Category: Corruption

Two Meanings of Corporate Governance

The Harvard Law School Program on Corporate Governance recently issued an important paper entitled “Corporate Political Speech: Who Decides?” Written in response to the Citizens United decision, the paper makes the case for requiring shareholder approval of corporate political expenditures:

Under existing corporate-law rules, corporate political speech decisions are subject to the same rules as ordinary business decisions. Consequently, political speech decisions can be made without input from shareholders, a role for independent directors, or detailed disclosure — the safeguards that corporate law rules establish for special corporate decisions. We argue that the interests of directors and executives may significantly diverge from those of shareholders with respect to political speech decisions, and that these decisions may carry special expressive significance from shareholders. Accordingly, we suggest, political speech decisions are fundamentally different from, and should not be subject to the same rules as, ordinary business decisions.

Meanwhile, as Marcy Murningham notes, “Congress faces a decision on the Shareholder Protection Act (HR 4790), which puts a [potential] check on the flood of corporate money into electoral campaigns.” Jennifer Taub makes a compelling case for passing the SPA. Ciara Torres-Spellicsy’s publication “Corporate Campaign Spending: Giving Shareholders A Voice” explains one way the process could work:

Congress should act to protect shareholders by giving them the power, under statute, to authorize political spending by corporations. The voting mechanics would work in the following way: At the annual meeting of shareholders, a corporation that wishes to make political expenditures in the coming year should propose a resolution on political spending which articulates how much the company wishes to spend on politics. If the resolution gains the vote of the majority of the outstanding shares (50% plus 1 share), then the resolution will be effective, and the company will be able to spend corporate treasury funds on political matters in the amount specified in the resolution. However, if the vote fails to garner the necessary majority, then the corporation must refrain from political spending until the shareholders affirmatively vote in favor of a political budget for the compan

Given the extant weakness of corporate governance mechanisms, I can’t guarantee that this will make a substantial difference for our public sphere. I reluctantly began to consider campaign finance reform a “lost cause” even before the opinion in Citizens United was issued. But I do think immediate and full disclosure of the ultimate source of contributions and expenditures is a sine qua non for a legitimate electoral process. New Jersey Senator Robert Menendez worries that “shadow groups [are] putting their thumbs on the scale with undisclosed, unlimited and unregulated donations.” It is deeply troubling to see entities like the US Chamber of Commerce promise “deniability” to donors. Proposals like the SPA and tougher disclosure rules would help put campaign finance back in the limelight it deserves, lest books like David C. Korten’s become the predominant social meaning of “corporate governance.”

The Question Concerning Finance: Party Like It’s 1929? Or Prepare Like It’s 1957?

Another day, another story of Wall Street’s failure to allocate capital responsibly. Today’s installment appears on ProPublica, and describes how “Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history:”

Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses: They created fake demand.

A ProPublica analysis shows for the first time the extent to which banks — primarily Merrill Lynch, but also Citigroup, UBS and others — bought their own products and cranked up an assembly line that otherwise should have flagged. The products they were buying and selling were at the heart of the 2008 meltdown — collections of mortgage bonds known as collateralized debt obligations, or CDOs.

As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created — and ultimately provided most of the money for — new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those. . . .Because of Wall Street’s machinations, more mortgages had been granted to ever-shakier borrowers.

The article explains the details of the deals, whose byzantine structures should be numbingly familiar to anyone who’s read ProPublica’s earlier work on Magnetar, or chapter 9 of Yves Smith’s book Econned. Smith calculated that, “if you look at the non-synthetic component, every dollar in mezz ABS CDO equity that funded cash bonds created $533 in subprime demand” (Econned, 261). (If mezz ABS CDO means nothing to you, I highly recommend Smith’s blog, or John Lanchester’s I.O.U., the most stylishly written of the “crisis” books.)

Behind all the reticulated swaps of risk and reward, in article after article, the crash of 2008 is boiling down to a familiar story: endless leverage designed to support ever more fee-generating deals. Read More

Recommended Viewing: American Casino and Flow

I was recently reading Bloomberg Businessweek’s excellent examination of commodity ETFs. Here’s a taste of the findings of Peter Robison, Asjylyn Loder and Alan Bjerga (which are well worth reading in full):

Lured by the idea of profiting from raw materials, investors put $277 billion into commodity ETFs and related securities by the end of 2009. Then they noticed a problem: When commodities go up, the commodity ETFs often don’t. . .

When the futures contracts that commodity funds own are about to expire, fund managers have to sell them and buy new ones; otherwise they would have to take delivery of billions of dollars’ worth of raw materials. When they buy the more expensive contracts—more expensive thanks to contango—they lose money for their investors. . . . Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks. “You walk into a casino, you expect to lose money,” says Greg Forero, former director of commodities trading at UBS (UBS). “It’s the same with these products. You’re playing a game with a very high rake, a very high house advantage, and you’re not the house.”

The article brought to mind two outstanding documentaries I recently watched on finance and the “real economy.”

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Louisiana as Petro-State

Here is an interesting take on the role of oil companies in Louisiana:

Long before the oil spill, [Louisiana]‘s embrace of the petroleum industry cast it under what economists call “the resource curse”: the paradox that countries rich in minerals or petroleum tend to grow more slowly and have lower living standards than other nations. Simply put, Louisiana is the closest thing America has to a petro-state.

Instead of blessing Louisiana with prosperity, the oil industry fostered dependency, corruption and an indifference to environmental damage. Our Cajun sheikdom’s oil and gas riches — like those of the Niger Delta, the Orinoco belt in Venezuela and the Iraqi marshes — also stunted its development, leaving it far behind states with fewer natural resources. . . . “We’ve always been a plantation state,” said Oliver Houck, an environmental law professor at Tulane University. “What oil and gas did is replace the agricultural plantation culture with an oil and gas plantation culture.”

Just as plantation culture had an impact in Texas, it appears to leave a lingering legacy in Louisiana as well. When many judges and scientists appear to be dependent on an industry, accountability is a long way off.

In the Venal Colony

Paul Romer is an accomplished man; as he puts it, “I revived growth theory. I made technology work in higher ed. I am two for two, and I think the impossible can be done.” His new idea is to promote economic growth in poor countries by establishing zones within them that are administered by business-friendly foreign governments:

Romer is peddling a radical vision: that dysfunctional nations can kick-start their own development by creating new cities with new rules—. . . centers of progress that Romer calls “charter cities.” By building urban oases of technocratic sanity, struggling nations could attract investment and jobs; private capital would flood in and foreign aid would not be needed. . . . [To run the cities,] Romer looks to the chief source of legitimate coercion that exists today—the governments that preside over the world’s more successful countries. To launch new charter cities, he says, poor countries should lease chunks of territory to enlightened foreign powers, which would take charge as though presiding over some imperial protectorate. Romer’s prescription is not merely neo-medieval, in other words. It is also neo-colonial. . . .

When Romer explains charter cities, he likes to invoke Hong Kong. For much of the 20th century, Hong Kong’s economy left mainland China’s in the dust, proving that enlightened rules can make a world of difference. By an accident of history, Hong Kong essentially had its own charter—a set of laws and institutions imposed by its British colonial overseers—and the charter served as a magnet for go-getters. At a time when much of East Asia was ruled by nationalist or Communist strongmen, Hong Kong’s colonial authorities put in place low taxes, minimal regulation, and legal protections for property rights and contracts; between 1913 and 1980, the city’s inflation-adjusted output per person jumped more than eightfold, making the average Hong Kong resident 10 times as rich as the average mainland Chinese, and about four-fifths as rich as the average Briton.

The idea of a “charter city” brings to mind some of Diane Ravitch’s critiques of charter schools:

The media like to focus on a star charter school, as though one extraordinary school is typical. The teachers are young and enthusiastic; the children are in uniforms and well behaved, and they all plan to go to college. But such stories often overlook important factors about charters: one, the good charters select students by lottery, and thus attract motivated students and families; two, charters tend to enroll a smaller proportion of students who are limited–English proficient, students with disabilities and homeless students, which gives them an edge over neighborhood public schools; and three, charters can remove students who are “not a good fit” and send them back to the neighborhood school. These factors give charters an edge, which makes it surprising that their performance is not any better than it is.

It would likely be very difficult to prove that a “charter city” succeeded on the basis of its “better laws,” rather than its attractiveness to the most ambitious workers. The questions of legitimacy raised by Romer’s proposal are difficult, too. US landlords may attempt to contract into their own “private Idahos” in Greenwich Village, but will international law smile on charter city arrangements? What happens when there is a regime change in the country that originally controlled the city space, and the new regime wants it back?

In any event, for further discussion of the idea, check out Russ Roberts’s interview with Romer, which is very substantive.

Here Comes FinReg

Via Ezra Klein’s Wonkbook (definitely one of my favorite morning emails), a variety of takes on what’s in the financial reform bill:

1. From Deloitte’s 12-page summary:

Because the new U.S. law is complex, it can be helpful to remind ourselves that its underlying purpose is relatively simple and has two powerful strands: 1. ‘De-risk’ the financial system by constraining individual organizations’ risk-taking activities and capturing a broader set of organizations’, including the so-called “shadow” banking system, in the regulatory net 2. Enhance consumer protections. . . .For example, the need for “arm’s-length” swap desk affiliates combined with the move from over- the-counter to exchange trading for derivatives, tighter constraints on leverage and risk-taking, and higher liquidity requirements imply lower profit margins in future from those activities.

Some estimates I’ve seen have estimated the profit margins might be around 15% lower.

2. Simon Johnson on the Kanjorski Amendment as a “new kind of antitrust:”

Effective size caps on banks were imposed by the banking reforms of the 1930’s, and there was an effort to maintain such restrictions in the Riegle-Neal Act of 1994. But all of these limitations fell by the wayside during the wholesale deregulation of the past 15 years. Now, however, a new form of antitrust arrives – in the form of the Kanjorski Amendment, whose language was embedded in the Dodd-Frank bill. Once the bill becomes law, federal regulators will have the right and the responsibility to limit the scope of big banks and, as necessary, break them up when they pose a “grave risk” to financial stability.

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Seeing the Law Through Crude-Colored Glasses

As might be expected in such a politically charged situation, groups are charging that the district court judge who “struck down the Obama Administration’s six-month moratorium on new deep water drilling” had oil-related interests that could have influenced his decision. Now the WSJ Law Blog reports that the Alliance for Justice has prepared a report on the oil ties of two of the three judges on the appellate panel that will review the district court judge’s finding.

I imagine all these judges might point to the Scalia non-recusal in Cheney v. United States District Court to justify their own decisions to hear the case. Michael Dorf had an interesting perspective on that controversy, where the underlying litigation concerned a “2001 advisory committee on energy policy that Vice President Cheney headed.” Here are some lines from Justice Scalia’s memorandum refusing to recuse himself:

For five years or so, I have been going to Louisiana during the Court’s long December-January recess, to the duck-hunting camp of a friend whom I met through two hunting companions. . . Our friend and host, Wallace Carline . . . runs his own company that provides services and equipment rental to oil rigs in the Gulf of Mexico.

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The Messy Political Economy of Finance and Energy

(This is Part 3 of a review of Ian Bremmer, The End of the Free Market: Who Wins the War Between States and Corporations? (Portfolio, 2010); Part 1 appears here and Part 2 here.)

If pervasive governmental intervention is inevitable in any developed economy, the question then becomes: what intervention is worthwhile? For Bremmer, the answer appears to be either a) not much or b) intervention that is not designed merely to enhance the power of the governing regime. Unfortunately, one of his central arguments for the value of the free market—the performance of multinational oil and gas companies—founders on the messy politics of energy. The second category of “pro-commerce” intervention appears less and less coherent as we look at the full breadth of programs state capitalist regimes engage in. State capitalists in China may well be promoting the sustainable commerce of the future by forcing certain sectors to act “politically” today.

Crude Distinctions in the Petroleum Industry

Bremmer notes that “the 14 largest state-owned energy companies control twenty times as much oil and gas as the eight largest multinationals” (56). He accuses state-owned energy companies of being corrupt, inefficient, and dangerous, and makes that case in some detail. He also says many of them are amoral, willing to work with the most repressive regimes imaginable. By contrast, he lavishly praises multinationals like Shell, BP, and ExxonMobil:

[E]fficiency gaps between privately owned companies and their state-owned rivals wider in the energy sector than in any other area of an economy. Multinationals offer higher wages, attracting better workers. They’re more likely than state-owned firms to benefit from economies of scale. They’re more innovative. Their managers and engineers are more experienced, and they use better equipment. These advantages will continue to matter in places like the Gulf of Mexico . . . where the technical demands of bringing oil to the surface are extraordinarily high. (62) (emphasis added)

If the BP hemorrhage continues indefinitely, that hole in the world might shake Bremmer’s confidence. Admittedly, the disaster happened after the book was released, but the more we dig into it, the more we find permanently captured regulators at Interior giving these companies whatever they want. Stories of the environmental devastation of Nigeria and Ecuador by Shell and Chevron have been familiar for years.
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Some Realism About Interventionism

(This is Part 2 of a review of Ian Bremmer, The End of the Free Market: Who Wins the War Between States and Corporations? (Portfolio, 2010); Part 1 appears here.)

Throughout his book, Bremmer contrasts “state capitalist” regimes (where the government is the lead economic actor) with “free market” nations which preserve more room for private initiative. While virtually every country has a few state-owned enterprises (SOE’s), in state capitalist regimes like China SOE’s predominate in “diverse sectors” and are used to enhance the political power of government (65). Such regimes also intervene in the economy pervasively. For example, Russia in 2008 “identified forty-two ‘strategic’ economic sectors in which restrictions applied for foreign investment” (109). In a chapter entitled “State Capitalism Around the World,” Bremmer piles up a litany of suspect interventions in places ranging from Nigeria to Mexico to Saudi Arabia.

Bremmer paints a stark contrast between the economies of liberal democracies and the state capitalist other. But at least since legal realist Robert Hale published his Coercion and Distribution in a Supposedly Non-Coercive State in 1923, the question of what constitutes state “intervention” in the market has been contestable. For example: at what point does licensing of doctors move from being a natural aspect of any competent health system to being termed a suspect “intervention”? If there is to be free trade in services, don’t we at least need some information about what constitutes genuine medical care? “Perfect information” is a cornerstone of idealized markets—isn’t some baseline of information necessary to any actual market?

Bremmer does not talk much about health care in his book, but it appears to be one important sector where the relative role of the government in state capitalist and “free market” regimes is flipped. On a cursory reading of Blumenthal and Hsiao‘s 2005 article in the NEJM, the US would appear to be more interventionist than China:
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