Every day we read the headlines, feel the tensions, observe the consequences of the recent failures of market and government. Having a serious conversation about how to remedy these failures lies at the heart of current American politics. And that conversation should address three distinct questions:
- What are the parameters of government intervention in the marketplace? What rules should we use in deciding when the government should act, and when it should let the market take its course?
- Has our response to the immediate crisis been successful?
- How might we restore an effective structure for corporate governance? The failures of corporate governance account for much of our economic troubles over the past 30 years. Getting out of the current mess will require addressing these underlying failures.
Answers to the first question, about government intervention, have changed quickly. Ayn Rand was an articulate, powerful voice for libertarianism, the notion that each of us individually deserves to own what he or she creates, and that the role of government must be minimized. For 30 years a libertarian ideology dominated leadership circles, beginning politically with President Reagan, who led a fundamental transformation in our political discourse—about the government’s role in everything from marginal tax rates to regulation. Many people think that Reagan was brilliant, and that his policies were necessary. Whether or not you agree with that assessment, you have to acknowledge that the Reagan agenda dominated our discourse until the fall of 2008, when the entire economic world appeared to collapse.
A year later we have Ken Feinberg, appointed by the president to determine how much CEOs will be paid. We’ve gone from finding government intervention anathema to accepting that a bureaucrat determines how much someone gets in stock options. But angry populism—180 degrees from libertarianism—is no better a guide than Rand. We understand the public anger, we sympathize with it, we all feel it. When the very people responsible for the cataclysm are reaping its rewards, we know something is wrong. But angry populism doesn’t direct us in figuring out what a government should do.
So we need to talk instead about when government should intervene: where, why, and with what limits. I will articulate three rules (and one footnote) in this effort.
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Rule 1. Only government can ensure integrity, transparency, and fair dealing.
When I was Attorney General of New York, we investigated what I refer to as the “analyst cases.” The cases were about investment banking. To understand them, all you need to know about investment banking is that the business has two sides: you have supposed analysts, who recommend stocks for investors to buy, and you have underwriters, who sell IPOs, secondary offerings, and other things that raise capital for the companies. We argued that there is an inherent conflict of interest when you have people in the same business who are both recommending a stock to retail investors—saying, “this is a great stock, buy it”—and doing the underwriting. The more successful the underwriting, the more fees it will generate, and the more favorable the analysis, the more likely the underwriting will succeed.
This is clearly a conflict of interest. In fact, Jack Grubman, the telecom analyst banned from the securities industry in 2002, brilliantly encapsulated this whole era: what used to be viewed as a conflict of interest, he said, is now viewed as a “synergy.” Think about that. What used to be viewed as a conflict of interest—hence dangerous to people, something to warn them about—is turned into something that creates value. This was the way we masked the problem. In the analyst cases, we didn’t discover the conflict of interest: everyone understood it and had accepted it for a long time. But at the attorney general’s office, we called it what it was.
We started with Merrill Lynch, but went after all the big investment banks, what are called the “bulge bracket” firms. We found graphic emails. Analysts were saying, “this stock is a piece of ,” and at the same time telling people to buy it, buy it, buy it. But things began to get really interesting after we put our case together.
When we were ready to file our case, I got a call from the lawyer for Merrill. He said to me (and this was arguably his most persuasive point): “Eliot, be careful, we have powerful friends.” I said, “Okay, I’m not sure that’s a legal argument.” Actually, what I said to him I won’t repeat verbatim. Needless to say, we went ahead.
The lawyers for Merrill came into my office. Now, when you’re a white-collar defense lawyer, you argue in the alternative. First you say the emails were taken out of context. Then you say: “you don’t fully understand them.” Then you say, “no, they were fabricated.” Then you say the person doesn’t really speak on behalf of the company. And then you check the limits on your insurance. I was a white-collar defense attorney for a number of years, so I know the drill.
They didn’t make any of those arguments. They came to me and said, in essence, “Eliot, you’re right. Absolutely right about the conflicts, the tensions, the problems. But we are not as bad as our competitors.” That was their defense to the charge that they were defrauding their customers and the marketplace. When I asked to hear more about it, they said, “let me tell you about Goldman and Citi.” I’ve turned defendants over the years, but these guys were the easiest flip I’ve ever done.
There is a very important point here: the people at Merrill Lynch understood that their business model was problematic. They understood that there was something wrong with recommending stocks that they didn’t think were any good. But they had to choose between ethics and profits, and they made the choice that harmed individuals and undercut the integrity of the market. And then they said it wasn’t up to them to enforce the rules of transparency. Somebody else should do it.
Who? Only government can do it. The market was driving investment bankers to an unacceptable, ineffective, market-destroying standard of behavior. To protect the market, government had to come in and say something very simple: tell the truth to your customer. Tell the truth about the stock. Everyone understands that investors take risks, that analysts and investors sometimes get things wrong. The problem is intentional deception. That’s what distinguishes being wrong from lying, errors from fraud.
Something else interesting happened. When Merrill said, “we are not as bad as our competitors,” they were really saying that they needed an industry-wide solution, that if they were the only ones who had to live by some new standard, they would be at a competitive disadvantage and lose market share. That wouldn’t be fair. I wasn’t terribly sympathetic, but what they were saying about holding everyone to the same standard was true. So I recommended that we get everyone to agree to a common code of conduct before we’d go through the agony of making a case against the other banks.
We couldn’t do it. The other banks simply didn’t want to play ball until we said we had the evidence on them also. We went through the same exercise. Then we announced a global settlement. That was December 2002. I would argue that the settlement worked, but that is a separate conversation. What matters to the current conversation is that only government could get these companies to tell the truth.
Transparency is not an issue only for financial-services providers. It is important to every sector of the economy. Here’s another story. We brought a case against a company called GlaxoSmithKline, which was at the time marketing their drug Paxil—an anti-depressant—as effective for teenagers. It had been approved for other purposes, but this was off-label marketing. We found that a significant number of the clinical tests they had done proved something directly at odds with their claims. It was not for me as attorney general to determine whether this drug was bad or good for teenagers, but to insist on full disclosure of critically relevant information so that doctors and journals could make that determination.
When we sued Glaxo, they thought we wanted money. But we only wanted them to change the way they acted. We asked them to create a Web site for the clinical testing data so that doctors and journals could make informed judgments. They agreed. The settlement became part of a longer process, a move toward substantially more disclosure when it comes to drugs and testing data.
From Glaxo’s perspective, the more data they withheld, the better it was for them. They could persuade more people to use Paxil. So, again: only government can ensure integrity, transparency, and fair dealing.
And here’s where I’m going to add my footnote: even though private companies compete, only government can ensure that there is competition. Everybody in business wants to be a monopolist. There’s nothing wrong with wanting more market share. That’s how you make money. But over the last 30 years, we lost our drive toward effective market enforcement. Judge Robert Bork argued that anti-trust laws are unnecessary, that the market enforces itself. We can now say that’s fundamentally wrong. If we don’t have government enforce competition laws, then we lose the vitality and creativity that competition generates. Before AT&T was broken up in 1974, for example, you could choose between a black phone or a “princess” phone. That was it. After that, people entered the telecom market and said, “let’s do something different, something more creative, something better.” The AT&T breakup was not the cause of all growth in that sector, but it is amazing how far we have come in telecom because of the competitive spirit it generated.
Rule 1 doesn’t go far enough—even with the footnote. Government needs to do more. Anyone who has taken introductory economics understands the notion of externalities—a positive or negative effect on third parties that is not factored into the price at which two private parties transact. If that externality isn’t factored into the price as determined by two private individuals, somebody has to adjust for that. That is the job of government, through taxes and subsidies.
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Rule 2. In the face of externalities, government must intervene to change the way the market behaves.
When I was attorney general, we brought environmental cases against a bunch of Midwestern utility companies. They were burning a lot of coal, generating pollution that came down over New York. So I went down to Washington one time to testify about the cases. Senator George Voinovich, sitting behind the dais, looked down at me. He said, “General Spitzer, I was the governor of Ohio before I was the senator, and when I was governor we cleaned up the air in Ohio, so why are you doing this?”
I applauded him for what he did, but reminded him that one of the ways the utilities cleaned up the air in Ohio was by building smokestacks a thousand feet tall. Smokestacks that tall aren’t cheap or pretty, but they do put all the carbon dioxide and sulfur dioxide up into the jet stream. It doesn’t come down in Ohio, or even Pennsylvania or New Jersey. It comes down in New York. If the pollution is coming down in New York, I told him, you’re creating a negative externality in New York, and under the Clean Air Act I can sue you. And that’s how to put the cost of cleaning this up back on the utilities, where it belongs.
Here’s another example of an externality that most people don’t think of in those terms: too much debt. Debt as an individual transaction may be viewed as okay. But when you aggregated all the debt, all the excess leverage in our economy over the last decade, you had what people call “systemic risk.” The whole system could shatter and collapse because you couldn’t service that debt. There wasn’t enough wealth-generation to handle it. Individual transactions looked okay, but the aggregate effect metastasized in a way that jeopardized the entire economy. The reason that government has to intervene in debt markets, then, is because too much debt is a negative externality just the way too much carbon dioxide is a negative externality in terms of global warming. In both cases, government has to intervene.
The third area in which government has to intervene is the most elastic, and, in a way, also the most important. It’s what I call core values. There are certain core values—values that we as a society embrace—that the marketplace simply will not address. I’ll give you two examples: ending discrimination and maintaining a minimum wage.
When I was getting an undergraduate degree, we had a policy seminar about discrimination at Princeton’s Woodrow Wilson School. One of the popular arguments we discussed is that discrimination is inefficient and that the market would therefore get rid of it: a company that would not hire men over six-feet tall would lose out on a certain universe of talent and would be less competitive. With lower profit margins, and trouble attracting capital, it eventually would go out of business. It’s a very nice theory. Men over six-feet tall were not the typical group discriminated against, but it was the same argument whether it was based on gender, race, or religion.
The problem is that the theory is wrong. After 200 years of market behavior, discrimination continued. It got better or worse in different eras, but the social mores that drove discrimination based on race, gender, or religion, continued to overpower the rational activity of economic actors. Those mores were a more powerful motivator than the pressure to hire the best person or sell to that additional customer. We didn’t begin to get rid of discrimination in this country until government passed laws that created a right of action, a way to sue for being discriminated against.
In the case of minimum wage, people ask, what is the economic argument for minimum wage? Shouldn’t we let the market determine the value of labor? No. We’ve made a societal judgment that people who work a 40-hour week should have enough money to buy food for their kids. That’s a value judgment that the market does not ensure. Government needs to intervene.
These two are merely examples of core values, and there is a large debate about what core values are—about whether they are determined politically or culturally. The term is elastic, but core values exist and define us as a community. And as long as we can understand those values, government intervention to permit and enforce them is appropriate and necessary. So we have:
Rule 3. The government needs to intervene on behalf of core values.
These three rules do not offer a universal theory that solves every problem, but they do create a rational framework that says government should be active in certain areas and for specific reasons.
• • •
Coming now to the current crisis, has government intervention been appropriate and effective? Perhaps not surprisingly, my conclusion is that it has not. When our economic world appeared to collapse, there was absolutely no question that an enormous sum of money was going to be spent creating solvency and liquidity; money needed to be pushed into the system. On that premise, there was universal agreement. And when it was done—the number $24 trillion is thrown about when you aggregate the straight cash given out, the guarantees, the money we printed—everyone cheered.
But when the cheering finished, three difficult questions emerged. First, who will pay the bills? Second, which regulatory reforms do you impose at the moment when you have the leverage and, in all likelihood, the only opportunity to make a change before the status quo reasserts itself? Third, how do you address the desperate need for jobs in a troubled economy?
On the first question—who pays?—a lot of people say that’s obvious. We all do. But wait a minute: a lot of the executives of the companies left with enormous bonuses. There were opportunities for clawbacks, which would have required asserting claims to recover salary and bonuses paid over prior years, perhaps on a theory of unjust enrichment. In aggregate this wouldn’t have been a big sum compared to all that we put in. But in terms of the message sent and the appropriateness of the remedies, this should have been considered and still could be.
We also could have required more debt-equity swaps, where the debt holders of the companies still had claims on the companies. Forcing them to convert their debt to equity would have put them in a very different position: they would have been at risk and been held to a different standard. We could have driven the equity to zero in many of these companies that were insolvent because of their financial shenanigans, but we didn’t. Think about the consequences for those who held options in these companies, who held a huge sum of public money, as the stock now begins to come back. It might have been down to two dollars, but once it hits $30, $40, $50 again—because of the huge infusion of public money—they make out extremely well. Should they have been put in a position to benefit? We didn’t have the discussion about whether to drive equity to zero, wiping out those option values that remained in the hands of the folks who created the mess. It is fair to ask why.
Passing the cost of the bailout straight to the taxpayer was exemplified in the case of AIG. When AIG was being bailed out—the first investment was $85 billion—everybody said that we needed to pay off the credit default swaps (essentially insurance contracts against defaults on debt repayment). If the holders of the credit default swaps were not made whole, everything would go bad. That was rubbish. There was absolutely no reason for those counterparties to get a hundred cents on the dollar. But when Goldman showed up, and CEO Lloyd Blankfein said, “we want our $12.9 billion,” Goldman, as a counterparty, got $12.9 billion.
When Larry Summers, Director of President Obama’s National Economic Council, was asked why he supported the full payments to Goldman, his answer was that “we are a nation of law, where there are contracts.” That’s a silly answer. There was a contract, but taxpayers were not a party to it. We didn’t make a deal with AIG to make whole every counterparty to every contract. Our government—with our support—said, “let’s do what needs to be done to resuscitate the economy and to make sure things don’t get worse.” Initially some of the low-level people at the Fed were asking the right question, trying to figure out what percentage to pay. They understood that this was the relevant question. But that question was taken off the table. The investment banks, the counterparties, got one hundred cents on the dollar and Goldman got a check for $12.9 billion, covering most of their bonus pot. Taxpayers funded their bonuses.
But it is even worse than that. Because then the Fed and the Treasury, which were being sanctimonious about this at the time, said, “we’re going to take stock in AIG.” Think about it. AIG was a worthless shell. Anybody would say: “I’m giving you, as a conduit, a check for $12.9 billion; you’re turning around and giving the check to Goldman? I want stock in Goldman. I don’t want stock in a worthless shell.” The Fed and the Treasury didn’t consider that possibility. I don’t know why, but it returns us to the question of who pays. The taxpayer picked up the whole bill. That was wrong.
On the second question, about regulatory reform, the government is doing even worse. (There may be some light at the end of this tunnel; on Capitol Hill there are some decent proposals that are being heard.) The biggest problems come from the terrible idea that some firms are “too big to fail.” Those who have analyzed the return of equity of major companies understand that when companies get that big they underperform because they cannot be managed. Too-big-to-fail is too-big-not-to-fail. But the major companies are now bolstered by what used to be an implicit and is now an explicit backstop of federal government/taxpayer guarantee on their debt. That guarantee—capital at virtually zero cost—does not improve company performance; it subsidizes continuing underperformance.
A global consensus has now emerged that too-big-to-fail is the biggest single threat to our bank system. Economist Henry Kaufman, a very conservative voice, had a lengthy op-ed in the Wall Street Journal that reaches this conclusion. Paul Volcker, Former Fed Chairman and now Chair of the President’s Economic Recovery Advisory Board, agrees. Former Fed Chairman Alan Greenspan, whose autobiography is one long standing ovation for Ayn Rand, has said that too-big-to-fail is dangerous. Mervyn King—the governor of the Bank of England—has said it. Unfortunately only two people seem not to get it: Larry Summers and Treasury Secretary Timothy Geitner. They say, “if it’s too big to fail, we’re going to backstop it.” That guarantee socializes risk and privatizes gain. You do that, and you’re going to get distorted investment patterns and the same excessive willingness to tolerate risk that caused all the problems in the first place.
We’ve also participated in a regulatory charade. All the CEOs say, “It’s not our fault. The regulators didn’t get it right.” The regulators say, “We didn’t get it right because we didn’t have enough power.” So everyone runs to Capitol Hill to write new laws to give regulators more power. We don’t need new laws. We need regulators who will use the power they already have. The Federal Reserve is putting in place new rules that say banks can’t increase credit card fees without getting consent from consumers. Nice idea. Why didn’t they do it five years ago? All the dramatic steps the Fed has taken to resuscitate, to bail out, to restructure, to guarantee: they could have done it all before. So Congress will pass a new law, there will be a big signing ceremony, and everyone will say it won’t happen again because now the Fed has the power. They already had the power. They didn’t want to use it, and passing a new law is not going to embolden them.
That’s what I refer to as the “Peter Principle on Steroids.” The Peter Principle says that people are promoted to the point of their incompetence. In the Peter Principle on Steroids, people are promoted to the point of their incompetence, but their incompetence creates a crisis, and—here is the new twist—they use the crisis to get even more power. They get a promotion beyond the point of their incompetence because of the crisis that they created. This is what we’re doing in Washington. The two entities at the heart of this crisis were the Fed and the Treasury Department. They failed. Completely, utterly failed. Now look at the reform proposals. The breakthrough idea is that the Fed is going to be our systemic-risk regulator. Wow. That’s important. But I hate to break it to you: they already are. That’s their job. That’s what they were supposed to be doing for the last twenty years.
Another bold breakthrough: the Fed’s idea to conduct “stress tests” on major banks. Great idea. But they are banking regulators. They had the power to do this. They just chose not to.
Think about what happened with subprime loans. Let me read you something written on the topic: “These loans are foisted on borrowers who have no realistic ability to repay them and who face the loss of their hard-won equity when all the inevitable defaults and foreclosures occur.” That’s from 2004, and I wrote it.
Now I am not a banking regulator. Still, we were trying to investigate subprime lending because back in 2004 we knew there was a problem. I don’t want anybody to misinterpret “foisted on” as absolving the borrower of responsibility. Everybody bears responsibility, and, on both sides of this transaction, people are at fault. The point is that the consequences to the financial sector and to the economy were clear.
We understood in 2004. We tried to investigate. Our investigation was shut down by the Office of the Controller of the Currency (OCC). It went to court to block our inquiry. Its partners in the courtroom were all the banks that later got TARP money. All the banks that got your tax dollars to fund the bonuses stopped the inquiry. The OCC’s legal argument was “we have the power to investigate, you don’t.” Did the OCC investigate? No. It was too busy shutting down people who were trying to do what it should have been doing.
Regulators don’t need additional power, they just need to use their existing power appropriately. And this will not happen unless different people are in charge. We are going through a huge regulatory reshuffle because what went on was absolutely horrifying. But all the laws and regulatory reforms will not matter at all unless we put in charge people who actually believe in enforcement.
The third question is about jobs, and here we are in deeper trouble than anyone wants to acknowledge. If you look at how many people are outside the employment structure, at what has happened to our manufacturing sector, at the few sectors that have added jobs—education and health care, which are hugely important, but do not form the long-term foundation of a competitive and self-sufficient economy—the trend lines spell disaster.
It did not have to be this way: all that money we spent could have been leveraged for job-creation. When we gave Goldman $12.9 billion and gave trillions to the banks, we didn’t say, “Do something useful, do something that will create jobs.” They went out and got involved in proprietary trading. If Goldman wants to make a fortune on proprietary trading, hats off to them. But they shouldn’t be doing that with tax dollars and our guarantees on their investments.
Let me give you two numbers: $12.9 billion and $8 billion. The first you’ve heard before. The second number is the amount in the stimulus package for investing in high-speed rail. Think about it. More than 50 percent more went to Goldman, even though there has been consensus for years that high-speed rail is critical: for energy, for efficiency. We’re not doing what needs to be done.
Or, consider the auto industry. We gave huge sums of money to resuscitate the shells of companies that probably won’t come back. Here’s another idea people had: why didn’t the government stand up and say, “We will buy 500,000 electric cars in 2013 from whoever gives us the best prototype, as long as 80 percent is produced domestically.” It doesn’t matter what the nameplate is—Kia, GM, Chrysler—but make them here. Set the number high enough so that the companies could generate a profit because of scale.
And here’s another idea: Eisenhower built the interstate highway system, but you can’t use an electric car there unless there are recharging stations. The government should build electric recharging stations wherever there are gas stations on the interstate highway system. There is an infrastructure project that creates jobs and transitions us away from gasoline-based cars and toward electric cars. We know we want to be leaders in that. We should be giving money to sectors that will invest in jobs and infrastructure in a big and fundamental way.
• • •
The success of everything I’ve discussed here depends on corporate governance. Corporations run the economy and they should. But if we don’t run our corporations properly, then we will not get ourselves out of this pit.
The chain of corporate governance includes a CEO, a board, and board committees. There are also three facilitators—lawyers, investment bankers, and accountants—who are hired to figure out how to implement the CEO’s plans. Then there are shareholders, who actually own the company.
I’m not going to spend time on the facilitators, but I’ll focus on where the problem is: fiduciary duty. Fiduciary duty embodies all of corporate governance. If the decision-makers don’t understand this notion—to whom they owe it and how to enforce it—nothing will work.
Let’s start with an example: corporate pay. Back in the mid-’80s, the Business Roundtable—an organization of corporate America—did a study of the ratio of the average CEO’s compensation to the average worker’s. It was about 40:1. People said, “Okay, this is capitalism, and that’s how things are.” In Europe the ratio was closer to 20:1, but we believed we had a more dynamic economy, so things seemed fine. By 2000, that ratio of 40:1 had exploded to more than 500:1. No one could seriously argue that CEOs became more than ten times more valuable to companies relative to average workers. Clearly the system had broken down. Anyone who digs into the issue of corporate compensation will see that what was going on was an outrageous betrayal of fiduciary duty.
Here’s another example. There’s something called spinning. When an investment bank does an IPO, and the IPO is hot—the stock is going to jump on that first day of sale—they give some of these hot stocks to the CEOs of their clients. Why? To keep them happy, so they stay as clients. As attorney general I said that should not be permitted; it violates the fiduciary duty of the CEO to the company. If the investment bank wants to give away something of value to keep a company as a client, it should give it to the shareholders, not the CEO. There’s an uglier term for spinning: commercial bribery. In 2002 we negotiated a global deal and outlawed it. People got outraged. One extremely powerful regulator today, a Peter-Principle-on-Steroids survivor, asked me then, “Don’t CEOs have any rights anymore?”
These kinds of violation of fiduciary duty shape the whole system. As a result, the CEOs and compensation committees no longer focus, as they should, on company performance.
These are vexing problems, and much has been said and written about how to resuscitate corporate governance. Boards and shareholders are the only real long-run answers. Boards have to become more active, and that means they will have to be chosen in a fundamentally different way. CEOs, frankly, need to have their wings clipped because the internecine relationship between CEOs and boards has led us down a dangerous path.
Every now and then, the SEC begins to approach the problem and proposes that shareholders choose the board members. The proposal is met with indignation: shareholders, we are told, will speak like a narrow special-interest group. Well, yes, they are the owners. The opposition to the notion that shareholders actually be given power is crazy.
But the participation of shareholders is genuinely difficult. The problem starts with the remarkable liquidity in the stock market. Owners of shares can trade out and sell their positions easily. Isn’t that a good thing? Of course. But it also means that shareholders do not stay in for the long, hard slog of reforming companies in which they have a momentary ownership interest. Liquidity thus undermines the urgency of and the argument for participation.
Albert O. Hirschman’s 1970 book, Exit, Voice, and Loyalty, brilliantly captures this dynamic. How do decision-makers consider the various options they face when they see a product—whether toothpaste, a political party, or a share in a company—and need to decide whether to use their voice to improve it or to exit and find something better? Hirschman presciently observed the implications of easy exit options for “perpetuating bad management”: because of the “ready availability of alternative investment opportunities in the stock market . . . any resort to voice rather than to exit is unthinkable for any but the most committed stockholder.” Somehow we have to overcome this problem. Perhaps shareholders should be given additional voting power if they own a stock longer. That solution has its own troubles. But we need to find a way to give shareholders the power and incentive to get involved.
Exit options are not the only hurdle to shareholder power. Consider who the largest shareholders are: mutual funds and pension funds (and university endowments, which are kind of the same thing). Why is that a problem? Lets take the case of mutual funds.
When I was attorney general, I participated in a panel on mutual funds at Harvard Law School. At that time an issue with mutual funds was whether they would disclose their records in proxy voting, whereby they exercise their customers’ voice on the boards of the companies they invest in. One of the participants was the general counsel for an enormous mutual fund company. She was asked if she would disclose how her company votes its proxies. And she said no, that it would be too expensive. That was a ridiculous answer. The reason mutual fund companies don’t want to tell their shareholders their proxies is that they almost always vote with the management of the companies in which they hold shares. Why? Because mutual fund companies make money by increasing the size of the assets they manage, and the size of those assets is directly related to whether they are chosen by companies to be the recipient of 401(k) business. If they vote against management, they won’t be put on the 401(k) option list. As a result, mutual fund companies help entrench management.
Because pension funds have never been activist either, we have denied ourselves the dynamism that we could get from the largest participants in the marketplace. CEOs and entrenched boards retain the power. We went down this path without taking a hard look.
To begin to repair corporate governance, it is important to understand what happened. I hope the Financial Crisis Inquiry Commission, which is supposedly the equivalent of the post 1929–crash Pecora commission, will investigate information flows along two lines. The first is about how information flows up to the boards at the major banks that failed. What were they told about the creditworthiness of their positions? One possibility is that they weren’t told anything, which tells us a great deal about their level of involvement. Or maybe they were told they were in a creditworthy position and need not worry. Or, they were told they were in jeopardy, but they didn’t do anything. Knowing the answer would give us a better understanding of the failures of corporate management. The second line focuses on the Fed and the Treasury. What did the New York Fed, the most important regulator of banks, and the Treasury know about the debt and leverage situations of these failing banks, and what did they believe?
To sum up, I want to leave you with ten points:
- Only government can enforce integrity and transparency in the marketplace; self-regulation is a failure.
- Only government can take necessary steps to overcome market failures, such as negative externalities or monopoly power.
- Only government can act to preserve certain core values in the market, such as prohibitions on discrimination.
- Too-big-to-fail is too-big-not-to- fail.
- We’re suffering from the Peter Principle on Steroids, and it will get us into deeper trouble.
- Taxpayers have been getting the short end of the stick in everything we’ve been doing. The Treasury Department is not negotiating for us.
- Risk is real, and no complex scheme of financial instruments can make it go away.
- We have de-leveraged the wrong way, by socializing risks and privatizing benefits. The government has accepted all the debt obligations of the private sector, and taxpayers now owe this money.
- The only way to reform corporate governance is to get the owners—the shareholders—of companies involved and actually paying attention.
- All of this is very tough: being able to diagnose a problem is a whole lot easier than mustering the will to fix it.