Revisiting Citizens United

When the United States Supreme Court decided Citizens United v. Federal Election Commission earlier this year, many commentators, including several on the Corporate Justice Blog, predicted that the decision would have a nefarious impact on future elections. Recall, that Citizens United essentially held that United States corporations are entitled to free speech rights in electioneering contributions and that Congressional prohibitions that restricted the ability of corporations to finance particular candidates in contested partisan elections were unconstitutional. The Supreme Court essentially freed corporations and unions to make unfettered election contributions to specific candidates in American elections. Now that the 2010 mid-term Congressional election period is in full swing, has Citizens United had the predicted nefarious impact? The answer to that question lies in one's perspective. Without question, corporate campaign contributions have increased in 2010 to levels never before seen.

Recent empirical analysis confirms what many feared: Citizens United has “liberated” corporations from most of the campaign finance restrictions imposed by the McCain-Feingold law which were struck down as unconstitutional. While 2008 was a record-breaking election year in terms of donations, now in 2010, due in large part to Citizens United, corporate political spending has increased by 10-15%, and this despite a relentlessly depressed economy. Compared to the last mid-term election in 2006, campaign contributions in 2010 are predicted to increase by more than 35%. “Super PAC’s” are taking in money like never before, including huge corporate contributions into and large negative advertising buys by Karl Rove’s American Crossroads group. More than anything else, Citizens United will likely increase exponentially the money spent on negative election advertising.

The GOP's Pledge to America: Extending the Bushonomics Misery

Remember those horrific last days of the Bush Administration when in September and October of 2008 global capitalism collapsed and the Bushies rushed to Congress to get an $850 billion rescue for the big banks? Well, the GOP now pledges to bring that hellish nightmare back if you elect them. That's right, in a desperate effort to escape responsibility for being the party of "NO" during the worst economic crisis of our time, the GOP now pledges to bring back policies that simply cannot be distinguished from the Bushonomics that caused the entire economic maelstrom in the first instance.

For example, today we are all familiar with the efforts of the Bush Administration to render government incompetent and ineffective. This effort allowed New Orleans to be destroyed, Bernie Madoff to engage in an unprecedented Ponzi scheme and the banks to run wild. "Around the world the Bush name is synonymous with arrogance, ignorance, reckless insouciance, torture, violence and ineptitude." The Bush approach proved the costliest episode of near criminal negligence in our history. So now, The GOP plans to freeze federal hiring so that the new financial reform bill will lack any regulators to enforce the new reforms. In other words, they want to let the banks go wild again. Basically, having lost the effort to defeat Dodd-Frank democratically, in Congress, the GOP intends to jam unregulated banks down our throats by refusing to hire regulators to regulate the banks. Defanging Dodd-Frank has been a hard right goal since even before it was signed.

They also pledge to increase unemployment by slashing government spending in the face of an economy that teeters on the brink of deflation, which even conservative voices recognize failed to work in 1937. They pledge to crash the real estate market by ending federal efforts to use Fannie and Freddie to provide the only life support between us and total housing collapse. And of course, they pledge to increase the budget deficit and impose billions in debt upon our grandchildren and great grandchildren by slashing taxes even more than Bush, including for all those making more than $250,000, at a cost of $700 billion.

The ultimate irony here is that they make these upside down proposals just as powerful new evidence has emerged that President Obama's stimulus efforts certainly helped save us from a depression--for now, at least.

Basically, the GOP offers Bush II. So, if you enjoyed the first economic collapse, prepare for Economic Collapse II. The GOP Pledges it.

More on Fannie and Freddie

As detailed on this blog, last week the Federal Housing Finance Agency (“FHFA”) released the first of what will be quarterly status reports of the financial health and condition of the mortgage giants Fannie Mae and Freddie Mac. The report provides a revealing snapshot of the companies, and its conclusions challenge many commonly-held assumptions about the reasons the quasi-governmental agencies nearly failed.

A handful of economists, hundreds of politicians, and thousands of citizens place entire blame for the financial crisis on the two mortgage giants, in particular for creating and later bursting the housing bubble that nearly collapsed the global economy. Wrong. The Report shows that Fannie and Freddie’s market share plunged in 2003 and at the peak of the dangerous subprime mortgage and mortgage backed securities markets, Fannie and Freddie’s combined total share was only 1/3 of the mortgage market. Fannie and Freddie are not blameless, in that they clearly dipped their toes in the subprime market mania most notably in 2005 and 2006. Still, the report makes clear that private investment banks drove the appetite for subprime mortgages, the mortgage backed securities market and the collapse.

"Fannie and Freddie Acquitted"

Case closed.

Oh yes, there are the so-called GSE investments. Problem there is that they lost a relatively measly $20 billion. Hardly enough of an investment to stoke a massive bubble. Quoting from the GSE Conservator report:

"The Investments and Capital Markets segment accounts for $21 billion, or 9 percent, of capital reduction from the end of 2007 through the second quarter of 2010. Losses in the Investments and Capital Markets segment stemmed from impairments of private-label securities, fair-value losses on securities, and fair-value losses on derivatives (used for hedging interest rate risk)."

Of course, as I have long noted on this blog Fannie and Freddie actually leaned against the bubble by essentially exiting the market just when it reached bubble proportions:

These are damning facts for those claiming that Fannie and Freddie caused the meltdown. Basically, their subprime investments were a drop in the bucket and they had little or nothing to do with the worst of the lending.

The bottom line is this: in a desperate effort to save face, laissez-faire ideologues strove mightily to impugn government efforts to facilitate home ownership rather than massive financial deregulation as the primary cause of the meltdown of 2008. They lacked facts and they ignored history--after all, Freddie and Fannie have been around for decades before the housing bubble whereas massive deregulation immediately preceded the fiasco. The Conservator's Report will not stop their delusions.

Students of history and economics know that laissez-faire does not work--it did not work in 1929 (before Fannie, Freddie, the SEC, the FDIC, etc.) and did not work in 1995-2008. It has not worked anywhere. Laissez-faire may be an attractive political philosophy in theory but it is an economic dead end. The subprime fiasco is just the latest laissez-faire disaster.

BASEL III: FINANCIAL ELITES WIN AGAIN

The Basel III accords released this weekend may seem like financial and accounting minutia, but it actually goes to the very heart of the ongoing financial crisis. In order to pump up profits bank managers used leverage--debt--to enhance the profitability of their risky bank activities. When bank assets fell their thin capital cushions vaporized and the government rode to the rescue with trillions in morally repugnant and economically damaging bailouts. Because of ongoing capital problems we have a deeply dysfunctional financial sector at the foundation of a deeply dysfunctional economy. As such, the failure of Basel III (combined with a similar failure of Dodd-Frank) to impose meaningful regulatory discipline upon the financial sector can only be termed yet another missed opportunity to avert a future meltdown. I see two huge problems:

First, the new capital standards do not take full effect until 2019--and by then we could well experience multiple financial crises. Moreover, because banks have been hoarding capital they all comply with the new standards already, as shown in the chart above. So, while it appears that higher capital standards are on the way this regulatory requirement is illusory. This why bank analysts call the new regime "surprisingly accommodative." The new regime changes nothing in any meaningful time frame.

Second, the new capital rules have no impact on accounting standards that allow banks to hide losses (like the now infamous practice of extend and pretend) underlying those capital standards. This means that banks still face severe capital challenges that Basel III fails to address. At best banks have taken only 2/3 of total write-downs. Just because losses are buried, however, does not mean they disappear; instead, they fester and create more problems in the future, including an enhanced risk of future meltdowns. Lack of an accord on accounting standards effectively "will scuttle Basel III before it’s even implemented." The new regime allows this basic accounting scheme to continue.

Basel III will not prevent a future meltdown--indeed Lehman's 31 to 1 leverage ratio complies with the new regime--and therefore fails to address the gaping holes I previously decried in Dodd-Frank. Its getting more difficult to see a positive ending to this misshapen reform effort.

We Need More Money

I enjoyed reading Prof. Ramirez's previous post and think the analysis is spot on. I slightly disagree, however, with his policy prescription. I believe he is absolutely correct in that "instead of trickle down bailouts the Obama Administration needs to pursue bottom up bailouts." I also agree that a massive stimulus would help the economy. But, learning the lessons of the previous stimulus we know that there are certain practical limitations on how quickly the government can spend money. For this reason, many economists believe that monetary policy is the best way to stimulate a recovery.

Probably the bast way to explain why this is is to start with why recessions happen in the first place. It's not because people make bad business decisions or because people desire to work less, but because of poor policy decisions made by those who handle monetary policy, the Federal Reserve. Paul Krugman explains in a piece he wrote in 1998 (for explanation why structural reasons are an unlikely cause of this recession I'd suggest reading the whole piece):

"A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?"

What Krugman is saying here is that we have lots of people who want jobs and lots of work for them to do, but people value money more than they value what is produced. There is excess labor and capacity, but not enough demand. Why does this matter? In an excellent post, which contains some colorful language , Karl Smith explains:

This is not a big deal like the GOP doesn’t appreciate public goods. Or, Democrats don’t understand incentives. Or some other such second order debate that could reasonably concern us in different times.

This is a failure of our basic institutions of production. The job of the market is to bring together willing buyers with willing sellers in order to produce value. This is not happening and as a result literally trillions of dollars in value are not being produced.

Let me say that again because I think it fails to sink in – literally trillions of dollars in value are not being produced. Not misallocated. Not spent on programs you don’t approve of or distributed in tax cuts you don’t like. Trillions of dollars in value are not produced at all. Gone from the world entirely. Never to be had, by anyone, anywhere, at any time. Pure unadulterated loss.

Time and time again I see people speak about recessions as if they are a bad harvest – an unfortunate event wherein we have to figure out how to go with less. Some say we should all sacrifice – some say the sacrifice should be based on X or Y. Some say each family should take their lumps as they come.

However, they are all getting the basic idea wrong. This is not a bad harvest. The problem isn’t that there is less to go around. The problem is that we are creating less, building less, making less.

We have people who would be working but are instead watching Judge Judy. We have machines that could be spinning but are literally rusting for lack of use. This is a coordination disaster.

So what is the right policy to solve this problem? Certainly stimulus helps, it puts people to work and creates demand in the economy because these jobs put money in their pocket, something the economy craves. A better approach, however, is to favor inflation (or rather a NGDP target). Without explaining the intricacies of inflation, this would make the debts that people currently have worth less and make them easier to pay off, reducing the incentive to save and the demand for money. This policy would also not only provide debtor relief, but does not require the consent of Congress who is clearly clueless as to how this recession happened and the policies that are necessary to fix it. In the end, it doesn't matter how the economy gets the excess demand that it requires, whether through stimulus or an inflation target, but that our institutions are strong enough to solve the policy errors that got us into this mess. On that count I'm quite worried.

Obama's Latest Stimulus: A Drop in the Liquidity Trap Bucket?

President Obama announced a brand new $50 billion (over six years) infrastructure bill today which is infinitely more than any GOP proposal to fix the economy but still is woefully inadequate. To get a sense of the scale of the problem consider our so-called banks. As is evident from the above, banks are still hoarding unbelievable amounts of capital and continue to starve the economy of credit. The above chart shows that for two solid years now reserves have soared to unprecedented levels, no doubt because the banks still do not trust their balance sheets which are still bloated with toxic assets. And that is literally the tip of the iceberg: corporations are now hoarding capital rather than risking the hazards of a credit strapped economy ($500 billion more than before the meltdown); investors of all stripes have crowded into Treasury bonds causing yields to plunge across all maturities; and, finally, consumers are paying down debt and cutting back on expenditures at a record pace. So at a time when Apple Computer alone sits a top a $50 billion cash hoard, the President kicks-off the midterm election season by announcing a $50 billion infrastructure plan over 6 years--about $8 billion per year. The smallness of the plan boggles the mind, particularly in light of the scale of the problem.

Amazingly, the US real economy seems to absorb blow after blow from the financial sector without falling off the cliff. Although the latest jobs report saw unemployment measures increase and the all-important employment ratio continue to stagnate, the markets actually rallied because they expected worse. Nevertheless, most experts, especially those that have proven right again and again, are not optimistic going forward, largely because the government seems politically paralyzed and unable to muster the political will for decisive action.

The economy and the Obama administration now sit at the edge of an abyss. The economy seems likely to either tip into a double dip recession or stagnate for years to come. Team Obama faces a historic electoral drubbing in November.

Why would Obama go so small under these circumstances?

For reasons that are difficult to comprehend Obama is wedded to the Rubinites--Larry Summers and Timothy Geithner. Rubin opposes any new stimulus. He will only support more tax cuts, which I have long argued will lead only to debt repayments in a deleveraging economy and thus more money for the banks. The 2008 tax cuts for example, initiated to forestall the catastrophe we now face, failed to demonstrably reignite spending and consumption. Instead most of the money went to payoff debt. Notably, President Obama seems poised to announce new tax cuts for businesses--to the tune of $200 billion.

The solution could not be more clear. Instead of trickle down bailouts the Obama Administration needs to pursue bottom up bailouts.

In December of 2008, I called for a massive recapitalization of the middle class, stating: "Trickle-down bailouts are poisonous. . . .Instead of [the] failed trickle down approach, the government must now immediately throw a lifeline to the 99% of Americans who have so far seen only pennies of the trillions the government has expended in its rescue efforts. We need immediate direct stimulus from the government on a scale more massive than ever before."

Later in 2009, in my Dayton Law Review article entitled Subprime Bailouts and the Predator State I argued that empirical evidence from the world of economic science demonstrated that you must terminate bank managers and extend generous debtor relief in order to avert extended economic misery.

What we needed and what we still need today is debt relief in the form of massive loan modifications as advocated by bond expert Bill Gross; a massive jobs bill on the scale of the CCC as advocated by economist Robert Shiller; and massive investment in our economy so that we have the world's best physical and human infrastructure as Paul Krugman has long advocated.

The Administration's first stimulus package probably created or saved 3 million jobs based upon the best economic studies to date. But it will expire before the economic gloom and pain. It is a shame that the Administration has given up on its own success and caved-in once again to the Robert Rubin dominated economic team.

Krugman on Economic Stimulus

Paul Krugman, winner of the Nobel Prize in economics, provided some interesting insights in the New York Times this week on the 2008 economic stimulus, including why it has not worked as hoped, and suggests ways to appropriately stimulate the economy in coming months. A few of the more salient points from Krugman include:

"The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round."

Krugman argues that the 2008 stimulus was too cautious, too minimalist and that a bolder, more profound stimulus would have better served the American people and the U.S. economy. He argues that a new round of stimulus is necessary and sound economic policy, but a second round of stimulus must be much bolder than the first.

Responding to critics of the 2008 stimulus as too much and those politicians suddenly concerned with Washington spending (where were they when tax cuts and defense spending drove the deficit into record territory?), Krugman rejoinders:

"And if, as expected, the G.O.P. wins big in November, this will be widely regarded as a vindication of the anti-stimulus position. Mr. Obama, we’ll be told, moved too far to the left, and his Keynesian economic doctrine was proved wrong.

But politics determines who has the power, not who has the truth. The economic theory behind the Obama stimulus has passed the test of recent events with flying colors; unfortunately, Mr. Obama, for whatever reason — yes, I’m aware that there were political constraints — initially offered a plan that was much too cautious given the scale of the economy’s problems."

Krugman urges President Obama to go bold next week and in coming months, in connection with stimulating the economy. Krugman's N.Y. Times Op-Ed can be accessed here.

The Coming "Conservative" Depression

Economist Paul Krugman warned in early 2009 that if the administration failed to stimulate the economy appropriately and resorted to more politically acceptable half measures instead that we would quickly find ourselves in a depression as fiscal policy became politically impotent. That warning proved prescient.

Tea Party protests across the nation (the photo at right is from Chicago) reflect genuine outrage that the government spent so much with insufficient benefits to ordinary citizens or the economy in general. Nor can the Tea Party be dismissed as a small group of extremists on this issue as most informed analyses of the 2010 mid-term elections now project a decisive GOP victory complete with a transfer of power in the House. Amazingly, one poll found that only 6% of Americans feel the stimulus package helped reduce unemployment.

Krugman is hardly alone among top economists that feel the economy is desperately in need of more stimulus. Another Noble laureate, Joseph Stiglitz, has repeatedly called for more stimulus spending since at least 2009. More recently, Noble economist Robert Solow published an article explaining the need for a second stimulus. The problem is that going forward the original stimulus will expire in the second half of 2010 and in combination with the cutbacks at the state level government spending will shift from stimulating our very weak economy to creating substantial headwinds that will slow growth at the least and tip us into depression at worst. The states are acting like fifty Herbert Hoovers in terms of cutting expenditures in the face of a severe downturn. In fact, government investment and consumption at all levels has actually stagnated or contracted as a percentage of GDP since the onset of the financial crisis in 2008. Most of the increases in government spending have not been due to any massive public works program (a relatively small part of the stimulus package) but rather automatic stabilizers such as unemployment insurance.

Those automatic stabilizers work wonders. For example, in Germany, automatic stabilizers have led to massive increases in government spending that exceed the increases in government spending in the U.S.--and led Germany into positive GDP to the tune of 9% growth. The United States however, suffers from built-in automatic destabilizers--the fifty states with balanced budget mandates and a body politic schooled in macroeconomic mythology.

If so, 2010 and 2011 are likely to see the "conservative" depression--with only tax cuts on the agenda that will further balloon the deficit while offering very little actual stimulus in the present debt-deleveraging context.

The upshot of this "inconceivably ugly" reality is that the economy is almost certain to face severe challenges this year and next with little or no prospect of either further monetary or fiscal support. The elections are likely to result in fiscal gridlock and our broken banking system renders monetary policy impotent.

This entire episode of fiscal policy impotence would have been a great historical example of why fiscal policy requires legal restructuring, including a shift to a depoliticized expert agency, to add to my article, Fear and Social Capitalism.

The Solution Is How They See The Problem

Now that the financial reform bill is in its final state, we finally have a clear look at what lawmakers view as the problems that led to the financial collapse. When the reform process began the approach that would be taken, and which problems in the financial sector would be solved, was far less clear. Essentially there were two options before policymakers, either limit the size and scope of banks or increase regulation and the power of regulators to prevent problems as they occur. The first approach called for hard and clear caps on the size, function, and actions of banks. Paul Krugman called this the “Roman approach”, an approach that would work even without skilled regulators:

“The pre-1980 system was, I’d argue, pretty robust. Bank regulators didn’t have to be all that smart, because the rules were simple — and besides, the large franchise value of banks, the fact that they faced limited competition and were almost guaranteed to be profitable, made bank executives unwilling to take big risks of killing the goose that laid golden eggs.”

This approach highlighted the staggering growth of financial sector profits as part of all profits in the economy, now 41% of domestic profits, and wanted to trim it down to size. Also questioned was the need and usefulness of “financial innovation” that led to ideas like the Credit Default Swap, the Mortgage Backed Security and further back the Long-Term Capital Management failure and the Savings and Loans crisis. Under this approach we have the ideas of capital requirements (not included in the bill but will be dealt with under Basel III), the plain-vanilla mortgage that would have to be offered to all customers (not in the bill), the Volcker Rule or re-imposition of Glass-Stegall (in the bill but in watered down form), and a financial transaction tax (not in the bill).

This was not the approach that Treasury, the Obama Administration or Congress decided to take. While the bill has received deserved criticism as being insufficient to prevent future crises, this has generally been criticism of the approach taken by the bill not its contents. To analogize to the Health Care debate, there were some who proposed that the only way to reform the system to an acceptable level is to have Single Payer health care, a fundamental change of the system. Instead the Administration took a less radical approach to reform and better the existing system in a less disruptive and conservative way. The less intrusive approach of financial reform relied on empowering regulators and giving the Fed as well as Treasury additional powers to deal with a large bank collapse in a quicker, transparent, and routine fashion. Mike Konzcal describes how this approach looks at the problem:

It’s a story where the regulators just needed a bit more power, a little more legal scope, and a greater extension of what jurisdiction the Federal Reserve has in order to rush in and save the day. A story where the Federal Reserve can successfully carry out prompt corrective action, detecting problems early and guiding banks back to health, on an institution with $2 trillion dollars on its sheet. A story where that institution’s off-balance sheet and the warehouse of derivatives it holds are no match for our regulator’s stare. But more importantly, it is a story where the regulators will be able to sweep in during a moment of crisis and keep the financial sector working no matter what.

Here the bill does well, giving Treasury the power to break up big banks or “resolution authority” that is commonplace under the FDIC and to help avoid situations like the Lehman bankruptcy that lead to panic and the seizing up of credit. There is also language in the bill to limit derivative trading to try to prevent some of the most egregious casino like behavior. It also will require regulators to draft new regulations that more closely fits the intricacies of the financial impact – it’s the use of a scalpel instead of a hammer.

So then what does this bill see as the problems that led to the financial collapse? This bill isn’t a harsh lesson to banks, punishing them for their part in causing the financial collapse only to be bailed out by the taxpayer. The bill doesn’t impose anything like the consequences that would have occurred if these banks had been left to fail on their own. But while not a total change this bill represents an ideological shift away from the culture deregulation that we have seen over the last thirty years. The bill is a clear message that continual deregulation, where the free market (or a market dominated by powerful political and economic actors in a world post-Citizens United) is wholly allowed to govern economic activity leads to inefficient outcomes and poses a systemic risk to the economy.

Dodd-Frank: My Final Take

The Dodd-Frank Act can only be termed an epic failure of policy. The Act includes some positive elements such as the corporate governance reforms and predatory finance prohibitions. Nevertheless, the importance of these reforms pales in comparison to the risks of another financial meltdown as well as deeply impaired macroeconomic performance far into the future. In fact, not only do I share the concerns voiced by Joseph Stiglitz and others regarding the risks of a future crisis, I fear that the Act fails to deal appropriately with the current crisis and instead seems predicated on the erroneous assumption that the subprime debacle and the financial crisis of late 2008 and 2009 are over.

For example, bank capital remains under siege. European debt could explode at any moment and the bailout of last spring appears inadequate. Student loans will inexorably erode bank capital because of the dearth of job opportunities for graduates. The residential real estate market continues to meltdown, with the commercial real estate market now inflicting comparable losses on the financial sector. One trillion dollars of consumer debt suffers from serious delinquency. Consumer deleveraging will continue to suppress demand for quite some time. This will continue to mean employment problems that will lead to more losses on debt. Dodd-Frank does nothing to address any of this and instead reaffirms the lack of real restructuring in the financial sector and virtually zero help for anyone other than the most economically powerful. Without any restructuring in the financial sector expect the same financial elite faced with same financial balance sheets to engage in the same conduct as today—hoarding cash.

The Act allows massive government guarantees to persist and therefore continues the massive subsidies implicit in the TBTF problem. Indeed, the Act directs the FDIC and the Fed to promulgate bailout programs that are “widely available” or that provide “broad-based eligibility” for bailout benefits. The Act formalizes the power of the FDIC and the Fed to bailout systemically critical financial institutions. The implicit guarantee now appears increasingly explicit, under sections 1101 and 1105. Moreover, even if a financially significant firm somehow fails notwithstanding such extraordinary support the orderly liquidation process offers further bailout mechanisms. Dodd-Frank therefore continues the regulatory indulgence, even facilitation, of excessive risk in the financial sector. Creditors have already concluded that Dodd-Frank preserves the too-big-to fail subsidies. In fact, the credit ratings agencies specifically give the mega-banks much higher credit ratings than otherwise due to the presence of government backing notwithstanding Dodd-Frank.

This Act’s approach to securities and derivatives trading exacerbates this fundamental distortion towards risk. The exceptions to the prohibition of derivatives trading within banks swallow the rule. The Act allows banks to trade securities and invest in hedge funds into the next decade. Thus, the Act gives large banks a subsidized cost of capital while largely preserving their ability to gamble in the derivatives and securities markets. CEOs and other senior bank managers therefore face the identical incentives to gorge on risk that they faced before 2008 to ring up short profits without regard to future losses that may come to fruition only after the payment of incentive based compensation. Even if the firm approaches insolvency the payment of golden parachute arrangements further blunts the disincentives senior managers face for excessively risky conduct.

The orderly liquidation regime under Title II of Dodd-Frank could operate to dissuade mangers from excessive risk, but most firms will never enter that process. No firm enters that regime without a recommendation of the Treasury and 2/3 majority votes of the Fed and the FDIC. Only the FDIC, under the admirable leadership of Sheila Bair, seems likely to have the fortitude to pull the trigger, and then probably only on the eve of a major meltdown, under the plain language of the statute. The gross negligence standard for director and officer liability for firms entering the regime precludes the applicability of insulating statutes like Delaware General Corporation Act section 102 (b) (7), but the FDIC historically displays a reluctance to pursue such claims although that may be changing. If a firm should find itself in the orderly liquidation regime senior managers will lose their jobs and their employment contracts and benefits (including severance payments) will generally be paid out last.

The Act mitigates these negative elements through the possibility of corporate governance reform. Unfortunately, the Act offers a package of reforms on this front that will likely prove too little too late. For example, non-binding shareholder resolutions seem exceedingly unlikely to stop the runaway executive compensation train. There is no shareholder say on golden parachute payments except for merger and acquisition shareholder votes. In 2011 we may look forward to independent compensation committees but in the past definitions of independence proved inadequate to actually stem CEO autonomy. The SEC holds the keys to major reform through their now explicit power to reform corporate democracy, combined with an immediately effective ban on broker votes. Unfortunately, the SEC traditionally failed to embrace shareholder suffrage.

So, the upshot of Dodd-Frank is that it continues and even formalizes massive subsidies for the largest financial firms (at the expense of smaller competitors as well as the economy) regardless of the recklessness (or worse) of their conduct. It continues CEO primacy and permits continued enrichment of managers for reckless (or worse) risk taking. This is a deeply suboptimal economic outcome and we as a society will pay the costs implicit in allowing capitalism to continue to degenerate into a rigged game in favor of those controlling the most vast amounts of wealth. Dodd-Frank may well entrench this pernicious economic reality by allowing it to fester within a more stable financial context. By outlawing consumer predation and exploitative finance future financial crises are unlikely to be as painful as the subprime debacle. A leveraged asset bubble that derails both the financial sector as well as the consumer base of our economy may be forestalled in the long run by Dodd-Frank’s outlawing of abusive consumer loans. It is difficult to oppose these regulatory improvements.

Nevertheless, Dodd-Frank may well operate to transmogrify a reform moment into an opportunistic and cynical effort to slowly bleed the American economy through the overweening power of a narrow and backward political and financial elite that is ever more divorced from concerns about the general economic well-being of the United States. If Dodd-Frank operates to prevent major financial cataclysms at the cost of subpar macroeconomic performance stunted by an entrenched elite that saps our collective economic strength in the name of short term wealth, then it may prove to be more costly than if Congress had done nothing. Whether Dodd-Frank is thus worse than nothing is still to be determined. But, by any measure it preserves the power and economic prospects of the very financial elites whose misconduct caused the crisis in the first instance. In my view, the estimated $591 million invested in lobbying (since January of 2009) and the $112 million invested in campaign contributions to the members of the conference committee (since 1989) yielded precisely the returns expected and demanded by our financial elite: the ability to play in the high risk securities and derivatives markets with continued government backing, without any prospect of being broken up. Moreover, Dodd-Frank encourages more lobbying by punting many issues to regulators and financial elites are already greasing the revolving door for a massive new lobbying blitz.

Finally, additional concerns should be raised, beyond macroeconomic costs and benefits. Government guarantees of the most powerful financial interests in our society simultaneously violate any norm of moral propriety as well as economic logic. If I am correct about the net effect of Dodd-Frank, then it raises red flags about our society that transcend mere economics. When a people in a democratic republic allow themselves to be milk cows for the very wealthy there is something wrong beyond the economic structure of that society. The ultimate irony may well prove to be that the pervasive loss of empathy for the disempowered ultimately empowers a small elite to exploit an entire society. When we lose suspicion of concentrated power and blame the weakest among us for our plight we are surely lost as a people. A people that are convinced that their plight is caused by the powerless in our society rather than those who control our society have lost the ability to hold power to account and to hold power in check. Dodd-Frank raises precisely this specter. Dodd-Frank evinces a near total void of suspicion with regard to concentrated economic power.

So, in the end, the most optimistic thing I can say about Dodd-Frank, is perhaps very pessimistic. It is so radically incomplete that it will surely spawn more financial and economic costs that could well support more appropriate reform efforts. Other than that ray of sunshine, Dodd-Frank proves the problem of allowing excessive concentration of economic resources to persist: regulatory and legal subversion in favor of entrenching the powerful at the expense of sound policy and the general welfare. Dodd-Frank stands as a monument to a deeply misguided, if not actually corrupt, political and economic elite.

Financial Reform: True Change?

Steve Ramirez has provided an excellent assessment of the Dodd-Frank Financial Reform Bill over the past several weeks as he has gone through the legislation by section and provided terrific insight and forecast. By my reading, Professor Ramirez suggests that the new legislation is a mixed bag, with some potential for real reform and thus guarded optimism, but Ramirez remains dubious, even extremely dubious, that the bill will prevent another meltdown and laments the lost opportunity (along with Joseph Stiglitz) to transform Wall Street culture and U.S. capitalism as currently practiced.

In addition to Professor Ramirez' critical insights, I have read two additional works that I recommend as crucial for appreciating and understanding the financial market crisis and the way too tepid legislative response, in my view.

First, I just finished reading Simon Johnson and James Kwak's book "13 Bankers" which is a tour de force in connection with situating the financial market crisis and describing the thoroughly sloppy and irresponsible governmental and regulatory embrace of Wall Street's laissez faire mantra and "smartest guys in the room" culture. That Dodd-Frank did nothing to sever this relationship continues to stun and discourage. Read 13 Bankers for a complete extrapolation of the run-up to the financial market meltdown.

Then, second, I just read Matt Taibbi's recent Rolling Stone Magazine article investigating the internal operations and negotiations in getting the Dodd-Frank bill passed, called "Wall Street's Big Win." Taibbi's sometimes crude, but stark assessment of the bill and the diluting compromises literally required by Wall Street, various Senators and the Obama Administration to get it passed, simply supports Johnson and Kwak's assessment that Wall Street, Pennsylvania Avenue and Capitol Hill all share the same mindset and commitment to investment banks and Wall Street executives as "the Way." Nothing (or very little) in Dodd-Frank will curtail the dizzying excess and reckless decision making by private bank executives that took the global economy to the brink of collapse.

Both 13 Bankers and "Wall Street's Big Win" paint a devastating picture for the future economy.

Per Taibbi:

"All of this is great, but taken together, these [Dodd-Franks] reforms fail to address even a tenth of the real problem. Worse: They fail to even define what the real problem is. Over a long year of feverish lobbying and brutally intense backroom negotiations, a group of D.C. insiders fought over a single question: Just how much of the truth about the financial crisis should we share with the public? Do we admit that control over the economy in the past dec­ade was ceded to a small group of rapacious criminals who to this day are engaged in a mind-­numbing campaign of theft on a global scale? Or do we pretend that, minus a few bumps in the road that have mostly been smoothed out, the clean-hands capitalism of Adam Smith still rules the day in America? In other words, do people need to know the real version, in all its majestic whorebotchery, or can we get away with some bullshit cover story? In passing Dodd-Frank, they went with the cover story."

See "Wall Street's Big Win" here.

Dodd-Frank X: Finally Doing Something About Race?

As the above chart from United for a Fair Economy shows, even high income minorities are much more likely to end up with high-cost, subprime mortgages than low income whites. The full report entitled State of the Dream 2008: Foreclosed is available here. This report is consistent with overwhelming evidence that minority borrowers were too often steered into subprime mortgages even though they qualified for less costly prime mortgages. As the National Coalition for Community Reinvestment found in a recent report, blacks are 80 percent more likely to end up in a subprime loan than whites, and Latinos 70 percent more likely, even after controlling for credit score, income, loan-to-value ratios and neighborhood characteristics. This racial steering dynamic, so central to the entire crisis, has also been detected in carefully structured audit studies. Indeed, Illinois Attorney General Lisa Madigan (and Loyola University Chicago alumnae) recently filed a massive lending discrimination lawsuit against Countrywide Financial alleging precisely this kind of massive and systematic steering after an exhaustive investigation based upon interviews with former employees, borrowers and a review of nearly 100,000 loan files. Many other such suits are now pending or have settled. As Cheryl Wade highlights, this racial steering has devastated communities of color.

So what does Dodd-Frank do to address this thorny problem?

Section 1403 simply provides: "For any residential mortgage loan, no mortgage originator shall receive from any person and no person shall pay to a mortgage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal)."

Section 1404 then creates a broad private action for violation of this provision: "The maximum amount of any liability of a mortgage originator. . . to a consumer for any violation of this section shall not exceed the greater of actual damages or an amount equal to 3 times the total amount of direct and indirect compensation or gain accruing to the mortgage originator in connection with the residential mortgage loan involved in the violation, plus the costs to the consumer of the action, including a reasonable attorney's fee."

This simply eliminates any incentive for steering, racial or otherwise.

But, Dodd-Frank does more. Section 917 requires a study regarding financial literacy. Section 1021 requires the new Consumer Financial Protection Bureau to conduct financial education programs. More education for consumers and the investing public in a true capitalist economy makes good sense. Markets pervaded by ignorant market actors are bound to spin into dysfunction.

More importantly, in a nation pervaded by tacit acceptance of white supremacy or widespread delusions regarding our so-called post-racial society, it is rather refreshing to see some reforms that could actually mitigate continued racial oppression, albeit in a facially non-racial way.

Combined with the near abolition of predatory lending, this near abolition of steering in mortgage lending holds the promise (much depends upon regulatory follow-up) of never permitting the subprime debacle to recur.