If the only goal were economic efficiency, it would make little sense to ban insider trading and no sense to define it as strictly as it is defined in Europe. The faster financial markets adjust to all available information, confidential or not, the more efficient markets become. So-called high-frequency trading, which lets certain traders know a fraction of a second before everyone else where money is going, makes the market even more efficient, although it gives these fast traders a large advantage over everyone else. If insider trading were defined broadly to prohibit all trades on information not equally available to all traders, such efficiencies would be lost. Yet systemic inequalities like these strike many people as unfair, as if the dice were loaded, and they undermine the confidence of small investors in the integrity of financial markets, which is why many people might be uncomfortable to learn that inside information is the “coin of the realm” on Wall Street.
Small traders aren’t the only ones disadvantaged when insiders trade on confidential information. Employees who invest part of their paychecks into the stock market through corporate-sponsored pension funds are also harmed when, for example, the funds charge them higher than normal fees and then rebate the excess to the corporation in the form of discounts on other financial services. The information the corporation does not share with its employees amounts to a conflict of interest, tantamount to fraud. But this practice has been found to be perfectly legal. Here again, the underlying issue is not whether the free market is superior to government but how government officials decide how the market is to be organized and which outside groups have the most influence over such decisions. And once more, the pattern in recent decades has been for large corporations, Wall Street banks, and wealthy individuals to have ever-greater clout.
To take another example, the law has long held that a contract will not be enforced if a party has been coerced into making an agreement. This is also a moral principle: Parties to an agreement should not be forced into making promises against their will. No one should be obligated to keep, and the law will not enforce, a contract entered into at gunpoint.
But how is “coercion” defined? Buyers and sellers have no real alternatives when a large corporation has locked up a market through its intellectual property, control over standards or network platforms, and armies of lawyers and lobbyists. Under such circumstances, contracts are inherently coercive, or so it might seem. And contracts today are often filled with conditions (likely in small print) that deny employees, borrowers, and customers any meaningful choice. Nonetheless, large corporations possess the political and legal clout to make sure they’re enforced.
One contractual provision that has become common in recent years is the requirement to take any grievances or claims of being denied basic rights to an arbitrator, often picked by the company, and accept the arbitrator’s verdict without appealing it to a court. This provision obviously fixes the game in favor of large corporations that insert such clauses into their standard contracts. According to a recent study, employees complaining of job discrimination got relief only 21 percent of the time when their complaints went to arbitration but 50 to 60 percent of the time when they went to court.
Similarly, many popular Internet sites require users to agree to terms of service that prohibit them from suing (individually or within class actions) the owners of the site if something goes awry. On some sites, users click on an icon that confirms they accept such terms and conditions, which they almost never read and about which they have no choice anyway. Other sites provide only a link to the terms, with which visitors are presumed to agree merely by using the site. In consequence, many users subsequently discover they have given up legal rights they assume they had. For example, when consumers sued several hotels and online travel agencies for allegedly conspiring to fix hotel room prices, lawyers for Travelocity, one popular site, successfully defended the company in court by arguing that consumers who used its site could not participate because they had “agreed” not to sue.
Such clauses can even prevent small businesses from alleging that large businesses with whom they’ve contracted have monopolized an industry, thereby giving the small businesses little or no choice but to accept the contract. When the owner of a small restaurant, Italian Colors, located in Oakland, California, accused American Express of abusing its monopoly power by imposing unreasonable rates on the restaurant, American Express responded that such a claim was prohibited by the mandatory arbitration clause in the contract Italian Colors had signed with it. The case went to the Supreme Court, and in 2013 a majority of the court (including all of the court’s Republican appointees) agreed with American Express. But as Justice Elena Kagan argued in dissent, the court’s decision puts small businesses in an impossible bind and gives large monopolists an easy out. “The monopolist gets to use its monopoly power to insist on a contract effectively depriving its victims of all legal recourse.”
Purchasers who check “I accept” might even relinquish their privacy rights. If you want Apple to store personal data on its iCloud, you must first agree to its terms of service, which stipulate:
You are solely responsible for maintaining the confidentiality and security of your Account and for all activities that occur on or through your Account….Provided we have exercised reasonable skill and due care, Apple shall not be responsible for any losses arising out of the unauthorized use of your Account resulting from you not following these rules.
In other words, if a hacker grabs compromising photos of you off iCloud and distributes them around the world, that’s too bad. Apple isn’t responsible. Technically, you had a choice because you didn’t have to agree to Apple’s terms of service. As a practical matter, you didn’t have a choice because every other service has the same terms.
The new contracts do not result from negotiations between two parties with roughly equal bargaining power. They are faits accomplis, emanating from giant corporations that have the power to demand acceptance. Mortgage applicants are required to sign a small mountain of bank conditions to qualify for a loan, even though they may thereby forfeit their right to go to court alleging predatory lending practices. Lower-income borrowers must agree to double-digit fees and interest rates if they fail to pay on time, even though they rarely know they’re accepting those terms. Students seeking college loans have no choice but to waive certain claims. Small-business franchisees must sign agreements setting forth their obligations in such detail that parent corporations can close them down for minor violations in order to resell the franchises at high prices to new owners.
State and federal lawmakers once sought to protect vulnerable consumers, employees, and borrowers by setting limits on certain contractual terms large corporations and finance companies can demand. But in recent years, those limits have been whittled back under political pressure from corporations and banks. For example, lawmakers in several states have increased interest rates lenders can charge on personal loans utilized by millions of low-income borrowers, resulting in installment loans now carrying rates of up to 36 percent. It’s not unusual for borrowers who want a $100 to $500 advance on an upcoming paycheck to agree to repay within a few weeks—at an annualized interest rate of 300 percent or more. Citigroup’s OneMain Financial unit, one of the leading lenders making these types of loans, has been hugely profitable as a result, which explains why Citigroup and similar lenders have been pouring money into state legislative races. “There was simply no need to change the law,” Rick Glazier, a North Carolina legislator who opposed raising interest-rate limits there, told The New York Times. “It was one of the most brazen efforts by a special interest group to increase its own profits that I have ever seen.”
Meanwhile, employees of large corporations often have to sign noncompete clauses prohibiting them from working for rival companies, thereby reducing the employees’ future job prospects. (California and North Dakota bar such clauses except in limited circumstances.) Their job prospects are further reduced when their employers make antipoac
hing agreements with competitors. In 2014, for example, a federal judge found that Silicon Valley’s tech companies engaged in “an overarching conspiracy” against their own employees by agreeing not to poach one another’s engineers. Court papers showed that in 2005, when Google sought to hire a group of Apple engineers, Steve Jobs, Apple’s CEO, threatened, “If you hire a single one of these people, that means war.” Not only did Google back down, but Jobs even got Google to fire one of its recruiters for attempting to hire from Apple. Apologists for noncompete clauses and nonpoaching agreements say employees have the same bargaining power as employers. That is rarely the case.
When large corporations have disproportionate power—not only over what’s sold, but also over the rules for deciding what contracts are permissible and enforceable by law—those who are relatively powerless have no choice. The “free market” is not, in this sense, free. It offers no practical alternative.
7
The New Bankruptcy
On the day Trump Plaza opened in Atlantic City in 1984, Donald Trump stood in a dark topcoat on the casino floor celebrating his new investment as the finest building in the city and possibly the nation. Thirty years later, the Trump Plaza folded, leaving some one thousand employees without jobs. Trump, meanwhile, was on Twitter claiming he had “nothing to do with Atlantic City” and praising himself for his “great timing” in getting out of the investment.
In America, people with lots of money can easily avoid the consequences of bad bets and big losses by cashing out at the first sign of trouble. The laws protect them through limited liability and bankruptcy. But workers who move to a place like Atlantic City for a job, invest in a home there, and build their skills have no such protection. Jobs vanish, home values plummet, and skills are suddenly irrelevant. They’re stuck with the mess. Bankruptcy was designed so people could start over. But these days, the only ones starting over with ease are big corporations, wealthy moguls, and Wall Street, who have had enough political clout to shape bankruptcy law to their needs.
Bankruptcy is the fourth basic building block of the market. It reflects a trade-off between competing goals, as do the other market rules. Contracts depend on a mechanism for dealing with failures to pay what’s due. If purchasers, debtors, and borrowers are too easily let off the hook, they may be just as careless about future obligations they enter into—and that carelessness may be infectious. (Such moral hazard can even affect big Wall Street banks.) Yet if those who can’t pay their debts are locked away in prison or otherwise punished (as was typically the case in the mid-nineteenth century), they may have no way of earning back the money needed to repay what they owe.
This can be true of entire nations: Those with crippling debt obligations may sink further into the hole, plunging their entire societies into deeper economic and social crisis (many historians argue that German reparations after World War I facilitated the rise of Nazism). In the late nineteenth century, when America’s giant railroad companies had gotten so deep in hock that they couldn’t repay their debts, creditors threatened to tear up the railroads’ tracks and sell them as scrap metal. Cunning businessmen figured that the creditors would do better if they agreed to reduce the amounts of their claims in order to keep the railroads running, thereby giving the railroad companies revenue to pay off most if not all of what they owed.
Bankruptcy is the system used in most capitalist economies for finding the right balance—allowing debtors to reduce their IOUs to a manageable level while spreading the losses equitably among all creditors, under the watchful eye of a bankruptcy judge. The central idea is shared sacrifice—between debtors and creditors as a whole, and among the creditors. Here again, the mechanism requires decisions about all sorts of issues, and these decisions are often hidden in court decisions, agency directives, and the subclauses of legislation. For example, who gets to use bankruptcy, and for what types of debts? What’s an equitable allocation of losses among creditors? And what happens when bankruptcy isn’t available? These questions and hundreds of others related to them have to be answered somehow. The “free market” itself doesn’t offer solutions. Most often, powerful interests do.
The U.S. Constitution (article I, section 8, clause 4) authorizes Congress to enact “uniform Laws on the subject of Bankruptcies throughout the United States,” and Congress has done so repeatedly—in 1800, 1841, 1867, 1874, 1898, 1938, 1978, 1994, and 2005. Wall Street banks and giant credit card companies have played major roles in formulating the most recent iterations, as have major corporations. (The credit card industry spent more than $100 million lobbying the 2005 bill; Wall Street bankers didn’t need to spend quite as much because their formidable campaign contributions had already guaranteed them a major seat at the table.)
Over the last two decades, every major U.S. airline has been through bankruptcy at least once, usually in order to renege on previously agreed-upon labor union contracts. Under the bankruptcy code (again, largely crafted by credit card companies and bankers), labor contracts stipulating workers’ pay have a relatively low priority when it comes to who gets paid off first. That means even the threat of bankruptcy can be a potent weapon for getting union members to sacrifice wages already agreed to. In 2003, American Airlines CEO Don Carty used such a threat to wring almost $2 billion of concessions from American’s major unions. Carty preached the necessity of “shared sacrifice” but failed to disclose that he had secretly established a supplemental executive retirement plan whose assets, locked away in a trust, couldn’t be touched in the event of bankruptcy. When Carty resigned he walked off with close to $12 million, courtesy of the secret plan.
Despite employee concessions, American slipped into bankruptcy in 2011. The corporation then promptly rejected what remained of its former labor agreements and froze its employee pension plan. On emerging from bankruptcy in 2013, American’s creditors were fully repaid, with interest. Even the company’s shareholders came out of bankruptcy richer than they went in. (American’s stock rose even further after its merger with US Airways later that year.) To top it off, Tom Horton, the CEO who had ushered the firm through bankruptcy, received a severance award valued at more than $19.9 million. Everyone came out ahead—except for American’s employees, who, even they retained their jobs, had lost much of their pay and benefits. So much for “shared sacrifice.”
The granddaddy of all failures to repay occurred in 2008, when, as noted, Wall Street nearly melted down. The Street’s biggest banks had bought hundreds of billions of dollars’ worth of risky products, such as subprime mortgages, collateralized debt obligations, and mortgage-backed securities. Although the banks sold many of these off to unwary investors, they also kept many on their books at full value. When the debt bubble exploded, the banks and many investors found themselves with near worthless IOUs. Some commentators (including yours truly) urged that the banks be forced to grapple with their problems in bankruptcy. That was not to be the case. When Lehman Brothers went into bankruptcy in September 2008—by far the largest bankruptcy in history, with more than $691 billion of assets and far more in liabilities—the event so shook the Street that Henry Paulson, Jr., the outgoing secretary of the Treasury, persuaded Congress to authorize several hundred billion dollars of funding to protect the other big banks. The banks also received an estimated $83 billion of low-interest loans from the Federal Reserve. Paulson and his successor at the helm of the Treasury Department, Tim Geithner, didn’t explicitly state that big banks were too big to fail. They were, rather, too big to be reorganized under bankruptcy.
The real burden of Wall Street’s near meltdown fell on small investors and homeowners. As home prices plummeted, many homeowners found themselves owing more on their mortgages than their homes were worth and unable to refinance. Yet Chapter 13 of the bankruptcy code (whose drafting was largely the work of the financial industry) prevents homeowners from declaring bankruptcy on mortgage loans for their primary residence. When the financial crisis hit, some members of Congress, led by Illinois sen
ator Dick Durbin, tried to amend the code to allow distressed homeowners to use bankruptcy. That would give them a powerful bargaining chip for preventing the banks and others servicing their loans from foreclosing on their homes. If the creditors didn’t agree, their cases would go to a bankruptcy judge, who presumably would reduce the amount to be repaid rather than automatically force people out of their homes.
The bill passed the House, but when in late April 2009 Durbin offered his amendment in the Senate, the financial industry flexed its muscles to prevent its passage, arguing that it would greatly increase the cost of home loans. (No convincing evidence showed this to be the case.) The bill garnered only forty-five Senate votes, even though Democrats were in the majority. Partly as a result, distressed homeowners had no bargaining power. More than five million of them lost their homes, and by 2014 another two million were near foreclosure. So much, again, for shared sacrifice.
Another group of debtors who cannot use bankruptcy to renegotiate their loans are former students laden with student debt. In the disappointing jobs recovery following the Great Recession, many with college degrees found themselves unable to find work but burdened with high levels of student debt. By 2014, according to the Federal Reserve Bank of New York, student loans constituted 10 percent of all debt in the United States, second only to mortgages and higher than auto loans (8 percent) and credit card debt (6 percent). But the bankruptcy code does not allow student loan debts to be worked out under its protection. If debtors cannot meet their payments, therefore, lenders can garnish their paychecks. (If people are still behind on their student loan payments by the time they retire, lenders can even garnish their Social Security checks.) The only way graduates can reduce their student debt burden, according to a 1998 law enacted at the behest of the student loan industry, is to prove in a separate lawsuit that repayment would impose an “undue hardship” on them and their dependents. This is a stricter standard than bankruptcy courts apply to gamblers seeking to reduce their gambling debts.
Saving Capitalism Page 7