On the Possibility of Both Monetary and Fiscal Impotence

dre cummings recently used the term "incredulous" to describe his reaction to optimistic accounts of the economy. As usual dre is right. Above is a chart of bank reserves held at the Fed. The bottom line is the banks are still hoarding massive capital--even more than during the fall of 2008. They obviously do not trust their own balance sheets, the economy or both. This represents a massive pool of idle capital. The flip side is that banks are not lending. Thus, the WSJ headline from Wednesday: Lending Falls at Epic Pace. Under these circumstances monetary policy is ineffective because it depends upon banks lending their liquid assets.

We are also out of fiscal policy ammunition. Credit markets are wary of sovereign debt, and as Martin Wolf (Chief Economics Commentator at the Financial Times) points out it seems that a sovereign debt crisis is inevitable. Frankly, we wasted our fiscal stimulus on ineffective tax cuts instead of massive investment, as I argued in late 2008. Political support for a timely stimulus is wanting to say the least.

So with no monetary policy solution and no fiscal policy solution any kind of crisis will not be met with appropriate government action. We seem destined to face the next major downdraft without hope of government rescue.

Will there be such a downdraft? Well, spring is just around the corner, and in Chicago during the spring even the thought that the Cubs could win the World Series seems plausible.

But, the economy is facing severe headwinds. One excellent summary of the problems (with some level of excessive pessimism) can be reviewed here. Everyone should look at the gory facts--all 15 of them. They fully support dre's point. Any one of these problems could cause a repeat of the nightmare of late 2008; in fact, our government has done virtually nothing to assure that such a repeat does not occur. As Noble prize winning economist Joseph Stiglitz puts it:

"On regulatory issues, almost nothing has been done. The structure of the banking sector is worse. The too-big-to-fail banks are bigger. Of the smaller banks, 181 went bankrupt since 2008. In the bailout, the banks didn't do what they were supposed to do, which was to restart lending."

Stiglitz also maintains that US standards of living now have nowhere to go but down. We have been living from bubble to bubble, consuming more than we produce for too long. Now we are indebted and need to tighten our belts not just to live within our means but to pay off excessive debt. Indeed, as the chart to the left shows, our debt situation has worsened through the present crisis, as our wealth has shrunk, our incomes are declining, and our debt is therefore more unsustainable now than it was at the beginning of this nightmare.

To sum up: we still have way too much debt in our economy; the banks still seem insolvent, terrified of their balance sheets and unable to lend; our regulatory system is a proven catastrophe; and we must under go a painful deleveraging that is just getting started because we missed our opportunity for massive government led investment. And, we have reached the point of both monetary and fiscal (or at least political) impotence--something that has never before happened in the history of modern capitalism.

The question I have is this: if we do experience another downturn and government is unable to respond in force, what does that reality look like?

Recovery?

Sitting in a Board meeting last week, I listened to a number of financial consultants and Mutual Fund presidents describe the economy as “recovering” or in one instance as “recovered.” I was incredulous at these pronouncements and proceeded to challenge these assertions. On Wednesday, the FDIC announced that it is bracing for a new wave of bank failures. This is amidst a looming commercial real-estate crisis where of the $1.4 trillion in commercial real estate loans that come due in the next few years, almost half are underwater, meaning that the borrower owes more than the property is worth. This is part of the reason that many of the nation’s 8,000 banks remain under enormous stress. Yet because the Treasury has rejected calls to extend stress tests to smaller, regional banks, the same ones they conducted on the 19 big banks, no one is quite sure of the severity of the potential commercial real-estate problem.

As the economy stares new challenges in the face, the new financial regulation proposed by the Obama Administration recently, known as the “Volcker Rule,” that aims to regulate some investment banking areas that led to this financial crisis is finding tough sledding in Congress. On Thursday, Fed Chair Ben Bernanke testified before the Senate Banking Committee and expressed skepticism about the Volcker Rule, saying “If you go about imposing the Volcker Rule, I think it would be difficult to do it on a purely legislative basis, because of the potential for having unintended consequences.” This comes after the Senate Banking committee members have discussed scrapping the Volcker rule, which would completely ban proprietary trading at commercial banks, for regulation on a “case-by-case” basis. The President, however, still vigorously backs the Volcker Rule, according to senior White House advisor David Axelrod. Any new financial regulation of Wall Street will take a steel backbone we have not seen from this Congress. According to TARP director Professor Elizabeth Warren, the financial industry has flooded Capital Hill with lobbyists in unprecedented fashion. Members of Congress are receiving visits from Wall Street lobbyists up to three and four times a day as Congress debates re-regulating the financial sector.

Now That the Cameras Are Gone: Foreign Direct Investment in Haiti

Just weeks after the 2010 earthquake in Haiti, former President Bill Clinton led a special session on Haiti at the World Economic Forum Annual Meeting in Davos, Switzerland. Representatives from the World Economic Forum and the United Nations joined with the Clinton Global Initiative to encourage business leaders from around the world to do business in Haiti. The goal of the meeting was to increase private sector investment in agriculture, tourism and other business opportunities in the island nation.

Denis O'Brien, the executive chairman of a cellular company that employs Haitians who sell his company's telephone cards made the case at the meeting for foreign direct investment in Haiti, explaining that the island nation is a good location for manufacturers. Urging attendees to invest in Haiti, O'Brien told them to invest "for the right reasons." He explained that they should invest "not just for altruistic reasons, but for economic reasons...." Brazil's Foreign Minister also spoke at the meeting explaining that business investments in Haiti "can be done not just to help Haiti but to make money."

These statement alarmed me. I'm not sure the kind of capitalism the Davos participants advocated is the best thing for Haiti right now. In the U.S., this kind of capitalism enabled a very small portion of the population to become very rich, burdened the middle class reducing its numbers dramatically, while increasing the numbers of poor Americans. The Davos participants envisioned that companies, primarily from developed nations, establish businesses that would employ a few Haitians at what I'm sure will be pathetically low wages. Only one of the speakers, the Managing Director of the World Economic Forum, briefly mentioned the possibility of foreign investment in Haitian businesses. (Brazil's Foreign Minister noted that Haiti's street markets were in business again but said nothing about investing in those businesses.) The session participants encouraged foreign direct investment that would employ a few Haitians without exploring the possibility of partnering with Haitian entrepreneurs. Employing Haitians at low wages while ignoring the potential promise of Haitian entrepreneurship sounds like exploitaiton. Haiti has been through this before.

Clinton ended the meeting by saying the following: "Haiti is the only successful country ever established as the result of a slave revolt. For that, they were punished by either being ignored or abused. The United States did not recognize them for nearly 60 years and when finally we did we were in with the rest of the crowd of European powers saying that they had to pay enormous reparations for winning their freedom."

Haiti does not need the kind of capitalism advocated by the World Economic Forum participants. The investment they envision will likely enrich private companies in developed natons while exploiting Haitian workers. Haiti doesn't need charity either. Haiti deserves reparations.

Latino Community and Internet Financial Fraud

I posted the following commentary on a new Latino law professors blog earlier in the week. I thought I would share the story with the readers of the corporate justice blog. Last Thursday afternoon, I received a frantic telephone call from my cousin who was born and raised in Ecuador but currently resides in Kendall, FL. After a few minutes of a harried conversation in Spanglish, she finally said, “oh my God, how could I have been so stupid, stupid, stupid.” My cousin has been the most recent victim of Internet financial fraud, and in the process has been swindled out of $3,800.

I assured her this type of financial fraud is very very common and the FBI has been looking into these types of financial frauds for years. I was rather surprised that she had never heard of these investigations. What happened to my cousin has happened to many many people. What I was more interested in determining was how a college-educated, well-experienced, accessories merchandise buyer for some of the most renowned fashion designer houses for more than 15 years, became the victim of a internet financial fraud scheme. She admitted that with the financial crisis, her job is not as secure as it used to be, and she was looking on the Internet, primarily on Hispanic-focused Internet websites for ways to make a little extra cash by working as a translator.

Last week, she responded to an email that offered her the opportunity to be a “secret shopper,” which required her to evaluate customer service procedures of local retailers in her community. This sounded right up her alley. The email suggested that the “Company” was looking for a “few secret shoppers in her area, and they would only select a few local residents.” She immediately, filled out an on-line form, which requested her personal data such name, address, and description of local community in particular types of retail stores. No credit card or banking information was requested. (I gather that would have triggered a red flag for potential victims.) A few days later she received a cashiers check for $3,800. The instructions required her to cash the check at “her local bank,” go to Western Union (WU) evaluate how well her local WU representative handled transactions with the public, in particular she should evaluate the level of courtesy, language ability, and efficiency displayed by WU representative. Once she had observed the WU representative she should conduct her own transaction and wire $3,600 (she should retain $200 as payment for her services) from the cashiers check that she had cashed at her local bank to the Company, which was located in Dubai, United Arabs Emirate.

My cousin immediately sent an email to the company and pointed out that $3,800 was a great deal of money for an initial customer service assignment, and whether there was anything “underhanded or potentially illegal” regarding the nature of the assignment. She received an immediate email response that assured her that the assignment was “100% LEGAL” and the amount of the cashiers check was the Company’s way of determining whether they were dealing with “honest secret shoppers.” My cousin’s fears were alleviated, and she performed her assignment as requested within approximately two hours of receiving the cashiers check including sending an evaluation report to the Company. She did not receive a response email from the Company. A few hours later, having heard nothing from the Company, she called me frantically, and shared this disturbing story.

The unfortunate reality is that the “cashiers check” is a fraudulent check. It was drawn on the United Federation of Teacher's Credit Union in Washington, D.C. A brief conversation with their Legal Department confirmed that they do not have a “secret shopper” pilot program nor do they have any representative or independent contractor that is located in Dubai, United Arabs Emirate. The check will not clear the inter-bank clearing process, which takes 2-3 days for in-state-checks and 3-5 days for out-of-state checks to clear. The account that the “cashiers check” is drawn on is not an active account. My cousin has been told that her local bank will withdraw the $3,800 funds from her personal account once the inter-bank clearing process rejects the cashiers check. I have advised my cousin to file a financial fraud affidavit with her local police department, which will permit her to file a theft and casualty loss on her itemized tax return for 2010. I also advised her to forward all correspondence to and from the Company to the FBI Criminal Investigation Division unit including the envelope in which the cashiers check was sent to her for forensic testing. The FBI Financial Crimes Report to the Public is available here. It really should be translated into multiple languages especially Spanish and French.

My cousin has learnt an expensive lesson. However, her experience has galvanized her to create an Internet Financial Fraud brochure in Spanish, which she will share with primarily Spanish speaking community groups in South Florida. I am a strong believer that all things no matter how demoralizing and painful they may be, happen for a higher purpose. Hopefully, my cousin’s unfortunate experience will prove to be a learning experience for many many people.

Lydie Nadia Cabrera Pierre-Louis

Professionalizing Corporate Governance

Stocks have been a lousy investment in the US for a long time. The S&P 500 closed at 1108 today--the same level it was at 12 years ago (as shown in the above chart). Nor is that 12 year period of zero returns aberrational. What was aberrational was the very high returns of the 1990s, which was one of the highest returns by decade on record, if not the highest. Since 1981 bonds have crushed stocks. Buy and hold is a myth.

I suggested in 2007 that a major problem is corporate governance, and cited evidence in support of inferior corporate governance standards. There is little doubt that some of the prime movers in the recent financial meltdown suffered from very weak boards. And a major problem with weak boards is that they are stacked with the CEO's cronies. Distinguished commentators such as Stephen Bainbridge long ago recognized the problems with CEO cronies populating many boards.

So, here is an idea: instead of having vast amounts of social wealth controlled by the CEOs' cronies, and dedicated to the infinite enrichment of CEOs, why not legally mandate that those governing the modern corporation do so professionally in accordance with professional standards similar to lawyers, doctors, stockbrokers, and any other number of regulated professions.

Recently, two Harvard Business School professors proposed just that. Their proposed code of conduct would require, among other things, that: managers "enhance the value of the enterprise to create wealth for society in the long term;" "uphold laws and contracts;"and "do not allow gender or race to influence decisions." All of these professional standards would be enforced through professional sanctions imposed through judgment of peers. In other words, directors could be disbarred. In 2005, I argued for a model based upon stock broker regulation including entry examinations and continuing education requirements. The essential point is that only those professionally qualified to be directors would be directors.

As I have written on this blog earlier, I believe that the Citizens United case makes corporate governance more important than ever. I have also written about the myth of the American meritocracy in light of the financial crisis--I posited that our corporate leaders lack ability as well as character. I also argued that all members of traditionally oppressed groups should be suspect of Citizens United because it shifts power from a more diverse body politic to a culturally monolithic group of corporate elites.

This all suggests a potential interest convergence among those in favor of superior corporate governance and those currently excluded from the ranks of board directors and officers. Both of these groups should be interested in a legally mandated regime of professionalization of corporate governance. This would open board membership to all comers based upon merit--and eliminate the need to be a crony of the CEO.

The Importance of Shareholder Ire

Earlier this past week, Royal Dutch Shell announced that it was “freezing executive pay and revamping bonus policy.” This choice came in response to a shareholder rebellion at last year’s shareholder meeting over compensation and bonus levels. Shell’s CEO, Peter Voser, and CFO, Simon Henry, will receive less in salary than their predecessors and their salaries will be frozen from July 2009 until January 2011. The performance based stock option plan, which specifically drew the ire of shareholders in 2009, previously required that the company be in the top three of its peers in shareholder return before shares were awarded, but when Shell ended up fourth amongst its peers last year, executives still awarded themselves the shares despite the plan strictures. The stock option plan has now been altered, by tying compensation to specific goals for the company such as ensuring projects are delivered on time and on budget. Shell says that this plan “demonstrate[s] appropriate restraint in the current economic environment” and “increase[s] alignment between executive and shareholder interests.” Some commentators hail this decision as a victory for those who promote greater shareholder democracy in corporations, as a non-binding shareholder vote here has seemingly provided sufficient pressure to affect officer’s positions on compensation levels.

Still, some evidence exists that suggests when shareholders are primarily institutional investors, there is no incentive to pressure executives when a firm’s compensation plan seems entirely disconnected from a “current economic environment.” The case of Lazard Ltd.’s executive compensation for 2009, seems to indicate that when “shareholder ire” is not a consideration for executive’s awarding themselves compensation, that in an environment when profits are down 95%, that it is still fine to increase executive compensation significantly. Lazard’s 2009 profits were way down, but its executives and employees were compensated at a rate that required payout of more than 72% of total annual revenue, up from 56% of annual revenue being earmarked to compensating employees in 2008.

“I don’t think it’s a coincidence that the short-term profit drive of corporate America happened at the same time that mutual funds became the major owners of these companies,” says Russel Kinnel the director of fund research at Morningstar Inc. If institutional investors are content to quietly watch executives increase compensation remarkably in the face of dreadful performance, can we really expect a “bonus based on performance” system to take root on Wall Street?

List Of The Top 20 Lobbying Clients In 2009

Despite last week’s post on lobbying and lobbyists I’m happy to report I was not kidnapped or harmed by lobbyists this past week for drawing heat to their livelihoods. Recall, last week I posted on the record $3.5 billion spent in 2009 on lobbying at the federal level. I want to follow up that post by sharing with you the list of Top 20 lobbying clients in 2009 as identified by the Center for Responsive Politics. Here they are:

Lobbying Client (Total Amount Spent on Lobbying Efforts in 2009):

1. U.S. Chamber of Commerce ($144,496,000)
2. ExxonMobil ($27,430,000)
3. Pharmaceutical Research & Mfrs. Of America ($26,150,520)
4. General Electric ($25,520,000)
5. Pfizer Inc. ($24,619,268)
6. Blue Cross/Blue Shield ($22,715,439)
7. AARP ($21,010,000)
8. American Medical Association ($20,830,000)
9. Chevron Corp. ($20,815,000)
10. National Association of Realtors ($19,477,000)
11. American Beverage Association ($18,850,000)
12. American Hospital Association ($18,347,176)
13. ConocoPhillips ($18,069,858)
14. Verizon Communications ($17,820,000)
15. FedEx Corp. ($17,050,000)
16. Boeing Co. ($16,850,000)
17. BP ($15,990,000)
18. National Cable & Telecommunications Assoc. ($15,980,000)
19. Northrop Grumman ($15,180,000)
20. AT&T Inc. ($14,729,673)

Do Large Public Companies Do Business With Minority Firms?

Even though businesses owned by Americans of color have suffered more than white-owned businesses as a result of the recent economic downturn, President Obama has not focused on the special problems that plague minority-business owners. The President’s silence about the impact of the financial collapse on communities of color is most likely attributable to the nation’s political and social climate generated by his election. There has been a great deal of discussion about the President’s election as the precipitating factor ushering in a new post-racial era. Many Americans want to believe that the election of the first African American President signals the end of racism and discrimination, particularly as they affect the African American community. I, however, agree with Michael Eric Dyson who said that “post-racial” is not synonymous with “post-racism”. It seems that for many Americans, the assertion that we now live in a “post-racial” world means that we no longer need to engage in discussions about race and racism. Our national discourse about race and racism has been superficial and wrought with difficulty, but since President Obama’s election, the post-racial assertion mandates silence on these issues. We have elected a Black President. Racism has ended. This seems to define today’s “post-racial” era.
President Obama’s silence regarding the disparate impact the financial collapse has had on Americans of color is not likely attributable to his belief that racism and discrimination are no longer problems. He has made several comments that indicate otherwise. But his silence about racism’s link to economic discrimination based on race obscures a troubling irony relating to minority entrepreneurship. Intuitively, one would think that in the Obama era, the so-called “post-racial” era, it would be easier for Americans of color to establish and succeed in their own small businesses. The counterintuitive reality, however, is that it was easier for African Americans to become entrepreneurs and thrive in the twentieth century than it is in this second decade of the twenty-first century.

Ernesta Procope, an African American, is a twenty-first century businesswoman, who has headed Wall Street’s largest minority-owned firm for decades. Her story is a success story, but, it is a story about success achieved in spite of subtle and perhaps unconscious decision making that impedes the entrepreneurial achievement of twenty-first century African Americans. This twenty-first century narrative reveals the intractability of the problem of lack of access to opportunity for black entrepreneurs.

In the 21st century, black entrepreneurs encounter more difficulties in establishing businesses and getting credit than their white counterparts. African American entrepreneurs frequently pay higher interest rates than similarly situated white businesspeople. It is more difficult for businesses owned by African Americans to remain viable. Black businesses’ sales and profits are typically lower than those of their white counterparts. Based on data gathered from the 1999 and 2001 U.S. Census Bureau, “…African American and Latino firms are less successful on average than are White or Asian firms. In particular, businesses owned by African Americans and Latinos have lower sales, hire fewer employees, and have smaller payrolls than White-owned businesses. African-American-owned firms also have lower profits and higher closure rates than White-owned firms”.

Mrs. Procope’s story reveals a counterintuitive proposition. The impediments to entrepreneurial success for 21st century black entrepreneurs are different from the obstacles their 20th century counterparts faced, but the obstacles are nevertheless as, and perhaps, even more serious. Minority entrepreneurs in the twenty-first century find themselves in a paradoxical situation. There are several federal, state and local programs in place designed to assist small minority-owned and women-owned businesses. These programs help small women and minority-owned businesses get loans and procure business from the federal government as subcontractors. In addition to these programs, many large public companies have diversity programs that attempt to ensure that the small business owners who supply them with goods and services are racially diverse. These programs, however, cannot resolve the problems that minority business owners face as a result of the subtle, often unconscious racism of the twenty-first century.
For example, because of federal and local programs, there is likely to be a perception that minority entrepreneurs have an unfair advantage. This perception may cause many of the decision makers at large publicly-held companies to overlook minority entrepreneurs and give business opportunities to white-owned firms who are seemingly disadvantaged by minority-business programs. This is likely to happen in spite of the public companies’ supplier diversity programs. This perception that people of color enjoy unfair advantages under programs designed to mitigate the effects of centuries of race discrimination fueled energetic anti-affirmative action efforts in recent decades.

Another obstacle to entrepreneurial success for minority business owners, particularly Black and Latino businesspeople, is best examined by understanding the subprime lending debacle that unfolded in the first decade of this century. There is irrefutable evidence that African Americans and Latinos were targeted by mortgage brokers and lenders for high-interest subprime loans even when the minority borrowers qualified for lower-interest prime loans. This discriminatory targeting occurred in consumer lending also. During the height of the subprime mortgage debacle, billions of dollars in wealth were drained from minority communities. This drain in wealth means that minority consumers have less wealth, resulting in a reduction in sales for many minority businesses. And, of course, discriminatory lending practices would impact minority entrepreneurs seeking capital to start or sustain their businesses.
In September, 2009, I visited The Museum of American Finance in New York City’s financial district. The museum is affiliated with the Smithsonian Institute and is the only public museum that focuses on entrepreneurship, money and the nation’s financial history. At the museum was an exhibit called “The Women of Wall Street” containing the stories of present-day and historical female icons in American finance and economic development. Incredibly, not one of the approximately ten narratives was about a woman of color.

The museum, located at 48 Wall Street, is just a few doors away from The E.G. Bowman, Co., Inc., the full-service commercial insurance brokerage and loss control firm founded by Ernesta Procope. Mrs. Procope, a renown and revered business icon, particularly in the African American community, is affectionately known as “The First Lady of Wall Street.”. I was stunned that Mrs. Procope’s story was not included in “The Women of Wall Street” exhibit. Hers is a compelling story of a brilliant and persistent entrepreneur who transformed the store-front homeowners and auto insurance company she founded into the commercial brokerage firm it is today. Her entry into the commercial market was not easy. She had to struggle to get major corporations to do business with her firm. Her struggle was successful, yielding a client list that has included PepsiCo Inc., General Motors Corp., International Business Machines Corp. and Time Warner Inc.

I spoke to Mrs. Procope about her exclusion from “The Women of Wall Street” exhibit a few days after I visited the museum. “I am not surprised”, she told me. I listened to her with quiet resignation as she told me about the racism and sexism she has faced for her entire professional life.

One of the most troubling aspects of Mrs. Procope’s exclusion from the exhibit is that it results from the type of racism and discrimination that cannot be legislated away because it is subtle and perhaps unconscious. The museum’s all-white “Women of Wall Street” exhibit is a type of denial of access to opportunity that is just as harmful to minority business owners as a Fortune 500 company’s refusal to do business. This denial of access renders minority firms invisible to potential clients. This is a problem that lingers in the twenty-first century. It is a problem that cannot be resolved by federal or local programs designed to assist small and minority businesses, nor can it be resolved by supplier diversity programs in the private sector.

“As far back as 1978, the federal government mandated that federal agencies – as well as corporations that do business with them – award roughly 8 percent of the value of their contracts to small, disadvantaged and minority-owned businesses, including those that are black-owned.” Most large public corporations have created programs designed to increase the likelihood that they will do business with minority suppliers. But, “[c]ontracts frequently get awarded to suppliers that the functional manager already knows – which according to the numbers, very likely don’t include any that are black-owned.”

The museum’s failure to include Ernesta Procope’s successful business story may also be attributable to unexpressed, perhaps even unconscious attitudes that perceive minorities in general, and the businesses they own in particular, as inferior. This unconscious bias is likely to be shared by the major corporations with whom Procope’s company seeks to do business. In fact, her company has been asked on several occasions to sign a contract with a major company as a supplier. The major company is fulfilling a requirement that it do business with a certain percentage of minority firms in order to procure government contracts that impose such requirements. But, the deal suggested by some major companies did not include the actual provision of services from Procope’s firm. The only thing the companies required was that Procope’s firm say it was a supplier, even though it had to provide no services at all. Mrs. Procope and her managers have consistently refused to participate in these arrangements.

Offshore Tax Evasion: Swiss Court Upholds Swiss Bank Privacy Laws

Approximately, two years ago, the U.S. began investigating offshore tax evasion schemes focusing on certain operations involving Swiss bank UBS AG (UBS). I commented on the details of the U.S. Justice Department (U.S.), and Internal Revenue Service (IRS) investigation regarding UBS and Citigroup last fall. It is available here. The U.S. and IRS reached a settlement with UBS in which, UBS agreed to pay $780 million to the U.S. and IRS as part of a deal to avoid criminal prosecution for helping wealthy Americans evade taxes. A central part of the settlement was a special agreement between the U.S. and the Swiss Government to permit UBS to disclose the identities of approximately 4,450 of its American clients who are suspected of hiding assets in offshore Swiss bank accounts. This disclosure was a major shift in the historical policies and existing Swiss law regarding Swiss bank privacy laws.


The Swiss principle of bank secrecy is derived from statutorily enforced privacy laws. Swiss law strictly limits any information shared with third parties, including tax authorities, foreign governments or Swiss authorities, except when requested by a Swiss judge's subpoena. The law only permits a bank to share information with third parties in cases of severe criminal acts, such as identifying a terrorist's bank account or tax fraud, but not simply for non-reporting of taxable income, otherwise known as tax evasion. A bank employee who violates a banking client's privacy is subject to severe punishment under Swiss law. Recent bilateral treaties negotiated between Switzerland and a number of countries are designed to weaken Swiss law privacy protections related to tax evasion. The bilateral treaties are analogous to the disclosure provisions contained in the special agreement between the U.S. and Switzerland concerning the disclosure of American UBS clients.

However, last month a Swiss Court, the Federal Administrative Court in Switzerland, ruled that Swiss authorities may not disclose the bank account details of a wealthy American who used UBS’ private bank to evade American taxes. Some commentators believe that the Swiss Court’s ruling may nullify the special agreement between the U.S. and Switzerland regarding the disclosure of American UBS clients. In the ruling, the Swiss Court noted that Switzerland is an independent democratic country with a clear separation of powers, and it is the court’s responsibility to maintain said independence by adhering to Swiss national law, and not provide confirmation of external political pressures. As such, the Swiss Court issued a ruling forbidding UBS to disclose information to the U.S. or the IRS regarding approximately 4,500 American UBS clients. Furthermore, the Swiss Court ruled earlier last month that Switzerland's financial regulator violated Swiss law when it turned over data regarding 255 UBS American clients last year. The Swiss Court’s decision cannot be appealed. The ruling has placed the special arrangement between the U.S. and Switzerland regarding American UBS clients in jeopardy. It is unlikely that the Swiss Government wants a confrontation with the U.S. One possible remedy would be an emergency decree by the Swiss Government to enforce the original special agreement between the U.S. and UBS. The decree would arguably be beyond the scope of the Swiss Court’s jurisdiction. However, this all remains to be negotiated or it may all lead to an international legal battle.

MWPOC 20: The Myth of the American Meritocracy & Board Professionalization

The Midwestern People of Color Legal Scholarship Conference will celebrate its 20th anniversary on April 16-18, 2010 at Loyola University Chicago School of Law and John Marshall Law School. Keynote speakers Derrick Bell and Richard Delgado will speak on April 16th and April 17th, respectively.

The theme of the conference is Paradigms Lost: Insider Scholarship, Outsider Scholarship and the Economic Crisis. Legal scholars wishing to present papers at the conference should contact Regina Burch (rburch@law.capital.edu) or Joe Grant (jgrant@law.capital.edu).

I will present a paper entitled The Myth of the American Meritocracy: From Crony Capitalism to Professionalized Corporate Governance. The paper is premised on the highly dysfunctional allocation of opportunities and responsibility within current America, as evidenced by the recent financial meltdown. Ideally, a rational system of advancement operates to allocate opportunities and responsibility in accordance with capabilities, skills, dedication and character. Such a system of advancement will promote macroeconomic growth by assuring that the most talented and responsible have the most power and responsibility. I have written much about the need for the law to cabin economic power and assure it is applied to socially beneficial ends. Less focus has been placed upon our system of advancement.

Appropriate disincentives and incentives mark of a system of a well functioning system of advancement. Consider what our so-called meritocracy has wrought: billions in losses at virtually every major bank, trashed communities all across the country, financial sector insolvency, trillions expended in government support of elites, an historic credit crunch/liquidity trap, skyrocketing unemployment, and a global recession leading to trillions in foregone GDP. For this, financial elites suffer little loss in wealth, huge bonus and compensation payments, and continued control of our financial sector. Some meritocracy!

Even before the financial crisis right of center voices such as The Economist suggested that higher inequality threatened to render the American meritocracy a myth. Since then study after study finds that economic mobility in the U.S. is lower than practically any other developed nation. Moreover, there is good reason to think mobility is declining in the U.S., with less mobility to come as a result of the disproportionate impact of this economic downturn--unemployment is highly concentrated among the bottom 20% of the income distribution.

All of this suggests real problems facing the American economy: we do not have the best and brightest running things, instead we are plagued by the pretense of privilege and the dullness of hereditary entitlements.

In my next post, I will suggest a potential solution, which forms part II of the paper I will present at MWPOC 20. That solution will build upon a proposal I made in 2005 for the professionalization of corporate governance.

Lobbyists Spend A Record $3.5 Billion In 2009: Did Average Citizens Profit From These Efforts?

For most people, 2009 marked a year in which many of us had to pull back and tighten the reins on our own personal budgets as a result of the overall downturn in the economy. Apparently, for some segments of society this was not the case. Did you know that lobbyist spent nearly a record $3.5 billion lobbying the federal government in 2009? Recently, I came across some interesting and compelling statistics compiled by the Center for Responsive Politics, a political watchdog group, that I’ll share with you in today’s post that gave me several moments of pause.

For example, companies and special interest groups spent a record $3.47 billion on federal lobbying efforts in 2009, this amount represented a 5% increase over statistics reported in 2008. Lobbyists were not deterred by the Great Recession, the decline of the dollar, bank failures, TARP bailouts, or near 10% unemployment nationally and far worse unemployment rates in a number of individual states. One lesson learned: lobbying appears to be a growth industry heading into the future if you are seeking employment and job security. In other words, lobbying appears to be a recession-proof industry.

The Obama Administration and Congress were busy over the past year pushing forward a number of hot-button issues like health care reform, financial regulatory reform, climate-change and other controversial legislation. In a year when Congress was busy debating such wide-ranging ideological issues lobbyists were paying close attention on the sidelines.

A number of industry sectors notably stand-out as the deep pocket and influential lobbyists. The pharmaceutical and health industry spent an estimated $266.8 million lobbying on health care reform—this happens to be the largest amount ever spent by a single industry in a one year period of time. Business associations spent $183 million on federal lobbying. Oil and gas lobbyists spent $168.4 million. The insurance industry spent $164.2 million. At the end of the day, all of these industry sectors that I mention spent more in 2009 than they did in 2008. However, the electric utility industry spent $144.4 million, slightly off the 2008 pace for that industry segment. To recap, the top five industry sectors in terms of spending were the following:

1. Pharmaceutical and Healthcare Industry ($266.8 million)
2. Business Associations ($183 million)
3. Oil and Gas Industry ($168.4 million)
4. Insurance Industry ($164.2 million)
5. Electric Utility Industry ($144.4 million)

The single largest institutional lobbyist was the U.S. Chamber of Commerce, an association that represents roughly 3 million businesses in various industries, which distributed $145 million for lobbying activities at the federal level. The Chamber of Commerce has consistently held the top spot as the largest single spender over the past nine (9) years. 2009’s figure of $145 million spent on lobbying activity by the Chamber of Commerce marks a 6% increase over 2008 figures.

I promise you that I’m not making these figures up. You can see them for yourself. A wonderful website www.opensecrets.org compiles and breaks down the numbers that I’ve just shared with you. As a citizen, and probably thinking along the same lines as other citizens, when I come across data like this I’m left scratching my head and asking one simple and basic question. Has spending such vast sums on lobbying improved the quality, scope, and reach of legislation and policy emanating out of Washington to make the everyday lives of a greater multitude of citizens better and more productive? I have my own answer and opinion in response to the question that I pose. I can only imagine what your response would likely be in answering this question.

AIG Bailout Inquiry

In recent weeks, the House Committee on Oversight and Government reform has expanded its investigation into the bailout of AIG to require testimony from former Treasury Secretary Henry Paulson and former Federal Reserve Chairman Stephen Friedman. The inquiry will interrogate the decision to fully compensate the counterparties of AIG when they were bailed out by the government. This inquiry responds to Republican Congressman Darrell Issa’s call for Paulson to testify after uncovering e-mails in which New York Fed lawyers told AIG to keep some details of the bailout secret. According to the AP:

"The committee is pressing for details about deals that sent billions from AIG's bailout to big banks including Goldman Sachs Group Inc. Lawmakers want to know why the New York Fed pressed AIG to be more secretive about the 'backdoor bailouts' and other aspects of AIG's management."

The following questions are expected to be addressed during the inquiry:

How was the Treasury’s decision to fully compensate the counterparties of AIG in its 182 billion dollar bailout reached?

Why was the decision made by then New York Fed Chair and now Treasury Secretary Timothy Geithner and Paulson to refuse to name those counterparties that were paid off in full?

The Committee on Oversight and Government will also be asking the GAO to examine the payments and inquire into the source of the direction to pay the counterparties in full and what steps were taken thereafter to block disclosure of those payments.

U.S. Not the Only Country Facing Economic Turmoil, Growing Economic Crisis in Europe is Brewing

The United Kingdom is the world's fifth largest economy and the economic slowdown currently occurring in the U.K., to some financial experts is analogous to the economic slowdown in Portugal, Greece and Spain, which are much smaller economies. Despite the U.K.’s economic slowdown, it has the highest rating for its government debt (gilts) on the international money market. A representative from the U.K. Treasury stated that all three major credit-rating agencies had reaffirmed the U.K.'s triple “A” credit status, which allows the U.K. to borrow at very favorable interest rates because the U.K.'s triple “A” credit rating means that the U.K. has a very low risk of default. However, some economist argue that the U.K.’s excellent government credit rating is due more to the U.K.’s past legacy of good repayment history than a reflection of its current economic status, as the most excessively-leveraged country in the G7. A short documentary clip explaining the U.K's growing debt crisis is available here. Simon Johnson, a former International Monetary Fund (IMF) chief economist, points out that “the financial markets are taking a long hard look at the fiscal accounts of all these [Euro zone] countries and they don't like what they see.”

This is all very fascinating to me, because the U.K. “officially” came out of a recession in the fourth quarter of 2009 (December 2009), which ended six consecutive quarters (1.5 years) of economic decline in the U.K. Economic growth for the U.K. during the last year was a mere 0.1%, which is much less than economists expected, and more analogous to the growth rate of a developing country. Typically when a country is in an economic slowdown, the government increases spending to give the country an economic boost. This is classic Keynesian economics that was applied during the Great Depression by President Roosevelt in the United States under the New Deal Programs, and fiscally analogous to President Obama's current U.S. economic stimulus package. However, one of the major concerns about a country having large budget deficits is that it cannot spend sufficiently to boost its economy. This is precisely the issue that certain commentators have raised about President Obama’s economic stimulus plan; the plan needs to be more aggressive—more money needs to be spent to really jumpstart the U.S. economy.

A spokesman for the U.K. Treasury stated, "it is right that borrowing has been allowed to rise so that the [U.K.] government has been able to protect the economy from the global downturn.” Additionally, a representative from the British Chamber of Commerce (BCC) stated that “despite the U.K. coming out of a recession, there is still a long way to go to economic recovery.” Ironically, despite the British government’s fiscal plan to jumpstart the U.K. economy, last week the Euro reached a seven month low against the U.S. dollar. The drop in the Euro’s value could not have occurred at a worst time for two reasons. First, it made traders worry that Greece's huge government debt problems could spread to other European countries such as Spain, Portugal, and the U.K. Second, it motivated Mr. Johnson, the former chief economist for the IMF, to describe the G7 group of leading economies as "fundamentally useless." Mr. Johnson criticized the G7 organization because it “did not react quickly enough” to the global economic problem, and for “remaining in an out-of-date mindset.” He continued that "the financial markets are taking a long hard look at the fiscal accounts of all these [Euro zone] countries and they don't like what they see." I previously commented on the G20's need to require member countries to implement fiscal monetary policies in September 2009. Mr. Johnson further noted that the "[the G7] seem to show no awareness at all that much of Europe is facing a serious crisis and it's not limited to Spain, Greece and Portugal, it's also going to include Ireland. I think Italy is also very much in the line of fire. There's a very serious crisis inside the Euro zone," Johnson warned.

Mr. Johnson’s comments occurred just hours after the G7 finance ministers held a meeting in northern Canada, at which the European countries had to reassure their counterparts from the US, Canada and Japan over the deteriorating state of the public finances in some Euro zone countries. The G7 finance ministers agreed, not to involve the IMF and to leave the matter to the European Union to resolve. UK chancellor, Alistair Darling, who was at the G7 meeting, commented that the world was set for a steady but slow recovery and that the various governments' economic stimulus packages should remain in place until the recovery was assured. His final words at the meeting ended on a hopeful note, "the important thing is that we all are absolutely committed to maintaining the support for our economies until we make sure we have recovered….” The same can be said for the U.S.

Citizens United and Crony Capitalism

Paul Krugman warned in 2002 that crony capitalism took root during the Bush Administration. Crony capitalism means that connections (particularly government connections) matter more than merit. Obama economic Czar Lawrence Summers is the epitome of crony capitalism: after making millions with his Wall Street Connections he has successfully burrowed himself into the highest echelons of the Obama Administration where he now dictates Wall Street Policy. In part because of Summers, I posit that things worsened recently and the Obama Administration failed to turn back to a merit based economy. Can we really tell the difference between the Bush-Paulson-Geithner-Bernanke Wall Street policies and the Obama-Geithner-Summers-Bernanke policies?


In terms of gentleness towards Wall Street elites the policies seem identical. For example, would it surprise you to learn that despite the government's massive bail outs in the financial sector, and despite its massive ownership positions, as well as the massive losses brought on by massive incompetence (or worse), 9 out of ten senior bank executives retained their positions, and the only ones leaving either retired or died? Or, "92 percent of the directors who approved the dramatically flawed compensation policies and ineffectual risk management practices that led to global financial failure are still in place and have received $12 trillion of taxpayer support." Where is the great American meritocracy? Wall Street incumbents remain incumbents under both administrations, regardless of ineptitude.

Alternatively, consider this: Goldman Sachs, Citigroup, and JP Morgan Chase gave the Obama campaign about $2.5 million. McCain's top contributors include Merrill Lynch, Citigroup, Morgan Stanley, Golden Sachs, and JP Morgan Chase, giving a total of $1.5 million. I suppose on Wall Street that would be termed a political straddle or hedge.

This has been the case for years. The charts at left show contributions for the five years leading up to the election. The same banks are supporting both candidates.

Citizens United will greatly exacerbate this problem. That decision creates a new corporate free fire zone during the last 60 days of every campaign. Hedges can be adjusted, and straddles can be lifted or put on up to the very end, limited only by the time available to produce commercials and buy air time. Moreover, by waiting until the last minute the campaigns will frequently be deprived of an effective rebuttal.

Think about financial and economic theory: would a trader in global markets be more or less effective if there were a no trade zone of 60 days prior to release of, say, GDP numbers? If you could spend money on the weekend prior to an election, knowing that the opposing campaign could not effectively respond prior to polls opening, would you increase your bets or decrease them? Simple logic thus suggests that the numbers shown above will increase and that our political leaders must be more attentive to the corporate leaders sitting atop mountains of wealth.

So, what to do? Well, first reformers must recognize what we are up against and match their tactics. It is a political monolith. The two parties are now one. If the most sophisticated financial traders in the world recognize this (just follow the Goldman Sachs and JP Morgan money) it is time for sophisticated reformers to recognize this central truth. The financial sector wins no matter which candidate is elected. Right now, I feel reform loses no matter which candidate prevails.

There is a third way. I argued in 2004 (in the Washington & Lee Law Review) that reform wins only when backed by sufficient political and economic power, and that reform in the corporate sector is no different than racial reform generally. There is only one way to break up crony capitalism and it is diversity. Citizens United means corporate governance must now reflect America generally. I will blog on that fact next. But today, the point I am trying to make is that the goal of diversifying corporate America must be pursued without any partisan pretense, with any support necessary from either party. With the election looming, a bi-partisan coalition must be marshaled now.

Perhaps, the Civil Rights Act of 1964, when more Democratic senators than GOP senators voted against the bill, furnishes the model for real reform in this environment. As GOP Senator Dirksen from Illinois then stated: "I trust that the time will never come in my political career when the waters of partisanship will flow so swift and so deep as to obscure my estimate of the national interest. . . . I trust I can disenthrall myself from all bias, from all prejudice, from all irrelevancies, from all immaterial matters, and see clearly and cleanly what the issue is and then render an independent judgment." Ultimately, the Senate Minority Leader mustered 27 0f 33 GOP votes in favor of cloture, shutting down the filibuster of the southern Democrats.

My point is simply that the battle against crony capitalism must disenthrall itself from the premise that the path to reform lies with either party.

A Global Sheriff?

President Obama’s recent announcement regarding new federal financial sector regulation, known now as the “Volcker Rule,” is slowly making its way through the United States Senate. Recently boosted by the firm support of Senate Banking Chairman Christopher Dodd, its consideration and potential passage is only a small component of necessary financial reform. The recent financial meltdown occurred on a global scale and responding to the underlying causes must adopt a global vision. To this point in time, the United States has resisted supporting any type of international financial banking regulation.

In recent days, international financial leaders, including Obama administration financial advisor Larry Summers and British Prime Minister Gordon Brown, met in Davos, Switzerland to openly debate the need for global regulatory solutions. George Soros's proposal of the need for a “global sheriff,” gained currency in Davos, while Howard J. Davies of the British Financial Services Authority proposed a “financial WTO.” That these talks have occurred and are being taken seriously reflects the continuing global outrage over the bailed out investment banks in the United States and those banks’ continuing refusal to break from “business as usual” in connection with executive compensation and freeing up restricted credit flow.

Just as Wall Street promises to mightily resist the proposed “bank tax” and the recently announced “Volcker Rule,” these banks appear determined to fight against a new global regulatory regime. To avoid new U.S. financial regulation, “too big to fail” banks have threatened to move operations to countries with less restrictive financial regulations. This move toward “regulatory arbitrage” would allow banks to structure their businesses in ways that avoid or circumvent particularized regulation and make real the “fiction” that the United States regulatory tradition forces capital out of the U.S. To wit, Goldman Sachs has threatened to abandon its “bank holding company” status in order to circumvent the Volcker Rule’s sufficient deposits requirement. Recall that Goldman was able to survive the financial crisis because the Government bestowed “bank holding company” status upon Goldman.

The arrogance of Wall Street banks (through their leadership) is laid bare by their furious resistance to new financial regulation as announced by the Obama administration. It is now clear that many of the enormous gains made by Wall Street financial institutions during the past decade were ill-gotten. Left to their own devices, Wall Street leaders (amongst many other culprits) allowed greed, reckless decision making, irresponsible risk modeling, and rating agency capture to drive the economy to the brink of disaster. That they now resist new U.S. regulation and the potential adoption of global sheriffing is astonishing. When President Obama announced his potential bank tax, he suggested to U.S. investment banks that rather than spending millions of dollars resisting and sending scores of lobbyists to Washington, D.C. Congressional offices, perhaps the banks “might want to consider simply meeting your responsibilities.”