April 23, 2012
JOBS Act Forum: Regulatory Stimulus: More Politics than Evidence
Posted by Erik Gerding

The JOBS Act seems to serve as a textbook of example of regulatory stimulus, in which politicians seek to jumpstart financial markets by relaxing financial regulations rather than using traditional tools like fiscal or monetary policy.  Neither of those traditional tools offers much immediate promise of promoting economic growth in this election year.  The Tea Party and bond market concerns with national debt (in both the United States and in Europe) thwarted any further attempt by the President or Congress to play Keynes.  Monetary policy loses traction at the zero bound, which is a fancy way of saying that interest rates are close to zero and the Federal Reserve cannot pay banks to borrow (and even that might not induce banks to lend).

Regulatory stimulus is not without historical precedent.  Japan engaged in financial liberalization after its own real estate bubble popped in the early 1990s.  Not coincidentally, Japan’s central bank was also approaching the zero bound on interest rates then and was effectively out of cards.

So with fiscal and monetary policy off the table, deregulation of securities presented an attractive political opportunity.  But not necessarily a wise one.  Macroeconomic modeling has suffered some withering criticism in the wake of the financial crisis (for a blog compendium, see here).  

But at least it has some basis in theory and empirical data.  As John Coates noted in Congressional testimony on the JOBS Act, we don’t have a lot of data to suggest that these profound legal changes will (or won’t) result in net job creation. 

Legislating with a lack of data should trouble us.  Legal scholars routinely criticize reforms that increase regulation without  a sufficient empirical foundation.  We should insist on a similar level of rigor for deregulatory efforts. 

But the JOBS Act may be better understood as an exercise in legislative marketing than about reasoned policy choices.  Bob Thompson already gave us a succinct account of the political history of this legislation.  The language of the statute provides a master class in drafting financial legislation for political optics (a topic that incidentally has attracted some interesting scholarship in recent years). 

This goes beyond the statute’s clunky title and the headings of the provisions (“Access to Capital for Job Creators”).  This Conglomerate forum will focus on “emerging growth companies” later in the week.  Our commentators will discuss how companies that fall under that definition are exempt from various auditing, corporate governance, and disclosure obligations.  

However, it bears noting upfront that the term “emerging growth company” has no necessary connection to either “emerging” or “growth” or job creation for that matter.  It just refers to companies with less than $1 billion in annual revenue (a threshold that is indexed to inflation.)

Bob gave us an analysis of why this deregulatory legislation gained traction so soon after a wave of new regulation in Dodd-Frank (much of which is still to be implemented).  The text of the statute also suggests that it buys into a belief that high-growth companies will rescue us from economic torpor.  Wall Street is still bad, but Silicon Valley is riding a white horse again.  There are of course a number of problems with this mythology.

First, as noted above, much of the statute has no necessary connection to high-growth companies.

Second, even if we think that high-growth companies are the best way to promote job creation, innovation, productivity gains, and apple pie (and it would be heresy to question this wisdom (or maybe apostasy in the case of this blog)), why do we think that diluting securities laws is the best tool to promote high-growth companies? 

Third, don’t assume that there aren’t some goodies in the statute for Wall Street too.  Bob and Joan will discuss the IPO on-ramp provisions.  Steven Davidoff focused on the issue of decimalization.  I’ll focus more on the backlash against an obscure but important SEC initiative in a post later this week.  For a preview, suffice to say that when the JOBS Act instructs the SEC to study whether small cap stock should no longer be traded in pennies, but in the old 1/8 increments, Wall Street firms stand to gain.

For now, it is important to note the internal political logic of the JOBS Act.  The first argument is that small growth companies need more capital.  The second argument is that we need to jumpstart the IPO market.  Those two arguments are in quite a bit of tension.  The truth is that VC funding rebounded after the tech stock bubble collapsed (see page six of this report).  Of course it didn’t return to late 1990s levels, but is that a bad thing? 

Now the problem is that VC funds claim they can’t use their traditional IPO exit and many individual funds that raised capital in the aftermath of the bubble years are approaching the end of their lifespan.  But should we run a bulldozer through the regulatory landscape just to perpetuate a particular business model of a fund life of 10 years with IPO as the home run exit?  Wouldn’t a more sensible approach be to ask first whether the VC business model ought to change according to market conditions?

More broadly and deeply, isn’t it possible that the problems in capital markets stem less from legal rules than from the fact that we had two bubbles implode in less than a decade?

There are two looming possibilities with the JOBS Act.  The first is that we are not going to get a lot of stimulus bang for the buck we are paying in terms of changes to securities law protections.  The second is that markets may respond too much.  I’ve spent the last week cleaning up a part of my book that looks at British corporate law in the 19th century.  A pretty chilling pattern emerges:

  1. Parliament promotes financial markets by passing bills that either incorporate new joint-stock companies or liberalize the incorporation process.
  2. Incorporations skyrocket, markets boom, railway companies defraud investors.
  3. Markets collapse in the Panic/Crisis of 18__.
  4. Parliament is “shocked, shocked to find that gambling is going on in here.”
  5. A few years pass, then Parliament rinses, lathers, and repeats.

Perhaps we have gone back to that political and market cycle.  (At least in this century, we can take comfort that central banks will act as lender-of last resort, Right? Right?) 


Corporate Governance, Corporate Law, Forum: JOBS Act, Securities | Bookmark

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