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Money, Power and the Rule of Law

economix.blogs.nytimes.comOct 5, 2012

By Simon Johnson

Economic policy is always torn between helping the broader social interest - lots of ordinary people - and favoring particular special interests. Unfortunately, special interests typically win out in the kind of situation we have in America in 2012, when it's all about spending money to win friends and influence people.

The most effective way to push back against powerful special interests is to have the same rules for everyone - and to enforce those rules fairly, even when they are broken by the richest and most politically connected people in the land. Attorney General Eric Schneiderman of New York took a major step toward restoring the rule of law this week, by bringing a case against JPMorgan Chase. But it will be an uphill battle; the forces against him are incredibly strong, including some within the Obama administration.

Special interests always want to take over and organize society for their own benefit. In the terminology of economics, there are always some "rents" to be had - meaning some form of extra compensation that you get from tilting the playing field in your favor. Powerful people are always "rent-seeking," another way of saying that they would like to feather their own nests. And such activities impose costs on society, lowering incomes and limiting opportunities for everyone else.

When money is the primary source of power, the special interests win hands down. They can create advantages for themselves. One way is through the market mechanism - as monopolists did with railroads and industrial sectors at the end of the 19th century.

Or they can capture the government and use state policies to help themselves - for example, by deregulating the financial sector and allowing excessive risk-taking in big banks. The ability to take such risks hurts all consumers and taxpayers while helping the special interests who get this advantage.

In a brilliant satire, Steven Pearlstein recently put his finger on a central problem: powerful people want one set of rules for themselves and different, less advantageous rules for everyone else. In modern America, Mr. Pearlstein points out, the rich and powerful also like to complain a lot.

Democracy can be a countervailing force. But if this is only about holding elections, and money buys votes, it is not much of a constraint on powerful people. At the beginning of the 20th century, the Senate was known as the "millionaires' club" for a reason - most of its members were rich or very close to rich people.

In his classic book "The Logic of Collective Action: Public Goods and the Theory of Groups," Mancur Olson articulated another central problem: it is hard to organize people around broader social interests, while special interests know exactly what they want and coalesce much more readily.

In this situation, it is essential to have elected officials who seek to enforce the law in an even-handed fashion. This was what Theodore Roosevelt did with antitrust law at the beginning of the century. J.P. Morgan (the man) was shocked that the Sherman Antitrust Act could possibly be applied to him, and he brought a great deal of political pressure against it.

Fortunately, Roosevelt was not prone to backing down, and we developed a broad and effective antimonopoly approach in the early decades of the 20th century.

In the case brought against JPMorgan Chase on Monday, Mr. Schneiderman's complaint is straightforward: Bear Stearns (acquired by JPMorgan Chase in early 2008) misrepresented securities that it sold to the public before 2008.

"Bear Stearns led its investors to believe that the quality of the loans in its RMBS had been carefully evaluated and would be continuously monitored," the summary of the complaint issued by Mr. Schneiderman's office said, referring to residential mortgage-backed securities. "In reality, Bear Stearns did neither."

As with the cheating by Barclays on Libor, or the recent money-laundering cases against HSBC and Standard Chartered, management was at best negligent (for background on those cases, see my Economix posts from the summer). More likely, in the case of Bear Stearns, misleading investors was a deliberate decision by top people.

The broader social costs of these reckless actions by Bear Stearns and others were enormous. If you have not already seen the recent report by Better Markets on the real costs of the financial crisis, you should read it, or its summary, immediately - it puts put total losses of gross domestic product at $12.8 trillion.

As Brian Kettenring of the Campaign for a Fair Settlement, Dennis Kelleher of Better Markets and others pointed out this week, this should be the first case of many to be brought by Mr. Schneiderman and presumably the relevant federal authorities. By all accounts, Bear Stearns behaved badly, and so did many other companies engaged in the business of issuing residential mortgages and turning them into securities that could be sold to investors.

The pushback against the New York attorney general is already intense, with bankers and their lobbyists mustering all possible political clout to prevent further cases and to force a small and inconsequential settlement when cases are brought.

The bankers assert that great damage will be done to the economy if they are held accountable. In fact, the greatest damage has already been done through their lack of accountability.

Since early 2009, the Justice Department and other government agencies have repeatedly declined to enforce the law as it applies to large financial sector companies. Jeff Connaughton provides chapter and verse in his compelling recent book, "The Payoff: Why Wall Street Always Wins," which I wrote about in August. People at the very top of the Obama administration deferred excessively to the very largest Wall Street banks.

Have we now turned a corner? Watch carefully what Mr. Schneiderman is able to accomplish and what kind of political support he draws.


Back to October 2012 Archive

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