Saving Capitalism

by Robert B. Reich

  Tally up these costs and it’s a whopper. Wall Street has blanketed America in a miasma of cynicism. Most Americans still believe, with some justification, that the Street got its taxpayer-funded bailout without strings in the first place because of its political clout, which was why the banks were not required to renegotiate the mortgages of Americans who, because of the collapse brought on by the Street’s excesses, remained underwater for years. It’s why taxpayers did not get equity stakes in the banks they bailed out nearly as large, in proportion, as Warren Buffett got when he helped bail out Goldman Sachs. When the banks became profitable again, taxpayers did not reap many of the upside gains. We basically just padded their downside risks.

  The Street’s political clout is not unrelated to the fact that top bank executives who took great risks or overlooked excessive risk taking retained their jobs, evaded prosecution, avoided jail, and continued to rake in vast fortunes. And why the Dodd-Frank Act, intended to avoid another financial crisis, was watered down and the rules to implement it were filled with loopholes big enough for Wall Street executives to drive their Ferraris through. The costs of such cynicism have leached deep into America, contributing to the suspicion and anger that have subsequently consumed American politics.

  Just as such litigation over agency rules waters them down, so too do fines that are so small, and settlements so mild, as to have the practical effect of repealing inconvenient laws. Consider JPMorgan Chase, the largest bank on the Street with the deepest pockets to dabble in politics and protect its interests with a squadron of high-priced legal talent. In 2012, the bank lost $6.2 billion by betting on credit default swaps tied to corporate debt and then lied publicly about the losses. It later came out that the bank paid illegal bribes to get the business in the first place. That same year, the bank was accused of committing fraud in collecting credit card debt; using false and misleading means of foreclosing on mortgages; hiring the children of Chinese officials to help win business, in violation of the Foreign Corrupt Practices Act; and much else. All this caused the Justice Department and the Securities and Exchange Commission to launch multiple investigations.

  JPMorgan’s financial report for the fourth quarter of 2012 listed its legal imbroglios in nine pages of small print and estimated that resolving all of them might cost as much as $6.8 billion. Yet $6.8 billion was a pittance for a company with total assets of $2.4 trillion and shareholder equity of $209 billion. Which is precisely the point: The expected fines did not deter JPMorgan Chase from ignoring the laws to begin with. No big bank or corporation will avoid the opportunity to make a tidy profit unless the probability of getting caught and prosecuted, multiplied by the amount of any potential penalty, exceeds the potential gains. A fine that’s small compared to potential winnings becomes just another cost of doing business.

  Not even JPMorgan’s $13 billion settlement with the Justice Department in 2013, for fraudulent sales of troubled mortgages occurring before the financial meltdown, had any observable effect on its stock price. Nor, for that matter, did Citigroup’s $7 billion settlement in 2014, over the same sorts of fraud. Nor even Bank of America’s record-shattering $16.65 billion settlement in 2014. In fact, in the days leading up to the Bank of America settlement, when news of it was already well known on the Street, the price of Bank of America’s stock rose considerably. That was because many of these payments were tax deductible. (The test for deductibility is whether payments go to parties who have been harmed. At least $7 billion of Bank of America’s $16.65 billion settlement, for example, was for relief to homeowners and blighted neighborhoods, which clearly would be deducted by the bank from taxable income.) Moreover, the size of the settlement paled in comparison to the bank’s earnings. Bank of America’s pretax income was $17 billion in 2013 alone, up from $4 billion in 2012.

  In 2014, Attorney General Eric Holder announced the guilty plea of giant bank Credit Suisse to criminal charges of helping rich Americans to avoid paying taxes. “This case shows that no financial institution, no matter its size or global reach, is above the law,” Holder crowed. But financial markets shrugged off the $2.8 billion fine. In fact, the bank’s shares rose the day the plea was announced. It was the only large financial institution to show gains that day. Its CEO even sounded upbeat in a news briefing immediately following the announcement: “Our discussions with clients have been very reassuring and we haven’t seen very many issues at all,” he said. That may have been, in part, because the Justice Department hadn’t even required the bank to turn over its list of tax-avoiding clients.

  When maximum penalties are included in a law, they are often quite low. This is another political tactic used by industries that do not want to look as if they’re opposing a law but want it defanged. In 2014, for example, General Motors was publicly berated for its failure to deal with defective ignition switches, which had led to at least thirteen fatalities. For decades, GM had received complaints about the ignition switch but had chosen to do nothing. Finally, the government took action. “What GM did was break the law….They failed to meet their public safety obligations,” scolded Secretary of Transportation Anthony Foxx, after imposing on the automaker the largest possible penalty the National Traffic and Motor Vehicle Safety Act allows: $35 million. Thirty-five million dollars was, of course, peanuts to a hundred-billion-dollar corporation. The law does not even include criminal penalties for willful violations of safety standards that result in death.

  In 2013, Halliburton pleaded guilty to a criminal charge in which it admitted destroying evidence in the Deepwater Horizon oil spill disaster. The criminal plea made headlines. But the fine it paid was a mere $200,000, the maximum allowed under the law for such a misdemeanor. (The firm also agreed to make a $55 million tax-deductible “voluntary contribution” to the National Fish and Wildlife Foundation.) Halliburton’s revenues in 2013 totaled $29.4 billion, so the $200,000 fine amounted to little more than a rounding error. And no Halliburton official went to jail.

  Government officials like to appear before TV cameras sounding indignant and announcing what appear to be tough penalties against corporate lawbreakers. But the indignation is for the public, and the penalties are often tiny relative to corporate earnings. The penalties emerge from settlements, not trials. In those settlements, corporations do not concede they’ve done anything wrong, and they agree, at most, to vague or paltry statements of fact. That way, they avoid possible lawsuits from shareholders or other private litigants who have been harmed and would otherwise use a conviction against them.

  The government, for its part, likes to settle cases because doing so avoids long, drawn-out trials that government agencies charged with enforcing the law can’t possibly afford on their skimpy budgets. In addition, because the lawyers in such agencies are paid a fraction of what partners in law firms hired by Wall Street banks and big corporations are paid, they are generally much younger and without the same experience and don’t have nearly the same number of paralegals and other staff to collect documents and depositions in preparation for a trial; a settlement avoids the risk of an embarrassing defeat in court. Such settlements therefore seem to be win-wins—both for the corporations and the government. But they undermine the enforcement mechanism.

  Corporate executives who ordered or turned a blind eye to the wrongdoing, meanwhile, get off scot-free. After several settlements and guilty pleas in which Pfizer, the pharmaceutical giant, promised to behave better, it again pleaded guilty in 2009 to bribing doctors to prescribe an off-label painkiller, and paid a criminal fine of $1.2 billion. But no senior Pfizer executive was ever charged with or convicted of a crime. Similarly, six years after Wall Street’s near meltdown, not a single executive on the Street had been convicted or even indicted for crimes that wiped out the savings of countless Americans. It was well established, for example, that Lehman Brothers’ Repo 105 program—which temporarily moved billions of dollars of liability off the bank’s books at the end of each quarter and replaced them a few days later at the
start of the next quarter—was intentionally designed to hide the firm’s financial weaknesses. This was a carefully crafted fraud, detailed by a court-appointed Lehman examiner. But no former Lehman executive ever faced criminal prosecution for it. Contrast this with the fact that a teenager who sells an ounce of marijuana can be put away for years.

  Mention should also be made of the large number of state judges and attorneys general who are elected to their positions, providing another channel for big money to influence how market rules are interpreted and enforced.

  Thirty-two states hold elections for judges of state supreme courts, appellate courts, and trial courts. Nationwide, 87 percent of all state court judges face elections. This is in sharp contrast to other nations, where judges are typically appointed with the advice and consent of legislative bodies. As former Supreme Court justice Sandra Day O’Connor said, “No other nation in the world does that, because they realize you’re not going to get fair and impartial judges that way.”

  Until the 1980s, judicial elections were relatively low-profile affairs. But beginning in the early 1990s, campaigns became far more costly and contentious. After the Supreme Court’s Citizens United decision in 2010 opened the floodgates to corporate campaign donations, spending on judicial elections by outside groups skyrocketed. In the 2012 election cycle, independent spending was $24.1 million, compared with about $2.7 million spent in the 2001–02 election cycle, a ninefold increase. A 2013 study by Professor Joanna Shepherd of Emory University School of Law showed that the more donations justices receive from businesses, the more likely they are to rule in favor of business litigants. A Center for American Progress report also found corporate spending on judicial elections paying off for corporations. “In the span of a few short years, big business succeeded in transforming courts such as the Texas and Ohio supreme courts into forums where individuals face steep hurdles to holding corporations accountable,” wrote the author, showing, for example, that the insurance industry in Ohio donated money to judges who then voted to overturn recent decisions the industry disliked, and energy companies in Texas funded the campaigns of judges who then interpreted laws to favor them.

  State attorneys general, in charge of enforcing the rules by bringing lawsuits, are also subject to election and re-election, and they, too, are receiving increasing amounts of corporate money for their campaigns. An investigation by The New York Times in late 2014 found that major law firms were funneling corporate campaign contributions to attorneys general in order to gain their cooperation in dropping investigations of their corporate clients, negotiating settlements favorable to their clients, and pressuring federal regulators not to sue. The attorney general of Utah, for example, dismissed a case pending against Bank of America, over the objections of his staff, after secretly meeting with a Bank of America lobbyist who also happened to be a former attorney general. Pfizer, the pharmaceutical giant, donated hundreds of thousands of dollars to state attorneys general between 2009 and 2014, to encourage favorable settlements of a case brought against the company by at least twenty states for allegedly marketing its drugs for unapproved uses. AT&T was a major contributor to state attorneys general who opted to go easy on the corporation after a multistate investigation into the firm’s billing practices.

  Enforcement of market rules doesn’t depend solely on government prosecutors. Individuals, companies, and groups who feel they have been wronged may also sue—for patent infringement, monopolization, breach of contract, fraud, and other alleged violations of the rules. But such litigation is expensive. Many small businesses and most typical Americans cannot afford it—unless the litigation is over an injury serious enough to attract a trial lawyer who anticipates a large damage award in which he will share.

  This gives the biggest corporations and wealthiest individuals, able to hire lawyers to sue on their behalf or to defend against lawsuits, an inherent advantage. Monsanto, Comcast, Google, Apple, GE, Citigroup, Goldman Sachs, and other corporations with deep pockets use litigation strategically, often as a barrier to entry against upstarts without anything near the same legal resources. Suits, or the mere threat of such lawsuits, can deter the most ardent small-business owner or entrepreneur. Wealthy individuals also deploy squadrons of lawyers, often defending themselves from all potential claims and threatening to sue at the slightest provocation. Predatory litigation is another way economic dominance leads to legal and political power, which further entrenches and enlarges economic dominance.

  Until recently, small businesses and average individuals had been able to join together in class actions, but these suits have become harder to mount. As we have seen, mandatory arbitration clauses in many contracts effectively bar them. In addition, the Republican majority members of the Supreme Court, whose sensitivity to corporate interests that backed their appointments has never been in doubt, have been busily closing the door to class actions. In 2011, in AT&T Mobility v. Concepcion, they ruled that companies could legally bar class actions within consumer contracts. The following year, according to a survey by Carlton Fields Jorden Burt, the number of large companies that included class-action bans in their contracts more than doubled. Subsequently, in their 2013 decision Comcast v. Behrend, the five Republican members of the court threw out $875 million in damages Philadelphia-area subscribers had won from Comcast for allegedly eliminating competition and overcharging them. Justice Antonin Scalia, writing for the court, said the Comcast subscribers had failed to show that Comcast’s wrongdoing was common to the entire group and that damages were therefore an appropriate remedy for all of them rather than for individuals.

  The effect of these rulings has been to reduce the ability of groups of consumers—or, for that matter, employees or small businesses—to band together to enforce the law. The power of giant corporations like AT&T and Comcast to suppress the voices of individual consumers and employees cannot be overestimated.

  9

  Summary: The Market Mechanism as a Whole

  A summary is in order. Markets are made by human beings—just as nations, governments, laws, corporations, and baseball are the products of human beings. And as with these other systems, there are many alternative ways markets can be organized. However organized, the rules of a market create incentives for people. Ideally, they motivate people to work and collaborate, to be productive and inventive; they help people to achieve the lives they seek. The rules will also reflect their moral values and judgments about what is good and worthy and what is fair. The rules are not static; they change over time, we hope in ways that most participants consider to be better and fairer. But this is not always the case. They can also change because certain people have gained the power to change them for their own benefit. Such has been the case in America and many other nations in recent decades.

  Private property, constraints on monopoly, contract, bankruptcy or other means for coping with default, and enforcement of such rules are essential building blocks of any market. Capitalism and free enterprise require them. But each of them can be tilted to the benefit of a few rather than the many. As noted, every one of these five building blocks depends on a large range of decisions by lawmakers, agency heads, and judges. They amend or modify such decisions as circumstances change, technologies evolve, new issues and problems rear up, and old solutions become outmoded. This critical mechanism has nothing whatever to do with the size or “intrusiveness” of government. It has no bearing on how much the government taxes or the amount it spends. The market simply cannot function without these decisions. Legislatures, agencies, and courts must make them regardless of whether government is relatively large or small.

  What guides such decisions? Abstract notions of the public good are unhelpful because there’s often no consensus about what’s good for the public. “Improved efficiency” provides little practical guidance because of the difficulty of measuring the benefits and costs of many proposed measures. Moreover, even if a decision makes some people better off without imposing a hardship on anyone
else, such a measure may worsen inequality if its beneficiaries are already among the best off. Ideally, such decisions reflect the best judgments of people authorized by a democratic system to make them, in response to the values and wishes of a majority of its citizens.

  In recent decades, however, the real decisions are more often hashed out behind closed doors, in negotiations influenced disproportionately by giant corporations, big banks, and wealthy individuals with enough resources to be heard. Their money buys lobbyists, campaign contributions, public relations campaigns, squadrons of experts and studies, armies of lawyers, and quiet promises of future jobs.

  As I’ve shown, the effect on legislators is often direct and immediate, as is the effect on elected judges and elected attorneys general. The effect on appointed officials who implement and enforce the law is less direct but no less potent. (While historically some Supreme Court justices have veered far away from the views of the presidents who appointed them, justices appointed in more recent years are more predictably partisan.)

  The mechanism thereby creates and perpetuates a vicious cycle: Economic dominance feeds political power, and political power further enlarges economic dominance. To an ever-growing extent, large corporations and the wealthy influence the political institutions whose decisions organize the market, and they benefit most from those decisions. This enhances their wealth and thereby their capacity to exert more influence over such decisions in the future.

  What I have described is not the same as corruption. Few if any public officials in the United States solicit or receive direct bribes. The seduction is more subtle. It is simply easier for officials to choose a path that’s been carefully laid out for them by lobbyists, paid experts, and smart and experienced lawyers than to strike out on their own through territory often regarded by the establishment as menacing. The lures of campaign contributions and well-paying jobs after government service only make the preferred path more enticing.