Congress and its banking patrons are understandably worried that college graduates might declare bankruptcy without ever trying to repay their student loans. But a better alternative—more consistent with the ideal of shared sacrifice—would be to allow former students to use bankruptcy in cases where the terms of the loans are obviously unreasonable (such as double-digit interest rates) or when loans were made to attend schools whose students have low rates of employment after graduation.
Although not, strictly speaking, a part of the “free market,” cities that enter bankruptcy can have significant effects on how the market is organized to allocate losses. In 2013, Detroit was the largest city ever to seek bankruptcy protection, looking to shed $7 billion of its debt and restore $1.7 billion of city services. Its bankruptcy was seen as a model for other American cities teetering on the edge. Among creditors from whom Detroit sought sacrifices were its own former employees, who depended on pensions and health care benefits the city had years before agreed to pay, and investors who had bought certificates the city issued in 2005. In the fall of 2014, at a trial to confirm or reject a plan for allocating the sacrifices and thereby allowing Detroit to emerge from bankruptcy, both groups claimed they were unfairly burdened. In the end, the investors holding 2005 certificates lost big, but many retirees had their pensions trimmed considerably, along with costly reductions in their health care benefits.
Yet one very large and prosperous group was left untouched. The mostly white citizens of neighboring Oakland County, far richer than those in mostly black Detroit, were not called upon to share the pain. Oakland County was one of the wealthiest counties in the United States, among counties with a million or more residents. In fact, Greater Detroit, which includes the Oakland County suburbs, ranked among the nation’s top financial centers and its top four centers of high-technology employment, and it was the second-largest source of engineering and architectural talent. The median household in the region earned close to $50,000 a year. The median household in Birmingham, Michigan, just across Detroit’s city limits, earned more than $99,000 in recent years; in nearby Bloomfield Hills, still within the Detroit metropolitan area, the median was nearly $148,000. Detroit’s upscale suburbs had excellent schools, rapid-response security, and resplendent parks.
Forty years earlier, Detroit had a mixture of wealthy, middle class, and poor. But between 2000 and 2010, Detroit lost a quarter of its population as middle-class and white residents fled to the suburbs. By the time of the bankruptcy, Detroit had become almost entirely poor. Its median household income was about $26,000. More than half of its children were impoverished. That left it with depressed property values, abandoned neighborhoods, empty buildings, and dilapidated schools. Forty percent of its streetlights didn’t work. Two-thirds of its parks had closed within the previous five years. In 2014, monthly water bills in Detroit were running 50 percent higher than the national average, and officials had begun shutting off the water to 150,000 households whose occupants couldn’t pay them.
If the official boundaries had encompassed both Oakland County and Detroit, Oakland’s more affluent citizens (as well as their banks and creditors) would have had some responsibility to address Detroit’s problems, and Detroit would likely have had enough money to pay all its bills and provide its residents with adequate public services. But requiring that the poor inner city take care of its compounded problems by itself got the whiter and more affluent suburbs, and the banks that served them, off the hook. In fact, the mere whiff of suggestion that they might have some responsibility invited righteous indignation. “Now, all of a sudden, they’re having problems and they want to give part of the responsibility to the suburbs?” scoffed L. Brooks Patterson, the Oakland County executive. “They’re not gonna talk me into being the good guy. ‘Pick up your share?’ Ha ha.”
Buried within the staid laws of bankruptcy are fundamental political and moral questions. Who are “we” and what are our obligations to one another? Is American Airlines just its shareholders and executives, or its employees as well? Is a financial crisis that brings down both big banks and homeowners a common problem or two distinct problems? When graduates cannot repay their student debts, do lenders have any responsibilities? Does society, which enjoys many of the benefits of a well-educated workforce? Are Detroit, its public employees, retirees, and poor residents the only ones who should make sacrifices when “Detroit” can’t pay its bills, or does the relevant sphere of responsibility include Detroit’s affluent suburbs, to which many of the city’s wealthier residents fled as the city declined, as well as the banks?
Bankruptcy and contracts conveniently mask such questions. It is far easier to assume that one party to an agreement is simply unable to fulfill its obligation to another party, and the only pertinent question therefore is how to make amends. The “free market” requires nothing more—while the underlying mechanism remains unexamined.
8
The Enforcement Mechanism
The fifth building block of the market is enforcement. Property must be protected. Excessive market power must be constrained. Contractual agreements must be enforced (or banned). Losses from bankruptcy must be allocated. All are essential if there is to be a market. On this there is broad consensus. But decisions differ on the details—what “property” merits protection, what market power is excessive, what contracts should be prohibited or enforced, and what to do when a party to an agreement is unable to pay. The answers that emerge from legislatures, administrative agencies, and courts are not necessarily permanent; in fact, they are reconsidered repeatedly through legislative amendment, court cases overturning or ignoring precedent, and changes in administrative laws and rules.
Every juncture in this process offers opportunities for vested interests to exert influence. And they do, continuously. They also exert influence on how all of this is enforced. In many respects, the enforcement mechanism is the most hidden from view because decisions about what not to enforce are not publicized; priorities for how to use limited enforcement resources are hard to gauge; and the sufficiency of penalties imposed are difficult to assess. Moreover, wealthy individuals and corporations that can afford vast numbers of experienced litigators have a permanent, systemic advantage over average individuals and small businesses that cannot.
Begin with the issue of liability—who’s responsible when something goes wrong. Entire industries with notable political clout have gained immunity from prosecution. In 1988, for example, the pharmaceutical industry persuaded Congress to establish the National Vaccine Injury Compensation Program, effectively shielding vaccine manufacturers and doctors from liability for vaccines that have harmful side effects. Gun manufacturers are also shielded from liability for any mayhem the use of their products creates. In 2004, after a court awarded the relatives of eight people shot by a sniper near Washington, D.C., $2.5 million from the maker and seller of the rifle used in the shootings, the National Rifle Association went into action. In 2005, Congress enacted the Protection of Lawful Commerce in Arms Act, which sharply limited the liability of gun manufacturers, distributors, and dealers for any harm caused by the guns they sold.
Not all industries have been as successful. Decades ago, the automobile industry dubbed cars safe and seat belts unnecessary, and the tobacco industry promoted the alleged health benefits of cigarettes. After tens of thousands of deaths and hundreds of millions of dollars in damage awards to victims, both industries began changing their tunes. Today, cars are safer, and fewer Americans smoke.
Individual companies with deep pockets can still avoid responsibility by persuading friendly congressional patrons and regulators to go easy on them. Long before Japan’s Fukushima Daiichi plant contaminated a large swath of the Pacific Ocean with radioactive material in 2011, for example, General Electric marketed the Mark 1 boiling water reactor used in the plant (as well as in sixteen American nuclear plants), a cheaper alternative to competing reactors because it used a smaller and less expensive containment structu
re. Yet the dangers associated with the Mark 1 reactor were well known. In the mid-1980s, Harold Den an official with the Nuclear Regulatory Commission, warned that Mark 1 reactors had a 90 percent probability of bursting if their fuel rods overheated and melted in an accident. A follow-up report from a study group convened by the commission found that “Mark 1 failure within the first few hours following core melt would appear rather likely.”
Why hasn’t the commission required General Electric to improve the safety of its Mark 1 reactors? One factor may be General Electric’s formidable political and legal clout. In the presidential election year of 2012, for example, its executives and PACs contributed almost $4 million to political campaigns (putting it sixty-third out of 20,766 companies), and it spent almost $19 million lobbying (the fifth-highest lobbying tab of 4,372 companies). Moreover, 104 of its 144 lobbyists had previously held government posts.
Similarly, the national commission appointed to investigate the giant oil spill in the Gulf of Mexico in 2010 found that BP failed to adequately supervise Halliburton Company’s installation of the deep-water oil well—even though BP knew Halliburton lacked experience in testing cement to prevent blowouts and hadn’t performed adequately before on a similar job. In short, neither company had bothered to spend enough to ensure adequate testing of the cement. Meanwhile, the Minerals Management Service of the Department of the Interior (now renamed the Bureau of Ocean Energy Management, Regulation, and Enforcement) had not adequately overseen the oil and oil-service companies under its watch because it had developed cozy relationships with them. The revolving door between the regulator and the companies it was responsible for overseeing was well oiled. Similarly, the National Highway Traffic Safety Administration has shown itself more eager to satisfy the needs of the automobile industry than to protect drivers and passengers. For decades the industry’s powerful allies in Congress, led by Michigan congressman John Dingell, ensured that would be the case.
Or consider the New York branch of the Federal Reserve Board, which has lead responsibility to monitor Wall Street banks. Even after the Street’s near meltdown, the banks’ legal prowess and political clout reduced the ardor of examiners from the New York Federal Reserve Bank. Senior Fed officials instructed lower-level regulators to go easy on the big banks and not pry too deeply. In one meeting that came to light in 2014, a banker at Goldman Sachs allegedly told Fed regulators that “once clients are wealthy enough certain consumer laws don’t apply to them.” Afterward, when one of the regulators who attended the meeting shared with a more senior colleague her concern about the comment, the senior colleague told her, “You didn’t hear that.”
Another technique used by moneyed interests to squelch a law they dislike is to ensure Congress does not appropriate enough funds to enforce it. For example, the West, Texas, chemical and fertilizer plant that exploded in April 2013, killing fourteen and injuring more than two hundred, had not been fully inspected for almost three decades. The Occupational Safety and Health Administration (OSHA) and its state partners had only 2,200 inspectors charged with protecting the safety of 130 million workers in more than eight million workplaces. That came to about one inspector for every 59,000 workers. Over the years, congressional appropriations to OSHA had dropped. The agency had been systematically hollowed out. So, too, with the National Highway Traffic Safety Administration, charged with automobile safety. Its $134 million budget for 2013, supposedly enough to address the nation’s yearly toll of some 34,000 traffic fatalities, was less than what was spent protecting the U.S. embassy in Iraq for three months of that year.
The Internal Revenue Service (IRS) has also been hollowed out. Despite an increasing number of wealthy individuals and big corporations using every tax dodge imaginable—laundering money through phantom corporations and tax havens and shifting profits abroad to where they’d be taxed least—the IRS budget by 2014 was 7 percent lower than it had been as recently as 2010. During the same period, the IRS lost more than ten thousand staff—an 11 percent reduction in personnel. This budget stinginess didn’t save the government money. To the contrary, less IRS enforcement means less revenue. For every dollar that goes into IRS enforcement, an estimated $200 is recovered of taxes that have gone unpaid. Less enforcement does, however, reduce the likelihood that wealthy individuals and big corporations would be audited.
In a similar vein, after passage of the Dodd-Frank financial reform law, Wall Street made sure that government agencies charged with implementing it did not have the funds to do the job. As a result, fully six years after the near meltdown of Wall Street, some of Dodd-Frank—including much of the so-called Volcker Rule restrictions on the kind of derivatives trading that got the Street into trouble in the first place—was still on the drawing board.
When an industry doesn’t want a law enacted but fears a public backlash if it openly opposes the proposed law, it quietly makes sure that there aren’t enough funds to enforce it. This was the case when the food industry went along with the Food Safety Modernization Act, which became law in 2011, after thousands of people were sickened by tainted food. Subsequently, the industry successfully lobbied Congress to appropriate so little to enforce it that it has been barely implemented.
Defanging laws by hollowing out the agencies charged with implementing them works because the public doesn’t know it’s happening. The enactment of a law attracts attention. There might even be a signing ceremony at the White House. News outlets duly record the event. But the defunding of the agencies supposed to put the law into effect draws no attention, even though it’s the practical equivalent of repealing it.
An even quieter means of rescinding laws is to riddle them with so many loopholes and exceptions that they become almost impossible to enforce. Typically, such holes are drilled when agencies attempt, through rule making, to define what the laws mean or prohibit. Consider, for example, the portion of the Dodd-Frank law designed to limit bets on the future values of commodities. For years Wall Street has profitably speculated in futures markets—food, oil, copper, other commodities. The speculation has caused prices to fluctuate wildly. The Street makes bundles from these gyrations by betting, usually correctly, which way prices will go, but they have raised costs for consumers—another hidden redistribution from the middle class and poor to the wealthy. Dodd-Frank instructed the Commodity Futures Trading Commission (CFTC) to come up with a detailed rule reducing such betting. The commission thereafter considered fifteen thousand comments, largely generated by and from the Street. The agency also undertook numerous economic and policy analyses, carefully weighing the benefits to the public of any such regulation against its costs to the Street.
After several years, the commission issued its proposed rule, including some of the loopholes and exceptions the Street sought. But Wall Street still wasn’t satisfied. So the commission agreed to delay enforcement of the new rule for at least a year, allowing the Street more time to voice its objections. Even this wasn’t enough for the big banks. Its lawyers then filed a lawsuit in the federal courts, seeking to overturn the rule—arguing that the commission’s cost-benefit analysis wasn’t adequate. It was a clever ploy, since costs and benefits are difficult to measure. And putting the question into the laps of federal judges gave the Street a significant tactical advantage because the banks had almost infinite funds to hire so-called experts (many of them academics who’d say just about anything for the right price) using elaborate methodologies to show the CFTC had exaggerated the benefits and underestimated the costs.
It was not the first time the big banks had used this ploy. In 2010, when the Securities and Exchange Commission tried to implement a Dodd-Frank requirement making it easier for shareholders to nominate company directors, Wall Street sued the SEC. It alleged that the commission’s cost-benefit analysis for the new rule was inadequate. A federal appeals court—inundated by the banks’ lawyers and hired “experts”—agreed. That put an end to Congress’s effort to give shareholders more power in nominating company d
irectors, at least temporarily.
Obviously, government should weigh the costs and benefits of every significant action it takes. But big corporations and large banks have an inherent advantage in the weighing: They can afford to pay for experts and consultants whose studies will invariably measure costs and benefits in the way big corporations and large banks want them to be measured. Few, if any, other parties to regulatory proceedings have pockets remotely as deep to pay for studies nearly as comprehensive to back up their own points of view.
In addition, when it comes to regulating Wall Street, one overriding cost does not make it into any individual weighing: the public’s mounting distrust of the entire economic system, a distrust generated in part by the Street’s repeated abuses. Wall Street’s shenanigans have convinced a large portion of America that the economic game is rigged.
Capitalism, alas, depends on trust. Without trust, people avoid even sensible economic risks. They also begin thinking that if the big guys can get away with cheating in big ways, small guys like them should be able to get away with cheating in small ways—causing even more people to distrust the economic system. Moreover, people who believe the game is rigged are easy prey for political demagogues with fast tongues and dumb ideas.
Saving Capitalism Page 8