Parting Thoughts

posted by Michelle Harner

I want to thank the authors of Concurring Opinion for giving me this wonderful space to guest blog the past several weeks. I truly enjoyed my experience, and I am grateful for the opportunity. I also want to thank the readers who provided thought-provoking and insightful comments on my posts. I enjoyed our ongoing dialogue.

I started my posts by concentrating on the economic crisis; the issues and flaws in our financial and governance systems highlighted by the crisis will keep many of us scholars, practitioners and politicians busy for the foreseeable future. Indeed, we are still revisiting issues from the economic downturn and corporate scandals of the early 2000s (e.g., the U.S. Supreme Court will hear Jeff Skilling’s appeal tomorrow, see here and here). Congress continues to propose new legislation intended to address the current crisis (see here for the latest proposal introduced by Senator Dodd to create a Bureau of Financial Protection within Treasury), and it is by no means evident that the current crisis is over (see here, here and here).

As I mentioned in several of my posts, many of the issues we face today as a result of the crisis are neither new nor novel. We have long struggled with corporate mismanagement, risk management, agency costs, executive compensation and regulating innovation. The recurring nature of these issues suggests that a fresh look at both the issues and the corresponding legal system is needed. Simply creating more rules or more bureaucracy is not the answer. Adversity often creates opportunity; I certainly hope that is the case here.

  February 28, 2010 at 9:53 am  Tags: Current Events  Posted in: Uncategorized   Print This Post   2 Comments

CEOs: The Favorite Child?

posted by Michelle Harner

Something about Tiger Woods’ press conference last Friday was very familiar. I felt as though I had heard those words before. “I knew my actions were wrong. . . . But I convinced myself that normal rules didn’t apply. I felt I was entitled.” (See here for this quote and an interesting comparison of the Woods and Toyota situations.) I then heard an interview yesterday with author and psychologist Ellen Weber Libby, who is promoting her new book, The Favorite Child (video description of book here). After listening to Libby’s interview, I realized that the hubris evident in Woods’ statement is similar to that we often hear in the comments, or see in the conduct, of corporate managers. Consider Ken Lay’s statement regarding the Enron scandal: “I take full responsibility for what happened at Enron. But saying that, I know in my mind that I did nothing criminal.”  (See also description of allegations in complaint against Bank of America here.)

Libby explains the “favorite child” scenario as one where a child makes her parents feel good and in exchange the child receives special privileges. Libby herself used Tiger Woods as an example in the interview and uses her brother-in-law, Scooter Libby, as an example in the book. Although treating a child as a favorite can promote positive characteristics, such as self-confidence, it also can impair a child’s ability to recognize the consequences of her actions, according to Libby. I cannot help but notice similarities between these natural family tendencies and those we observe in the corporate “family” context. (Notably, the overconfidence and failure to appreciate consequences sometimes apparent in the corporate context might be a combination of the two; a corporate manager raised as a favorite child in her natural family and then further enabled by her corporate family. Indeed, personality traits such as narcissism are identified by some commentators as indicative of an overconfidence bias in corporate managers.  See here and here for discussion of overconfidence in the current and past economic downturns.)

The analogy is not perfect, but I think it fosters valuable analysis. Corporate boards may overlook or be more lenient with respect to scrutinizing the conduct of corporate managers when times are good and the managers’ performance is making the board feel good about the company. The same arguably can be said about oversight from shareholders, regulators and the markets. But this leniency obviously is troublesome when exceptional corporate performance is based on inappropriate risk-taking or illegal conduct. So the challenge then becomes how to motivate appropriate oversight and encourage a healthy dose of skepticism into corporate governance. I touched on this issue in a prior post, and I come back to it here because I think it is an extremely challenging task. Creating a legal rule is not difficult, but designing a rule to change human behavior in an effective manner and without unwanted side effects is. And then you have to consider how best to implement that rule—e.g., legislation, best practices, etc. This difficulty may explain our long history of corporate scandals (for just a portion of this history, see here and here), but it should not discourage us from continuing to try.

  February 27, 2010 at 9:24 am  Tags: Corporate Law, Current Events  Posted in: Corporate Law, Current Events   Print This Post   3 Comments

The Power of the People

posted by Michelle Harner

On Sunday the Conservative Party in the United Kingdom introduced the concept of a “people’s bank bonus.” Party representatives justified the move by stating, “Taxpayers bailed out the banks, so they deserve a ‘people’s bank bonus’ when the time comes to sell the government shares.” The basic concept is that once Royal Bank of Scotland (government owns 84% stake) and Lloyds (government owns 41% stake) stabilize and recapture market value, the government would offer its shares to the people at a discount rate (see here). Some apparently suggest that the government should even endow the shares to the people (see here).

This announcement is just the latest example of the intense public outrage and related public and political responses to the economic crisis and bank bailouts in the United Kingdom.  Admittedly, factors leading to the economic crisis have outraged people across the globe, but I have been intrigued by the passionate U.K. outcry.   Perhaps it is because many outsiders view people in the United Kingdom as being more reserved and less emotional in the public forum.  That image does not quite fit with the popular U.K. game “Whack a Banker” in which “[y]ou pay 40p to hit as many bankers as you can in 30 seconds as their heads pop up. It’s based on an older game called ‘Whack a Mole’.” (See here.) There also is an online version of the game. (See here; beware, slightly graphic.)

The rally cry of the people encouraged the bank bonus tax announced by the U.K. finance minister in December (see here), additional bonus restrictions that limit the cash component and permit amounts to be clawed back (see here) and a British singer to threaten withholding his own taxes until the government regulated excessive bank bonuses (see here and here). The CEOs of Lloyds, Royal Bank of Scotland and certain other banks have waived their 2009 bonuses. (For an interesting article suggesting that the focus on bonuses is misplaced, see here.) And, according to a recent survey, the U.K. public anger continues to linger. In fact, several companies are hoping to take advantage of public discontent to break into the retail banking market. As I noted in a prior post, it remains to be seen whether any of the noise surrounding the economic crisis will result in long-term change, but it certainly has generated a lot of activity across the pond.

  February 23, 2010 at 5:08 am  Tags: Current Events  Posted in: Uncategorized   Print This Post   2 Comments

Regulating Innovation

posted by Michelle Harner

I was honored last week to attend the Fourth Annual Law & Entrepreneurship Retreat, hosted by Gordon Smith at the BYU Law School. It was a wonderful collection of legal scholars who focus aspects of their teaching and scholarship on legal issues affecting entrepreneurs and innovation. Several of the papers and much of the general discussion considered innovation, particularly whether we can or should attempt to regulate innovation and related risks. The economic crisis provided the general context for this discussion; should we restrict or monitor innovation in the financial industry and, if so, how can we perform those tasks effectively?

I was struck by several things during the conference, including the universal and recurring nature of the innovation conundrum. I realized as we were debating solutions to abuses of credit derivatives that the proposed subject of regulation was novel, but the problem was not. We struggled with governing “the marriage of steam power and iron rail” in the late 1800s (see sample of related text here); it is a habitual problem in the biotech, energy, intellectual property and other fields (see here, here and here); and the problem is not confined to the United States (see here).

The recurring Hobson’s choice lies in the nature of innovation itself—to innovate is to create something new or different. As one commentator observes, “Genuine novelty knows no rules. We cannot reduce to routine what we do not know. Yet of course we cannot resist trying.” (See here at 1.) And innovation is often a very good thing (see here). So the challenge is to mitigate the negative side effects of innovation without stifling it altogether. (For a discussion of the regulation choices and challenges in the financial product context, see here, here and here.) Certainly easier said than done.

  February 21, 2010 at 11:11 am  Tags: Corporate Law, Current Events  Posted in: Uncategorized   Print This Post   6 Comments

Winning the Battle Only to Lose the War?

posted by Michelle Harner

Many incredible and interesting stories have emerged from the economic turmoil of the past few years. One story that has intrigued me since I first read about it in late 2008 is that of five Wisconsin school districts that invested in collateralized debt obligations (CDOs) on a leveraged basis and lost approximately $200 million. The story underscores the confusion surrounding CDOs and the almost blind faith with which investors made investment decisions prior to the crisis. (For one of my prior posts on this story, see here.) For example, the school districts apparently thought they were investing in corporate bonds and did not understand the insurance-like nature of their investment in synthetic CDOs. As the school districts later discovered, however, they actually invested in a pool of credit default swaps that insured against defaults on certain bonds. (For helpful diagrams of synthetic CDOs, see here and click “Profits in Crisis” link in this New York Times article.)

Given the nature of synthetic CDOs, the school districts would make money (from premiums paid by credit risk protection buyers) as long as the underlying bonds were performing. If those bonds defaulted, however, the school districts’ investment would be used to pay the credit risk protection buyers, leaving the districts with nothing. We of course all know what happened, and like many investors who lost everything, the crisis left the school districts in a liquidity crunch, facing budget cuts and looking for answers. As one of the districts’ teachers explained, “I am really worried. . . . If millions of dollars are gone, what happens to my retirement? Or the construction paper and pencils and supplies we need to teach?” (See here.)

The Wisconsin school districts sued Stifel Nicolaus & Co. and Royal Bank of Canada for, among other things, alleged fraud and misrepresentation in connection with the districts’ investments. According to the districts’ complaint, “[T]hey were told that ‘15 Enrons’ would need to happen before the districts would be affected, none of the CDO’s had sub-prime debt, and the investments were ‘safe’ and ‘conservative.’”  (See here.)  At the end of last month, Milwaukee County Circuit Judge William W. Brash III denied Stifel’s and Royal Bank of Canada’s motions to dismiss on all counts. But as one of Stifel’s lawyers noted after the ruling, now the districts have the difficult and expensive task of proving their allegations. (This sentiment was echoed by Stifel’s CEO in an interview on CNBC last week, see here (comments come at end of interview).) Indeed, the litigation has already been very costly for the districts (see here).

So what does this small victory mean for the districts? Do they really have viable claims against Stifel and Royal Bank of Canada, or is this simply a human reaction by the judge to public empathy for the districts? Perhaps it is similar to some of the judicial reaction to the Enron and WorldCom scandals, where courts appeared to lower entry barriers for litigants even though the ultimate standards for liability remained the same. (For a discussion of that reaction, see here.) And if that is the case, at what cost does this victory come? It will be interesting to watch the resolution of this and other crisis-related lawsuits to see if litigants achieve any meaningful relief.

  February 13, 2010 at 3:46 pm  Tags: Current Events  Posted in: Uncategorized   Print This Post   No Comments

The Merits of Merit-Based Pay

posted by Michelle Harner

Yesterday, Bingham McCutchen announced its move to a merit-lockstep compensation scheme. Under the scheme, associates’ base salaries will be determined on a lockstep basis that considers years of experience and hours billed. So if you are a second-year associate who bills 1,900 hours or more, you make $170,000. If you are a second-year associate who bills less than 1,900 hours but 1,500 hours or more, you make $165,000. If you bill less than 1,500 hours, your salary is frozen (see here). Bingham McCutchen’s bonuses, however, will be based on a more individualized merit evaluation. In contrast, firms like Drinker Biddle, Howrey and Orrick are moving to a complete merit-based compensation structure that generally places associates in different tiers tied to individual evaluations. (For a discussion of the difficulties of transitioning to these new schemes, see here.)

In theory, merit-based compensation structures sound great. Consider Howrey’s description of its new procedures: “‘We will expect certain levels of performance and certain levels of experience, and it will be the responsibility of the law firm and the partners that oversee them to make those experiences available to them.’ . . . Associates will be assigned to partners who will be responsible for their development and their individual evaluations.” More mentoring and individualized supervision of associates would enhance not only law firm productivity but also client service, the quality of law firms’ products and the profession generally.

But will merit-based compensation really encourage more meaningful partner/associate dialogue and professional development efforts or just re-emphasize the importance of billable hours? Most firms using merit-based compensation structures consider an associate’s billable hour number as a significant factor in her evaluation. More billable hours do not, however, translate into quality products or meritorious performance (see here and here). In fact, efficiency itself may be among the best indicia of a truly talented associate. Will merit-based compensation structures account for and reward efficiency, or will they encourage greater inefficiency? The answer, I think, depends largely on firm culture and the individual partners performing the evaluations, but I have to say I have my doubts.

  February 10, 2010 at 5:25 pm  Tags: Current Events, Law Practice  Posted in: Uncategorized   Print This Post   14 Comments

Tale of Two CEOs

posted by Michelle Harner

As I mentioned in a previous post, Bank of America and some of its current and former executives, including its former CEO Ken Lewis, are facing tough times. The executives were named as defendants in a scathing complaint filed last week by New York Attorney General, Andrew Cuomo, relating to Bank of America’s 2008 acquisition of Merrill Lynch. And yesterday, Judge Rakoff suggested that he might not approve Bank of America’s latest $150 million deal with the SEC to settle allegations of fraud and misconduct in connection with the Merrill Lynch acquisition. Judge Rakoff expressed his views that the settlement was too small, lacked focus on the individual executives and did provide sufficient oversight of Bank of America’s proposed corporate governance changes.

In contrast to these trying times for Bank of America and its executives, one former Bank of America/Merrill Lynch executive is getting a second chance. John Thain, the former CEO of Merrill Lynch who orchestrated the Bank of America deal and then redecorated his office for a reported $1.2 million, was named as the new CEO of small business lender, CIT. Admittedly, CIT could use a talented turnaround artist at its helm; having just emerged from bankruptcy, CIT has a long way to go. And the markets seem to think Thain is the guy. Time will tell whether Thain can achieve for CIT what he did for NYSE and Merrill Lynch. In the interim, Thain’s new opportunity must add insult to injury on the heels of Bank of America’s and its executives’ latest legal challenges, which stem in part from bonuses that Thain approved for Merrill Lynch employees immediately before the Bank of America acquisition.

  February 9, 2010 at 7:50 am  Tags: Corporate Law, Current Events  Posted in: Uncategorized   Print This Post   No Comments

Corporate Versus Individual Accountability

posted by Michelle Harner

The recent announcements that the SEC reached a new $150 million settlement with Bank of America (see here) and that the New York Attorney General commenced civil litigation against certain current and former Bank of America executives (see here) are an interesting study in corporate versus individual accountability for corporate misconduct. The SEC did not pursue any actions against the individual executives at Bank of America (see here); rather, the SEC’s action and resulting settlement focus on the corporate entity. The Attorney General’s action, on the other hand, focuses on alleged individual misconduct.

The different approaches may be due in part to different legal standards of liability. In general, the SEC must establish intentional misconduct on the part of individuals in this context (see also here); the applicable New York law does not include this type of scienter requirement. (A cynic also might say that the difference relates to public opinion and Andrew Cuomo’s potential campaign for the governor’s office.) Nevertheless, the New York Attorney General’s approach appears to address more directly the concerns expressed by Judge Rakoff when he rejected the SEC’s original $33 million settlement with Bank of America (see also here).

The different approaches also raise an important question regarding whether corporate or individual liability is a more appropriate or effective remedy and deterrent for corporate misconduct. How far do we want to extend the legal fiction of the corporation? How in either situation do we avoid the corporation and its shareholders paying for individual misconduct that harms the corporation and its shareholders (e.g., indemnification)? How do we distinguish between good faith, honest mistakes and reckless, cavalier misconduct? And how do we level appropriate sanctions against individual wrongdoers without deterring other qualified individuals from serving on corporate boards?

These are difficult questions that courts, legislatures and commentators try to balance and address. I am not convinced that we have reached an appropriate equilibrium, and perhaps we never will. But I think we could benefit from acknowledging that corporate misconduct is caused by individuals and that some individual accountability is necessary to deter future misconduct. Notably, that remedy does not need to be a monetary penalty. In fact, public reprimands and temporary and permanent bars could be even more effective because those remedies impact reputation and arguably make it more difficult for the individual to commit similar wrongs in the future. (For a discussion of bars and the SEC’s and courts’ use of them, see here and here.) They also may ameliorate the concern that holding an individual liable for the amount of losses typically associated with corporate misconduct is too punitive. (For other means to address this concern, see here.) As we continue to reflect on and try to learn from the economic crisis of the past few years, I hope we consider alternatives to link more directly corporate misconduct and corporate accountability.

  February 5, 2010 at 8:09 am  Tags: Corporate Law, Current Events  Posted in: Uncategorized   Print This Post   6 Comments

So Young, So Cynical

posted by Michelle Harner

As I mentioned in a previous post, I teach (and really enjoy teaching) Legal Profession. In my prior post, I noted my sense that students resist ethics courses because they view themselves as moral, ethical people who will be moral, ethical lawyers. That trend has continued this semester, but I am also hearing more cynicism about the profession than in the past.

Now, it may be that I am teaching 1Ls this semester, as opposed to 3Ls who simply want to graduate and do not want to stir the pot. (And I have to say that I have a very thoughtful and engaged group of 1Ls.) It may be that law students are questioning their decision to enter the profession in different ways and on different levels than in the past because of the current environment. Indeed, given the amount of money these students invest in their legal education, they must cringe when they read the newspapers—or more likely the Internet—these days. (For recent stories regarding downsizing in the profession, see here, here and here.) Regardless of the reason, the sentiment is striking. I should note, however, that I am not surprised by it given the generally negative public perception of lawyers.

So what type of cynicism am I hearing? We recently were discussing what constitutes lawyer misconduct, a lawyer’s obligation to report the misconduct of colleagues and a lawyer’s obligation to disclose her own misconduct to the client. That last duty always gets them, and we typically discuss in detail the origins of this duty (see here, here and here) and the circumstances that might give rise to the duty basically to tell your client that you made a mistake. In several discussions with my students both in- and outside class, the common questions have been along the lines of: “Well Prof. Harner, this all sounds great in theory, but who actually reports misconduct in the real world? And why would you ever report your own misconduct?” These are very honest and sobering questions.

I do my best to instill in my students the importance of the self-reporting nature of the profession and the value (both personal and professional) to being an ethical, honest lawyer. We discuss the trust and integrity that underscore the lawyer-client relationship and what happens to legal process when that trust is breached. And I think they get all of that. But I also think they are sensitive to life in the real world, and the pressures they will be facing—assuming they can actually get jobs—as associates subject in many respects to the whims and behaviors of more senior lawyers and clients. As one of my students told me in discussing ABC’s new series, The Deep End (see also here), “You know Prof. Harner, the associates always find a happy resolution to ethical dilemmas on television, but I doubt it is really that easy in practice; being ethical and calling a colleague on her misconduct could end your career.”

I think my students are raising valid concerns; these certainly are not new concerns but perhaps they have renewed importance as students are more and more concerned about getting and then keeping jobs. I find that shock therapy helps drive the point home for some students, so I give them many examples of lawyers being disbarred and note the junior associate who now faces sanctions and discipline in connection with the Qualcomm discovery litigation (see here and here). And I hope that when they face that hard decision in practice, they will make the right one.

  February 3, 2010 at 5:50 pm  Tags: Current Events, Ethics  Posted in: Uncategorized   Print This Post   8 Comments

Conflicts and Competitive Advantage

posted by Michelle Harner

This week, Toyota announced a massive recall of some of its most popular models, including Highlander, Corolla, Venza, Matrix and Pontiac Vibe. Specifically, “Toyota has recalled 2.3 million vehicles for sticky accelerator pedals . . . and has shut down sales and production of eight models while it works on a fix.” (See here.) Notably, “[t]he Obama administration said it pressed Toyota to protect consumers who own vehicles under recall and to stop building new cars with the problem.” (See here.) Although I understand and appreciate the administration’s concern for consumer safety, I cannot help also seeing a glaring conflict of interest in the administration’s conduct.

As you might recall, the government owns stock in General Motors and Chrysler—key competitors of Toyota. And consider the following: “GM announced today it will offer interest-free loans and other incentives. In and of itself, this is no big deal, but GM is making the offer exclusively to Toyota owners who may now want to get rid of their vehicles because of the recall involving faulty gas pedals.”  (See here.)

GM’s decision might be good business; companies often seek to capitalize on a competitor’s misfortunes. And I suspect that the administration’s involvement in the Toyota recall was unrelated to GM’s business decision regarding the Toyota incentive plan. But it just does not look good, and it highlights the significant issues with the government intervening in and owning private businesses. (For a more detailed discussion of these issues, see here and here.)

Also, as a follow up on my prior post regarding the General Motors and Chrysler bankruptcies and the government’s decision to grant arbitration rights to dealers who are party to rejected franchise agreements, recent reports suggest that over 1,400 dealers are pursuing their arbitration rights. Chrysler also has agreed to participate in the arbitration program.

  January 29, 2010 at 7:31 am  Tags: Bankruptcy, Current Events  Posted in: Uncategorized   Print This Post   No Comments

Making Money in a Down Economy

posted by Michelle Harner

For the past few years, many businesses have struggled to meet payroll and keep the doors open. But such challenges are not bad news for everyone. At least one group of investors (a/k/a distressed debt investors) has found a way to capitalize on the financial troubles of businesses. In fact, recent reports (see here and here) suggest significant above-market returns for hedge funds that utilize a distressed debt investment strategy (e.g., Avenue Capital Group, Third Avenue Funds, Third Point Funds).

A distressed debt investor basically buys the debt of a troubled company and then flips the debt for a quick profit or seeks returns through a longer investment horizon. Investors that fall in the latter category may simply wait for the debt to be refinanced or cashed out, or they may seek to utilize the leverage associated with the debt instrument upon a default or potential default by the company. In fact, “activist” distressed debt investors may use their distressed debt holdings to influence management decisions (think of Carl Icahn’s letter to CIT bondholders) or gain control of the company through a debt-for-equity exchange or credit bid at an asset sale (think of Carl Icahn’s recent acquisition of Tropicana Entertainment and bid for Trump Entertainment).

The existence of an activist investor in a company’s debt holdings can swiftly change the dynamics of the company’s restructuring negotiations. These investors typically want to achieve their objective at the lowest cost (thereby maximizing their upside), which often conflicts with the objectives of other stakeholders. Conflict can lead to delay, expense, litigation and even liquidation. Many companies, such as Adelphia, Aleris, Foamex, Fairpoint, Lyondell and Tropicana Entertainment, have experienced this type of conflict firsthand.

That being said, hedge funds and private equity firms that typically invest in distressed debt may be a good (or the only) source of funding for troubled companies. And their investment objective (maximizing their upside) is understandable given their obligations to their own fund investors and, let’s be honest, the typical fund fee structure.  So the question then becomes who is or should be protecting the interests of other stakeholders to mitigate conflict and obtain a fair deal for the company? Is management, particularly in a distressed situation, up to the task? Even if it is, management typically does not learn about the presence of a distressed debt investor in the company’s capital structure until it is too late. Notably, this issue is beyond the scope of the proposed Hedge Fund Transparency Act of 2009 and the Financial Regulatory Reform: A New Foundation proposal submitted by the Group of 30. Moreover, proposed revisions to Bankruptcy Rule 2019 (requiring some disclosure of holdings) may help some companies and other stakeholders in the bankruptcy context, but again the information may come too late and only for bankrupt companies. And whether you focus on disclosure, representation or accountability in considering the creditor control issue, you certainly need to target more players than just hedge funds and private equity firms.

  January 27, 2010 at 2:08 pm  Tags: Bankruptcy, Corporate Law, Current Events  Posted in: Uncategorized   Print This Post   No Comments

Time’s Cover Jinx?

posted by Michelle Harner

Sports fans are probably familiar with Sports Illustrated’s cover jinx. As SI itself explains, “Millions of superstitious readers — and many athletes — believe that an appearance on Sports Illustrated’s cover is the kiss of death.” (The SI jinx timeline really is remarkable, see here.)

So, is the same type of jinx emerging with Time’s “Person of the Year” cover? Richard Nixon receives the honor (for a second time) in 1972, and the Watergate scandal breaks in 1973. Ronald Reagan, Bill Clinton and Barack Obama all receive the honor in the year they are elected President of the United States, and their approval ratings drop dramatically in the following, first year of their presidential terms. “You” receive the honor in 2006, and we all know what happens to the bank accounts of many of those honorees in 2007 and 2008. And now just a month after being named Time’s Person of the Year for 2009, Federal Reserve Chairman Ben Bernanke’s confirmation is in question. (See here and here.)

Admittedly, Chairman Bernanke is controversial. Some believe that he pulled the global economy back from the brink, sparing us from further devastation in another depression. Others believe that he leans too closely towards Wall Street and did not do enough to prevent the economic crisis. But what would a “no” vote at this time mean for the economy? Markets like certainty, and at least Chairman Bernanke is a known quantity, particularly when there is no known “Plan B.” In the end, I suspect that all of the political anxiety about the confirmation will fall into the category of being “much ado about nothing,” (see here) and the political rhetoric of the past week will simply be another example of politicians governing with an eye towards the next election, rather than the long-term interests of the country.

  January 24, 2010 at 8:25 am  Tags: Current Events  Posted in: Uncategorized   Print This Post   No Comments

Are Hedge Funds and Private Equity Firms Next?

posted by Michelle Harner

As widely reported, President Obama came out swinging yesterday against large financial institutions. Under the administration’s proposal, commercial banks no longer could invest in or sponsor hedge funds or private equity firms, and the banks would be subject to new leverage caps. This proposal is the most recent step by the administration to try to regulate risk. According to President Obama, “We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers and that could pose a conflict of interest.”  (Full text of speech here.)

As you might imagine, the financial sector is highly critical of the proposal (for example, see here) and some commentators are questioning whether it is feasible given the structure of firms like Goldman Sachs (for example, see here) and the global nature of the economy (and mixed reactions from the U.K. and Europe so far, see here and here). You also have to wonder what is next. Given Tuesday’s election results (for a discussion of resulting policy shifts, see here) and the reappearance of Paul Volcker on the scene, those aspects of the Group of 30 report, Financial Regulatory Reform:  A New Foundation, previously not pushed by the administration might be back on the table. Indeed, the administration previously downplayed the need to restrict the size or activities of large financial institutions:  “We have created them [i.e., large financial institutions], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.” (Comments of Diana Farrell, Deputy Director of the National Economic Counsel.)

If that is the case, will we see a renewed focus on hedge funds and private equity firms? They were among the initial targets of public anger and Congressional inquiry, but little has been done with The Hedge Fund Transparency Act of 2009 or the more aggressive oversight proposed by the Group of 30 report. And will any of these efforts really mitigate financial risk in the market? Even if you believe that some government intervention is necessary, is the government really equipped to perform a meaningful oversight role?

  January 22, 2010 at 8:21 am  Tags: Current Events  Posted in: Current Events   Print This Post   2 Comments

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