis or momentum for even greater coordination abroad in areas relating to the accounting of financial instruments, the regulation of clearinghouses and central counterparties, and even, perhaps, greater prudential regulations for the shadow banking industry. International cooperation and standard-setting often arises in a series of rounds, where successive iterations of negotiation lead to both substantive reforms in earlier standards as well as more prescriptive rulemaking. Meeting counterparts head on should thus still be possible, if only as a weigh-station for more definitive agreements as post-election regulatory policy takes shape.
I’m sure a clever experimentalist has tested the do-something bias – that when advising others, we are more likely to recommend action than inaction, even when we would sit tight in the advisee’s position. It’s easy, after all, to charge others with the emergent necessity of action when the costs (like getting it wrong) aren't ours to bear, and the Conglomerate pays its masters by the affirmative word. [I kid. They pay in prestige.] The charge of this master’s forum is to consider “a Business Law Agenda for the New Congress and the President.” My contrarian instinct is to consider whether the right agenda is no agenda: maybe nothing is good enough for the next two years.
By nothing I don’t mean rolling back Dodd-Frank, the Healthcare Omnibus, or reanimating the dying Bush tax cuts. Rather, I'd advise permitting the status quo to ferment for a little while, and see what bubbles up. We just had a “do something” congress”. I am myself still trying to figure out what the 111th Congress did to innovation and entrepreneurship. Will health care portability enable more small business risk-taking, or will regulatory costs bury main street? Does Dodd-Frank’s anti-systemic risk and derivative trading apparatus meaningfully increase liquidity and/or transparency, or does it simply drive bad actors into tighter tangles & more shadowy corners. It seems obviously true to me – as my former colleague Jonathan Lipson observes here - that very little of Dodd-Frank was empirically tested before its adoption. Similarly, although health care economics & behavior is a deep and richly mined field, HCR itself is already creating unanticipated effects as the market & consumers react to the unfolding of the State’s new & multi-tentacled regulatory arms. I believe, moreover, that early reactions to previous reform efforts (like SOX) appeared to be wildly overstated on both sides of the academic aisle. It strikes me what business really need over the next two years is certainty. This (nothing more but nothing less) are the rules of the game you will play under. Good or bad, we're sticking with it for a while to see what happens. Take regulatory change off of the table: grapple with your own competitive demons.
This approach has the notable disadvantage of being over- and under-inclusive at dealing with problems. It is over-inclusive in that it leaves in place certain problematic aspects of HCR and Dodd-Frank – like the very unclear grants of power by the 111th Congress to new agency heads. Consider Elizabeth Warren, both brilliant and beloved. How much power will she have? What is her agency really going to do? So even leaving things in place means that there will be a degree of uncertainty.
Similarly, the approach is underinclusive. It leaves unaddressed serious systemic problems in our system of business regulation. Among them, what to do about business bankruptcy? Is sunlight still the best disinfectant in the Digital Age? Can we preserve a state-federated model of entity governance when duties run across national borders? How might we best cabin in arbitration & preserve the public good that is corporate and contract doctrinal common law? What is outsourcing's effect on the the deterrent & expressive reach of our employment, labor, IP, & environmental regulatory regimes? These aren’t trivial problems – far from it. But they might be problems that we have to leave on simmer as we see what comes of the grand experiment in economic redesign that we’ve just put into motion. Let's get some evidence before we decide to rip it all out, root and branch.
There’s an additional advantage to my approach: gridlock is what is most likely to happen in a world where the Republicans aren’t going to be able to override the President’s veto. Let's make a virtue of necessity. Better deliberate inaction than inconsiderate stagnation! A motto for law school faculties and the country alike.
Welcome to the 2010-2011 addition of the Conglomerate Masters. We are continuing a one-year old tradition (unlike any other) of asking prominent law professors in different fields to comment on the hot topics of the day in business law. We are starting this academic year by asking our new roster of Masters to comment on what should be the business law agenda for the new Congress and the President for the next two years? Our Masters have a wide range of research interests – from bankruptcy and commercial law to tax – and have been given license to define “business law” however they please. They may take a pragmatic approach and focus on what could be accomplished – and we’ve already heard a prediction from Professor Zaring that that space to maneuver might not amount to very much if gridlock reigns – or they could focus on what should be on the agenda.
Masters, you may fire when ready.