On financial reform, it’s not merely that the big banks opposed the Dodd-Frank bill, but there was absolutely no counter-lobbying from firms in the non-financial economy in favor of it. And that’s not to say that Dodd-Frank was the greatest thing since sliced brad, but there were no proposals coming out of corporate America for any financial regulatory overhaul of any kind. Yet clearly something went badly awry in 2007-2008. But the business class united behind TARP, then united to oppose any regulatory reforms, and is now united against any return to pre-Bush levels of taxation on rich people.
During the financial reform debate there was no push by the corporate sector to reform the broken financial sector. I’ve put a bit of thought into why this might be. A few ideas, non-conclusive:
Financialization of the Corporate Sector
This graph, from the book Financialization and Strategy: Narrative and Numbers (authors: Froud, Sukhdev, Leaver, Williams, 2006), is from a chapter that is an extensive case study of the “financialization” of General Electric. It shows how General Electric derived a growing amount of revenue from its financial activities:
I talked more about GE, this business model, and the bailouts in this post. That money came in from a very active business line in the subprime loan business during the housing bubble, among many other activities. As Froud et al point out, their capital markets business structure was dependent on a form of ratings agency arbitrage, where the financial market part of the business piggybacked onto the industrial and manufacturing base’s excellent AAA credit rating (“This solid industrial base is the basis for GE’s triple- A credit rating, which allows GE Capital to borrow cheaply the large sums of money that it lends on to consumers and commercial customers…”). Regulators, analysts and investors look at the boring store in front selling light bulbs, while the real money is in the casino running out of the back room.
AIG did a very similar thing, where it used the excellent credit rating the Ratings Agencies gave its boring insurance business to take a massive position in the credit default swap market. This gave them a huge advantage in posting collateral, fending off regulation, and duping investors. I wonder if anyone else does this?
Here’s a promotional document for potential clients from Koch Supply and Trading, LP which states:
Koch Supply & Trading companies are subsidiaries of one of the world’s largest privately held companies, Koch Industries, Inc., and backed by the strong credit rating of Koch Resources, LLC.
KS&T companies are significant suppliers, traders and financial market makers of many commodities. KS&T’s affliated companies include a diverse group of global businesses that operate in most industrial commodity sectors….
Why Koch Supply & Trading?….[We are] Backed by credit rating higher than 98 percent of rated energy companies.
So if a sensible person looked at the financial crisis and thought that the ratings agencies needed to be reformed lest they hand out huge regulatory arbitrages, that off-balance sheet shenanigans should be fixed, and that the derivatives market could use some transparency and sunlight, and then wondered why the Tea Party was being funded to treat sensible financial reform as a Road to Serfdom boot stamping on a human face forever event, there’s one clue.
Financial Innovation as Corporate Capital Structure Arbitrage
That’s even before we get to derivatives themselves acting as a capital structure arbitrage, using the 2005 bankruptcy “reform” bill as a wedge to juke unsecured creditors. As law professor Stephen Lubben told me:
[Konczal] So it sounds, all things equal, you would prefer to make a regular contract into a derivatives contract after 2005.
[Lubben] Yes, and we saw some things change after 2005. Supply agreements started to morph into swaps or another forms of derivative to take advantage of the bankruptcy exemptions. You see this especially with utility contracts. So a manufacturer’s got some sort of contract with the utility to provide electricity or natural gas. Post 2005, the utility decides it is going to rewrite that contract into an electricity swap or a natural gas swap, basically move it out of the bankruptcy code.
Is it useful to think of this as some sort of capital structure arbitrage by structuring normal contracts as derivatives?
Well, first off from a bankruptcy person’s perspective, if you convert something that is a normal contract into a derivative you are putting more risk of loss onto the remaining unsecured creditors because you’ve jumped ahead in line. That itself is a kind of arbitrage or a wealth transfer from the remaining counterparty to the derivative counterparty.
And since they have this super-priority status, they may have gained an edge in terms of pricing and things like that. And who are the unsecured creditors left behind? The obvious people are employees with unpaid wage claims. The other one are tort creditors. So there is a wealth transfer going on there.
This gives an example of how financial sector innovation gives corporations an important edge they are unlikely to want to give up, an edge that is debatable in value but important in distributional effects and amplifying agency problems.
Big Finance and Biggest Finance
There was one point of opposition. I tried to get people to focus on the rage of the 1.5% class, or the idea that the people fighting the hardest for financial reform were those in finance who were one level underneath the elite sell-side firms. People making $250,000/year, not those making $2 million/year. Since then I’ve been told $250,000 is the new struggling middle class (and $50,000 for a teacher is the new Robber Baron), so I suppose it makes sense that they’d fight the hardest.
68% of Chartered Financial Analyst (CFA) holders (think super-MBA for Finance) approve or strongly approve of the Volcker Rule at the time it was being debated. The CFA Institutional Centre for Financial Market Integrity sponsored a study of derivatives regulation, U.S. Financial Regulatory Reform: The Investors’ Perspective, a blue-ribbon panel of financial reforms, that suggested: “Standardized derivatives should trade on regulated exchanges and clear centrally, OTC trading in derivatives should be strictly limited and subject to robust federal regulation…The United States should lead a global effort to strengthen and harmonize derivatives regulation.” Republicans fought any-and-all derivatives regulation. This is strong stuff, but then again look at the title – financial reform from the investor’s perspective, not Wall Street’s perspective.
The same CFA Institute has been going to the line fighting for proxy plans against the Chamber of Commerce (Kurt Schacht, managing director at CFA Institute: “The important test for lawmakers will be whether they can hold the line for these important investor protections. We expect that banking and other special interests will do their level best to strip many of these important protections from the final bill”). They’d be surprised to learn that people fighting for investor rights are the next union goon slur.
Elites, Doing Their Thing
Speculation: There’s a critique of the regulators and key decision makers during the crisis that invokes cultural capital and the idea that regulators are socialized with Wall Street in a way that it is difficult for them to exercise any type of power over them, to see their interests in conflict. I wonder if the same is true for the corporate sector. As the firm goes global, and as the white-collar workforce is broken by computerization and globalization, more and more elite corporate positions will be filled by those leaving Wall Street. (Has this already happened? Data/Studies?) If so, you’ll see an even more lucrative revolving door between corporate elites and financial elites. As such, any natural checks to financial sector power coming from the corporate market space is less likely to happen.