Friday, November 6, 2009

CEO Primacy and Unemployment

The new jobs report came out this morning and its very disconcerting. The headline unemployment number jumped to a 26 year high of 10.2%. It came on the heels of yesterday's news that productivity is surging. The surge in productivity means that US corporations are wringing more efficiency out of their labor force.

That may sound good, but what it means is that corporations are brutally cutting hours and slashing jobs to the bone to maintain profitability. As the Financial Times puts it "The US experience contrasts sharply with that in Europe. . .where companies cut back on employment and hours much less than their US counterparts, resulting in lower unemployment but worse productivity." In fact, hours worked is still in a free fall: "Total hours worked in the economy fell 0.2%. The average workweek was steady at a record-low 33 hours."

I previously highlighted the employment ratio, in my post "Runaway Unemployment?" That number too remains in a free fall. As the Brookings Institute states: "The current recession has also seen the steepest decline in the employment-to-population ratio in the modern era. Since the peak of the last economic expansion in December 2007 the percentage of Americans who hold jobs has fallen 4.2 percentage points, dropping from 62.7% to 58.5% of the population 16 and over." The upshot of this is that Americans are faced with a historic and rapid deterioration in the labor market.

This is consistent with my argument for years (starting in 2005 in the St. John's Law Review) that American corporate governance law devolved into a system of CEO primacy over the last two decades, as a result of CEO political power. I recently argued that CEO primacy drove the current subprime crisis by allowing CEOs to ring up profits and bonuses today at the expense of huge risks in the future. The last thing on the minds of CEOs was any concern at all for the well-being of the system that empowered them and allowed them to thrive.

Today, I posit that CEO primacy naturally leads to higher unemployment because CEOs can boost short term profits by brutally cutting employment which will enhance their "performance" compensation. The fact that cutting too much may lead to higher expenses down the road is irrelevant to CEOs. The fact that brutal employment cuts destroy the commons of consumption is even more irrelevant. As I wrote in 2006, without any effort to durably support consumption, CEO primacy will consume itself in a massive crisis of buying power.

CEO primacy is destroying American capitalism.


  1. Over the past quarter-century America’s unemployment rate has averaged 5.8%, compared with 9.5% in France and 9.1% in Germany.

    The Economist

    That's right, the average unemployment rate in most of Europe, over the last 25 years, has been very near the rate we are experiencing in the depths of this recession. If that's the result of "CEO primacy", count me in.

    One of the reasons that Europe has "cut back on employment and hours much less than their US counterparts" is because labor laws forbid it. This is by design. Extremely generous unemployment benefits make laid off workers an enormous burden for the state. The state has responded by making it much more difficult for firms to cut their payrolls, shifting costs back onto the firm, resulting in a decrease in productivity.

    CEO's are in fact not, "cutting too much" without regard to "higher expenses down the road". They are cutting, and not hiring, in anticipation of higher future costs. Health care reform, climate change legislation and promised higher taxes all present significant structural challenges to profitability. Why hire anyone now, given significant over capacity, without knowing what the true costs of employing that worker will be?

    In fairness, the Europeans have generally done a much better job of responding to this downturn than the Obama administration has done here. They have not engaged in a major restructuring of their economies at a time of uncertainty. They have cut payroll taxes and avoided poorly thought out and expensive stimulus spending.

    Having said that, I still think that "CEO primacy" is the way to go.

    Here are two articles contrasting Europe and the US economically:

    Europe 'needs 75 years' to catch US

    Europe vs. America

    Yes, they are older articles, but nothing has changed, except for the size of our budget deficit.

  2. I recently argued that CEO primacy drove the current subprime crisis by allowing CEOs to ring up profits and bonuses today at the expense of huge risks in the future. The last thing on the minds of CEOs was any concern at all for the well-being of the system that empowered them and allowed them to thrive.

    The "CEO primacy drove subprime crisis" thesis seems completely wrongheaded to me. The firms in question made money by packaging and selling mortgages. The commission on each sale was not illusory, it was real. Further, many of these firms were engaged in this activity at the behest of the federal government who, in their wisdom, had directed that an ever increasing portion of GSE lending be directed at the subprime market.

    As Peter Wallison, of AEI, explains in this WSJ piece, two-thirds of all bad mortgages were bought by government agencies or required by government regulations.

    Mortgage brokers had to be able to sell their mortgages to someone. They could only produce what those above them in the distribution chain wanted to buy. In other words, they could only respond to demand, not create it themselves. Who wanted these dicey loans? The data shows that the principal buyers were insured banks, government sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, and the FHA—all government agencies or private companies forced to comply with government mandates about mortgage lending.

    Now, if by "CEO primacy driving the subprime crisis" you are referring to the CEO's of Fannie and Freddie, I would have to agree.

  3. Well, first, on November 5, 2009 the Economist concluded that the US has much to learn from Europe about how best to reduce unemployment and noted that unemployment in Europe is now lower in the US. So your use of the Economist as a source is disingenous at best. Here is the link: So you are sorely in need of updating your thinking rather than simply assuming that the American system is unquestionably the optimal approach. The last 18 months have revealed deep seeded flaws. Where have you been?

    With respect to the second comment, the fact is that Fannie and Freddie originated zero subprime mortgages. The government never passed any law or regulationthat required unsafe and unsound lending and as a law professor I challenge you to show me any law or regulation that required any bank to make any imprudent loan. It does nor exist!

    Wallison is a good guy and when we debated this point at Northwestern last spring I can assure you that no attorney in the audience believed for a moment that these banks jumped off the cliff because the government told them to do so. It never happened.

    The firms jumped off the cliff to give huge bonuses to their CEOs.


  4. Second, I am amazed that at this late date, after all we have been through, that are any people left who really think that CEOs need more power.

    Exactly which firms are you CEOs of, or which firms are paying to shill for CEOs?

    You really cannot be serious that CEO power is optimal, can you?

  5. ... your use of the Economist as a source is disingenous [sic] at best

    The point I was making was that unemployment in Europe has been consistently and substantially higher than the US for MORE THAN 25 YEARS. Further, we are only approaching their structural unemployment rate in the depths of a severe recession. The last 18 months is only a data point on that time scale. That the Economist article suggests Europe is handling the economic crisis better than we are, given the ineptness of our current leadership, does not change that fact. Your attempt to ignore our outperformance over such a long period of time because it doesn't support your narrative is what is disingenuous.

    The last 18 months have revealed deep seeded flaws. Where have you been?

    US performance relative to Europe over the last 25 years has revealed deep seeded flaws in European socialism. Where have you been?

    ... the fact is that Fannie and Freddie originated zero subprime mortgages

    So, what? Fannie and Freddie created the market for subprime mortgages and, as Paul Wallison points out, without that market there would have been no subprime crisis, period.

    I challenge you to show me any law or regulation that required any bank to make any imprudent loan.

    Wow. How about this, I challenge you to show me the economic logic behind making an imprudent loan absent a sucker to buy it.

    The question isn't whether or not CEO power is optimal, the question is who gets to decide if it is or isn't, the shareholders and their board of directors or a group of economically illiterate lawyers and public servants.

  6. You are correct about the long term fact that US unemployment has been lower than Europe for the past 25 years, on average.

    But, so what? CEO primacy is new.

    Fannie and Freddie securitized zero subprime loans. Even in terms of investment, Fannie and Freddie were bit players until Bush and Paulson ordered them to invest in subprime.

    That was done under law. You still haave failed to show me single law requiring that imprudent loans were required by law.

    There is none! Case closed.

  7. Even in terms of investment, Fannie and Freddie were bit players until Bush and Paulson ordered them to invest in subprime.

    That statement is just complete nonsense. Here's a 1999 article from the New York Times addressing just who was responsible for making Fannie and Freddie major players in the subprime market:

    In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

    The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

    Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

    In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

    Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

    The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants.

    New York Times

    George W. Bush was still in Texas.

  8. Here's another from the Village Voice:

    There are as many starting points for the mortgage meltdown as there are fears about how far it has yet to go, but one decisive point of departure is the final years of the Clinton administration, when a kid from Queens without any real banking or real-estate experience was the only man in Washington with the power to regulate the giants of home finance, the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), better known as Fannie Mae and Freddie Mac.

    Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis. He took actions that—in combination with many other factors—helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded "kickbacks" to brokers that have fueled the sale of overpriced and unsupportable loans. Three to four million families are now facing foreclosure, and Cuomo is one of the reasons why.

    What he did is important—not just because of what it tells us about how we got in this hole, but because of what it says about New York's attorney general, who has been trying for months to don a white hat in the subprime scandal, pursuing cases against banks, appraisers, brokers, rating agencies, and multitrillion-dollar, quasi-public Fannie and Freddie.

    The Village Voice

  9. The fact is that the Bush administration tried repeatedly to rein in Fannie and Freddie:

    The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

    The plan is an acknowledgment by the administration that oversight of Fannie Mae and Freddie Mac — which together have issued more than $1.5 trillion in outstanding debt — is broken. A report by outside investigators in July concluded that Freddie Mac manipulated its accounting to mislead investors, and critics have said Fannie Mae does not adequately hedge against rising interest rates.

    Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

    ''These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

    ''The regulator has not only been outmanned, it has been outlobbied,'' said Representative Richard H. Baker, the Louisiana Republican who has proposed legislation similar to the administration proposal and who leads a subcommittee that oversees the companies.

    New York Times, 2003

  10. Fannie and Freddie securitized zero subprime loans.

    Again, slowly, this is immaterial. They were the major buyers of subprime loans creating a market for these toxic assets. You still have failed to explain the economic logic of writing an imprudent loan absent a sucker (Fannie and Freddie) to buy it.

    And while you seem confused about all of this, internal memos at Fannie and Freddie show that they understood exactly what they were doing:

    Internal Freddie Mac documents show that senior executives at the company were warned years ago that they were offering mortgages that could pose dangers to the firm, hurt borrowers and generate more risky loans throughout the industry.

    At Fannie Mae, top executives were told it was necessary to develop “underground” efforts to buy subprime mortgages because of competitive pressures, although there were growing risks and borrowers often didn’t understand the terms of the loans, documents show.

    The House Committee on Oversight and Government Reform, which has the documents, is holding a hearing today to discuss Fannie and Freddie’s downfall. The companies were seized by the government three months ago after nearly collapsing in the wake of billions of dollars of losses on mortgages.

    In a memo to former Freddie chief executive Richard F. Syron and other top executives, former Freddie chief enterprise risk officer David Andrukonis wrote that the company was buying mortgages that appear “to target borrowers who would have trouble qualifying for a mortgage if their financial position were adequately disclosed.”

    Andrukonis warned that these mortgages could be particularly harmful for Hispanic borrowers, and they could lead to loans being made to people who would be unlikely to pay them off. “The potential for the perception and the reality of predatory lending with this product is great,” Andrukonis wrote.

    Washington Post

  11. You still haave failed to show me single law requiring that imprudent loans were required by law.

    Here is an extremely prescient article, in the Winter 2000 issue of City Journal, concerning the regulatory pressure/extortion being applied by the government, working hand-in-hand with "community organizers", to banks in an effort to get them to increase subprime lending. I'd excerpt it, but you should read it all.

    "The Trillion Dollar Bank Shakedown", City Journal, 2000

    To be sure, the crisis was much larger than the subprime market, encompassing nearly every type of esoteric loan and their derivatives. But the fact remains that the failures of Fannie and Freddie were the triggering events:

    Bankers have lost their heads in the past several years. The financial system has run amok. When the federal government took control of mortgage giants Fannie Mae and Freddie Mac, the takeover was deemed a “credit event,” triggering the credit-default swaps that other companies held as insurance against such an event. A week later, Lehman filed for bankruptcy, shrouding the market in an even greater fog. And then, investors in A.I.G. panicked. The insurance giant had written hundreds of billions of dollars’ worth of protection on the supersenior slices of mortgage-backed securities. Because of its high credit rating, A.I.G. hadn’t needed to post any initial collateral. But as the market sent the cost of default protection soaring, A.I.G.’s trading partners demanded collateral from the insurer. A.I.G. didn’t have it. Credit-rating agencies downgraded the insurance company, requiring that it post even more collateral. This left A.I.G. teetering on the edge of bankruptcy, and in an unprecedented intervention, it had to be nationalized by the federal government. For the first time, the C.D.S. market shrank in the first half of the year, after doubling every year since 2001.

  12. Of course, there was another group of people who profited greatly from all of this activity. You may have overlooked them because they are not CEO's:

    Given my experience with defendants and targets in mortgage fraud, I'm surprised that more law offices haven't been the target of subpoenas and seizures. Shocked really. Not that what I'm about to say has anything to do with Guldi per se, as I don't know him and suggest nothing about him, but I've come to realize that there are a bunch of real estate lawyers who ran closing mills and were integrally involved in the frauds of their mortgage broker clients. The brokers referred them business, and often involved them directly in their scams by way of investment as well as straw-buyers, they were hip-deep in fraud.

    The lawyers made a ton of money participating in these schemes. To call them lawyers is somewhat misleading, as they were doing secretarial work as far as the closing were concerned, and were far more interested in being a part of the scheme to defraud than they were in doing anything remotely approaching legal representation.

    What shocks me is that they have largely been ignored in the mortgage fraud investigations. When law enforcement runs down the list of bad deals, whether because of fraudulent appraisals, fraudulent applications, straw-buyers or any of the other various mechanics of these schemes, they will find the same names appearing time and again. The names of lawyers representing sellers and buyers.

    Some of these lawyers were doing four or five closings a day. Some were doing only one, but owned a piece of everything that was sold. When they represented the buyers, they never mentioned they had an interest in the property being sold. When they represented the banks, they never mentioned that they knew the buyers were strawmen, used to scam the banks out of mortgage money on a fake flip based on a scam appraisal showing a 50% increase in value in six months.

    Simple Justice

    Case closed? More like mind closed.

  13. anonymous:

    i've read each and every one of your posts (assuming that you are the same anonymous poster for each of them), including the linked articles to each post, and i want to give you props for posting each of those links. they were very helpful to your arguments. i have also read each of prof. ramirez's posts and his responses to your rejoinders. you both, i think, articulate quite well the conservative and liberal views of this subprime debacle, which i think is very instructive.

    i believe there is a fundamental disconnect between your posts and prof. ramirez's posts that i hope i can highlight. let me note also anonymous, that your posts drip with elitism and sarcasm, which i think will help me identify what i believe the major disconnect to be.

    one of the foundational points you make that underlies almost everything that you've argued, as far as i can see, is that the government, through fannie mae and freddie mac and the community reinvestment act, were the primary progenitors of the subprime market meltdown, because the c.r.a. forced banks to make risky loans to underqualified minorities (as forced to do through clinton era policies) and that fannie mae and freddie mac created the market for these irresponsible subprime loans by agreeing to buy them and buy them with vigor. so, the government created the market, the impetus and the incentive. thus, major national and regional banks, taking the lead of the government, began writing these subprime loans because a sucker existed to buy them (fannie and freddie) and because they were being forced to write them by government regulators (clinton era c.r.a. watchdogs).

    so, in your words, "inept" and "economically illiterate" government employees and regulators were forcing bright and brilliantly educated private sector CEOs and corporate bank executives to unwillingly enter a market fraught with disaster, risk and stupefying overleveraging. you are asking folks to buy the notion that economically savvy and brilliant bank leaders and titans were strong-armed by the government to purchase, securitize, insure (through credit default swaps) and trade subprime loans? i'm sorry anonymous, i just can't buy what your selling. seriously, the private sector took its lead from the government and its regulators? you yourself prove the absurdity of this line of reasoning. you call government regulators, employees and professors ignorant and illiterate, but then expect folks to believe that CEOs and bank executives followed them off of the precipice. i seriously doubt this.

    as for the "forced" subprime loan writing because of the c.r.a., i have to call foul on that point too. as well read as you are on this meltdown, then you've probably read all of the wall street journal and n.y. times stories and studies that indicate only a minute percentage (less than 10%) of banks writing subprime loans were those even governed by the community reinvestment act. most banks writing subprime loans were irresponsibly chasing profits, not being forced to write them because of a government regulation.

    so, i think the disconnect, is that you want folks to buy the notion that private sector "educated" and "literate" leadership is absolved of responsibility for the subprime morass because fannie and freddie would buy the toxic loans and because the c.r.a. mandated that an extremely minor percentage of banks actually write the subprime loans. why write the loans, purchase the securitizations, insure everything with c.d.s.'s and trade on those securitizations and c.d.s.'s if not for the enormous profit incentive? certainly the government shoulders some responsibility for enabling a subprime market, but to pin the economic meltdown at the feet of the government and absolve private sector CEOs, is just as ridiculous.

  14. Please see most recent blog entry of today.

  15. What will the prolonged unemployment mean…. I think it will mean the already great gap between the superrich and everybody else will be even greater. Maybe the growth in unemployment will finally lead people to organize in way they haven’t before. If something terrible is happening in the economy, I hope I can at least impel people to become angry and militant and do what was done in the 1930’s. In normal times, one out of five kids grow hungry, people lose their jobs and homes are foreclosed. When those situations exist we don’t call it an economic crisis… We have to understand that when we have an economic system in which wealth gravitates to the top, we have a permanent under class of people living in poor homes, struggling to find jobs and are with out health care that are in a constant economic crisis. Until we re-examine the kind of economic system we live in this will continue to hold true.