Government Interventions Regulate Ethics
Within the US Mixed Economy Marketplace
Daniel R. Faber
Walsh College: BSBIT Undergraduate Program
15th Annual Charles M. Bauervic Foundation Writing Competition
Prepared for Dr. Barbara Alpern
March 15, 2007
Introduction
The focus of this paper is Free Enterprise and how it is affected by government regulations
that are designed to minimize unethical exploitations of the U.S. markets. Government
deregulation of almost every industry, whether it is within the United States or any
western nation, has been a very hot topic since the 1970s. Arguments for and against have
been written by thousands of journalists and anyone riled up enough to send a letter to
their local editor. I have read headlines for years about the need for deregulations and
watched the results following these new laws being enacted. I have witnessed incredible
scandals within corporate America that were blamed upon unethical leaders that exploited
these deregulations.
These events sparked an intense curiosity within me as I pondered the topic for this
writing competition. I was persistently distracted by my lack of understanding about why
the regulations were enacted initially. Why was there so much effort to deregulate “now”
instead of “before”? If the regulations cause so many problems for an industry in today’s
market, how could our past leaders have been so inconsiderate? What was their
motivation? When were these regulations put in place, anyway?
Following my investigation, I was somewhat surprised to find that it wasn’t all that long
ago – clearly within the time frame of a Modern American History course – that most
government regulations were put in place. It was also not too difficult to find many
articles from different eras of American history and objectively get a sense of what people
were thinking when the regulations were enacted. I began my research with a reasonable
unbiased perspective, and I present my evidence as objectively as I can. Whereas today,
most articles have always swayed me to believe deregulation is absolutely necessary, I
found that historical articles influenced me otherwise, firmly.
Motivation and Markets
When dealing with markets involving more money than can be conceptually imagined, I
do not believe that you can trust anyone capable of influencing the direction of a market.
The idea that you can trust competition and ethical business leaders to steer our mixed
economy seems to be extreme naiveté. Similarly, it is a sad but accepted fact that the
leaders of our government are motivated by lobbyists and cash contributions from PACs
and party committees, all dedicated to specific agendas. When these agendas involve
regulations of corporate practices, how can you determine whether the motivations are
honest or deceitful? Are they opening or closing an exploitable loophole? My research
provides an answer to this question: it typically depends on whether the law was enacted
as a reaction to voter outrage or from business leaders requesting increased competition. If
the politician can gain more votes by championing a solution to unethical exploitations,
then it might be a “good” thing. If the law seeks to increase competition by relaxing
regulations then the odds are it’s a “bad” thing. Of course, this is only a generalization, but
please read my historical examples below, to see why I have come to this fundamental
conclusion.
Capitalism and Markets
Capitalism in its purest state is unregulated by the government. The idealistic approach to
a free market economy is to have no external stimuli other than direct ethical competition;
the ideal stable economy will evolve. This is known as a Pareto Optimized Economy,
where any effort to improve the markets will not have a negative effect on any other
participant in the economic environment (Repulio, 2004). This is also considered highly
theoretical, albeit a noble idea. Even in the early days of capitalism, completely free
markets were never envisioned without some governmental intrusions. At that time,
leading economists were struggling with the idea of a purely free market. This was known
as a Laissez Faire Market, meaning “let events go ahead and happen as they might.” This
term is used to refer to the policy of non-intervention from the government. All
proponents of this approach, no matter how intently they support this concept, have some
point of agreement that government regulation must be involved. Generally, this list
includes public sanitation, public education, antitrust legislation, public utility regulation,
construction of bridges, harbors and roads, demand management, national defense, central
banking and the creation of a patent reward system. (Greenwald, 1982)
The free market economy of the United States is more correctly described as a Mixed
Economy, defined as an economic system that “reveal ownership features of capitalism
and socialism”(Black, 2002). Therefore, the “Free Market” economy is impacted by
government regulations, which I feel are more properly called market “intrusions”. These
are dynamic, transitional or iterative efforts to find a harmonious middle ground between
the goals of the businesses and the well being of the general population. Ethics, morals
and general economic policies come into play in an effort to get as close to a Pareto
efficient economy as possible. My research shows that that there is an apparent cycle of
regulatory activity: periods of regulatory increase followed by periods of regulatory
decrease. I see this as a pendulum effect, swinging past a desired balance point,
perpetually missing the desired level of a regulated competitive environment.
My position is that government interventions regulate ethics within a mixed economy.
These interventions or regulations are necessary to control the insatiable and necessary
greed that drives the economy. For the last thirty years or so, a concentrated effort has
been put forth to reduce regulations that have been in place for forty to seventy years prior
to these recent adjustments. Some industries thrived under deregulation; many became
mired in scandals with heinous repercussions and new regulations put in place to prevent
similar results. Hundreds of billions of dollars have been lost due to the exploitation of
some deregulations, and still the US economy grew at an amazing rate during the 1980s
and 1990s with the longest economic expansion in the history of America. What was the
role played in this by deregulation? What caused the “dot com” bubble burst in 2001 and a
mirror image recession? Can it be traced back to deregulation or was it caused purely by
unethical management decisions - decisions that toppled some of the largest corporations
in the world. Could these leaders have made these decisions prior to the deregulation? The
evidence shows that they could not have done so and that the relaxed regulations lead
directly to exploited and unethical business practices.
What was the motivation behind governmental intrusions? When were these regulations
put in place? I will present the evidence historically to show what the motivations were
“then” and compare that to “now”. I will then project how regulatory dynamics may
impact the future.
American Economic History, Historical Evidence
The first 100 years:
The American revolt to British rule seemed an appropriate place to start since this seemed
to be the first American governmental effort to modify the conditions of our markets and
our government. Following the founding of the new government, Congress did impose
taxes and managed the day-to-day business of the country, but there were few
interventions into the marketplace.
For more recent historical activities, I am able to use the New York Times as a research
tool to gauge the historical impact and “see” the attitude of the general population toward
government interference. The New York Times newspaper (NYT) presently offers the
ability to search every article archived since 1851 on their web site. A search of these
articles by topics related to government regulations or deregulations shows an interesting
trend of societal and governmental concerns. What the headlines report on and the
frequency of these articles provides an objective evaluation of the perceived significance
of the government’s intrusive behaviors.
The 1850s are an interesting starting point, as I found that three major industries warranted
articles regarding governmental intervention within the NYT: railroads, trade in spirits or
alcohol, and trade in human slaves. The first two industries are still with us today,
following many iterations of regulatory adjustments. The latter became a major issue of
state’s rights and a significant intrusive effort into the American economy. The US
government was willing to tear apart the heart of its nation in civil war to protect its right
to intrude into the slave market of expatriated African human beings. Ironically, within the
next few decades they would aggressively support the genocidal atrocities toward the
indigenous American populations, justified to pave the way for further capitalistic
expansion in the western territories.
One headline in 1871 points out the concerns related to the railroad industry and the
reporters that worked to expose the issues:
THE RAILROAD POWER.; Evil Results of the Existence of Great Monopolies
Corrupt Corporations Speculations on the Remedy for the Evil by Charles Francis
Adams, Jr.
January 4, 1871, Wednesday. One of the two most noteworthy articles of the
January number of the North American Review, is on "The Government and
Railroad Corporations," by CHARLES FRANCIS ADAMS, Jr., the other being a
paper by Gen. J.D. COX, on "Civil service Reform," in which he sets forth in
strong language the existing abuses and corruptions, and advocates competitive
examinations, open to all and tenure of office during good behavior as the remedy.
(NYT editor, 1871)
An interesting headline from 1893 points out the tendency to change regulations at that
point in time:
December 20, 1893, Wednesday WASHINGTON, Dec. 13. -- "The American
people, after the fullest and most thorough debate ever given by any people to their
fiscal policy, have deliberately and rightly decided that the existing tariff is wrong
in principle and grievously unjust in operation." (NYT editor, 1893)
The second 100 years, 1875 to 1975:
I view the last part of the 1800s as the end of the American Free Market Economy and the
phasing in of the American Mixed Economy. Further analysis of the articles found in the
New York Times between 1875 and 1900 show an increasing number of them relate to
government intervention. These match the rapid increase in industrial activities and the
increasing awareness of the exploitation of human resources. The 1900s saw exponential
growth of industrial powers, and new industries entered the marketplace that directly
impacted the general population (electric power, automobiles, trucking, busses, airplanes,
unions, etc.) These came in amidst the swelling anger of the general population at the
horrible human conditions and how monopoly and collusion in critical industries drove up
prices and reduced the satisfaction received from them. Upton Sinclair wrote his famous
book, The Jungle in 1907, exposing the meatpacking industry’s horrific exploitation of
workers (wage slavery) and the even more nauseating methods of how meat was packaged
and delivered to the public. Government investigation independently corroborated the
claims, and according to Adam Cohen in a January 2007 editorial:
“The Jungle”, and the campaign that Sinclair waged after its publication, led
directly to passage of a landmark federal food safety law, which took effect 100
years ago this week. Sinclair awakened a nation not just to the dangers in the food
supply, but to the central role government has to play in keeping it safe. (Cohen,
2007)
The great depression of the 1930s and the intense analysis to find the causes and institute
sweeping changes (or rather intrusions into the free markets that needed adjustments)
became the pinnacle of American intervention, solidifying our position as a “Mixed
Economy” and placing the nation farther from a “Free Market” society than it has ever
been. These changes took many years and long battles with the powerful and connected
industries that lobbied Congress and brought cases to the Supreme Court in defiance of
virtually every angle of corrective action that was employed. When the dust settled and
several iterations of corrective laws were complete, the US economy saw its most
prestigious growth and general prosperity increase dramatically. American governmental
intervention was practiced, tested and poised to maintain the US economy and the
country’s position as a world power indefinitely.
The Power Utilities, an example:
One example of the regulatory pendulum was the progression of the Electric Power
Utilities and the cycles of corruptions that influenced the industry and the government’s
efforts to find a balanced Pareto economic position: In 1882, Edison developed the world's
first central electric generating plant on Pearl Street in New York City's financial district.
Electric motors found use as replacements for bigger, more expensive and more difficultto-maintain steam engines in factories. Market expansion and the natural competition and
innovative equipment lead to economies of scale, increased usage and reduced prices.
Power costs plummeted, allowing the company to sell more electricity at still lower rates.
Collusion issues surfaced: consolidation between companies became common place.
Concerns grew as the companies reminded many of other abusive monopolies like the
railroads that merged operations and drove prices higher. This led to government
corrections via regulations and innovative laws creating bodies that would regulate rates.
A “natural monopoly” approach was the outcome where a commission-regulated and noncompetitive environment was deemed to be the most efficient. The railroad, power
utilities, water, and transportation industries were included in this phase of government
backed intrusions. The commission had the right to investigate companies' books as part
of the process for determining rates based on the physical valuation of a company's
properties. The state regulation of utilities became commonplace. During the next two
decades, services expanded and the price of electricity declined 55% (Emergence, 2006).
Innovation in financing: To help finance the great expansion of power stations across the
country, the utility industry exploited a financial innovation known as the "holding
company." A holding company issues stock and bonds using the subsidiaries' securities as
collateral and investors rushed to be involved (Emergence, 2006).
Next iterations of capitalistic exploitations: During the 1920s, the holding company
concept got lost in a desire to exploit its business structure. Higher fees were charged for
services beyond their natural costs and companies pyramided one sub-holding company
on top of another without any assets to support it. The top company could control the
assets of operating companies with very little investment. By 1932, only eight holding
companies controlled almost three-quarters of the investor-owned utility business. And
their operations usually were exempt from the investigation of state regulatory
commissions, since much of their business crossed state boundaries (Emergence, 2006).
Next iterations of government corrections: a six-year investigation pursued by the Federal
Trade Commission began in 1928 (even before the market crash of 1929 and the
depression motivated industry regulations under Roosevelt’s New Deal) lead to The
Public Utility Holding Company Act of 1935. This outlawed the pyramid structure that
had been at the core of financial abuses. Also, newly created in 1935, the Securities and
Exchange Commission oversaw interstate operations. The President sought to impose
safeguards by using government oversight while at the same time sought to preserve the
sanctity of the private capitalist economy. The legal battles lasted for years as the utility
companies sought to invalidate the laws but eventually, the act stood firm (Emergence,
2006).
The end of the second hundred years of American economics was relatively unchanged by
regulations. With a relatively stable economy, the amount of new iterations in
governmental adjustments to the domestic markets during the 1950's and 1960's were
negligible. Governmental intrusions were accented most notably by foreign policy issues
dealing with military interventions in Korea, Cuba, Viet Nam and the Cold War in general.
However, the third 100 years of American economic history was ready to unfold.
The 3rd hundred years, 1975 to present:
Although seemingly not that great a length of time had passed since most regulations were
initiated and the great legal battles of the 1930s and 1940s completed, the pendulum of
corrective action was well on its way to the other side of center and would slowly but
surely have its effect on the markets of America. Indeed, it seemed that the natural
demands of a free market to move and fluctuate freely continuously squirmed and
squealed and gnawed at its tethers. The leaders in the last quarter of the 1900s were
dealing with new variables: inflation was climbing higher, new forms of international
collusion were being practiced by OPEC (Organization of Petroleum Exporting Countries)
and a general mistrust of our government following the Watergate scandals and Viet Nam
military actions helped set up motivation for change. Something had to be done to
stimulate the economy, and an adjustment of government regulations seemed to be the
logical place to start.
Articles from the New York Times during this period show the deregulatory process just
from their headlines or opening paragraphs. The primary concerns of the people and
considerations of options regarding both sides of deregulation philosophy were heard, but
mostly pro-deregulation arguments would get the limelight. As the business interests and
their lobbying played out, reporters described the flow of corrupting dollars going to
Capital Hill but it seems that no one really noticed. Here are some abbreviated headlines
and opening paragraphs from this time frame:
WASHINGTON, July 20, 1975: During the last few months, President Ford
[dealing with] the conflicting pressures exerted by industry, labor and the affected
public… His aim has been to reverse the 88-year-old trend of regulations…in
order to generate more competition while protecting…the American consumer.
(Burnham, 1975)
WASHINGTON April 23, 1978: The $16 billion domestic airline industry,
nurtured on a diet of regulation, protected routes and administered prices, has
suddenly been thrust out into the cold. (Williams, 1978)
WASHINGTON May 31, 1978: After striving for cheaper fares by stimulating
airline competition, the antitrust subcommittee of the Senate Judiciary Committee
has turned its attention to trucking, a much larger, tougher and more complicated
industry. (NYT editor, 1978)
WASHINGTON, June 13, 1978: Of all the tactics of President Carter's emerging
war on inflation, none has been more hotly debated thus far than the plan to curb
governmental regulation in order to help cut the costs of doing business....
(Shabecoff 1978)
The immediate results from some of the first changes to free up some markets and the
almost instantaneous negative impact – higher consumer costs, charges of corruption,
congressional investigations, prosecutions, etc. – did nothing to slow the changes. Further
regulations were reviewed, industry by industry, and the protections dismantled.
“Problems would be temporary” and “the markets need time to adjust” were the simplistic
answers to the public’s outcry. Newer re-regulations were put in place for some
“problems”. Indeed, the ongoing adjustments to the amount, type and intensity of
government interventions seemed endless.
Savings and Loan Market
The most significant early deregulation problems that developed occurred in the Savings
and Loan industry. Long controlled and restricted to its niche of the free market, it had
historically produced much success in the mortgage market. However, that changed in the
1970s when inflation ate up its margins, and these so called “thrifts” were stuck with
mortgages they couldn’t market. Since the industry functions on the basis of a constant
flow of dollars, when that stops, so do the profits. New laws to relax governmental
intrusion were expected to stimulate the market and make it less of a hassle to report on a
company’s financial position. However, much concern was raised regarding corruption
charges by those adjusting the regulations. In the end, the cost to American taxpayers was
about 132 billion dollars ($132,000,000,000.00) (FDIC, n.d.). According to research done
by Hartley, “By 1988, of the nation's 3,178 so-called thrift institutions, 503 were insolvent.
Another 629 had less capital on their books than regulators usually require. In 1987, 630
thrifts had lost an estimated $7.5 billion, half as much as the earnings of all the rest
combined.” (Hartley, 2005)
The deregulatory solution to S & L problems did not consider the unbridled greed that was
soon to accompany this greater freedom. So the seeds for disaster were laid. Washington
aggravated the problem and the potential for disaster by failing to hire adequate regulatory
staff or replenish the reserves of the Bank Board or FSLIC. All this time, S & Ls in the
Southwest continued to slide into bankruptcy. (Hartley, 2005)
Please reference Appendix A for a summary of articles documenting the Savings and Loan
scandal of the 1980s. Here is a brief timeline of the deregulation changes and the results
for the S&L industry:
1930s: Roosevelt administration created the two deposit-insurance funds we know
today, the FSLIC for S & Ls, and the Federal Deposit Insurance Corporation
(FDIC), which insures commercial bank deposits.
June 1980: The trade group for savings and loan associations accused Federal
regulators today of blocking a recovery in housing construction by making
restrictive rate decisions.
July 1980: The Federal Home Loan Bank Board relaxes regulations for Federal
savings and loan associations, giving them permission to expand their markets.
1980: Congress passed the Depository Institutions Deregulation and Monetary
Control Act in 1980 which phased out interest-rate ceilings on deposits and
allowed S & Ls to make various kinds of consumer loans. This was insufficient
and the Government felt the industry needed further assistance (hard to know what
influence S&L leaders purchased from corrupt politicians). Congress acted again
to "remedy" the situation, only the remedy led to worse abuses.
1982: The Garn–St. Germain Act was passed. This further loosened the restraints
on S & Ls, now giving them lending powers to make acquisition, development,
and construction loans, form development subsidiaries, and make direct
investments.
December 1986: A regulatory proposal that appears corrupt, sponsored by a
member of the Federal Home Loan Bank Board, prompted a Congressional
investigation.
December 19, 1986: Government warnings that allow S&L institutions to
diversify their business activities and invest larger unsecured amounts of their
assets into real estate are highly risky and can lead to excessive losses to the
Government’s insurance fund the FSLIC. The S&L industry counters that
regulations represent excessive Federal intervention and overrides certain state
laws that permit much higher levels of real estate investment.
January 1989: Investigative articles point out that the savings industry has been in
trouble since the 1970s... But the origins of the current crisis lie in the poorly
conceived deregulation of the early 1980s, which led to an orgy of speculative
investments…But legislators conspired with the Reagan Administration to
postpone [the investigation] until the 1988 elections. The cost of delay has been
staggering. Today, one-third of all savings institutions are insolvent, and the
bankrupt units' liabilities to depositors exceed the value of their assets by at least
$50 billion.
January 1989: Reagan’s budget for 1990, handed off to Bush, includes $10 billion
to fix the S&L problems. Other estimates of the cost... exceed $100 billion. Recent
year-end wave of closings are likely to lead to new calculations.
December 1989- The Federal Home Loan Bank Board chairman, M. Danny Wall,
who took over to oversee the S&L bailout is forced to resign.
December 1989 --Five Senators are accused of improperly intervening with
Federal thrift regulators in early 1987 on behalf of Charles H. Keating Jr. who had
contributed handsomely to each of the Senators' campaigns.
Profitable Legislation
Regulatory changes can be very profitable for everyone involved, either from the
government or the regulated industry. There is no way to be sure of the motivations of the
players. The only assumption is that you can be sure people will press to change the status
quo to their favor. Some changes to the regulations took years to complete, but with
tenacious efforts, industry leaders from the government and the private sector would
continue to press for their pet projects. Here is a brief example of articles indicating the
timeline (late 1970s to late 1990s) for the changes to the Banking, Insurance and
Securities industries and the rather obvious efforts at bribing government officials to make
the desired decisions. (Note: These became the foundation of the current “Sub-Prime”
Mortgage issues currently facing our country.)
April 7, 1998 Congress came very close to moving ahead on the necessary
legislation just last week. But the Republican leadership in the House pulled the
bill at the last minute when it became clear that it would once again fall victim to
the Byzantine politics that has afflicted similar efforts since 1979, when Congress
first began trying to update the 1933 Glass-Steagall Act and the 1956 Bank
Holding Company Act, the main laws separating banks, Wall Street and insurance.
With banks, securities firms and insurers all battling over how to rewrite the rules
of the game…members of Congress have seen their campaign coffers swell from a
constant flow of money from companies and lobbying groups. (Stevenson, 1998)
Electrical and Power Industries
The electrical power industry was also deregulated in the 1990s which allowed for the
immediate creation of companies that brokered the sales of electrical power, in a manner
very similar to the holding companies that were dismantled in the 1930s by Roosevelt’s
campaign to eliminate corruption within the industry. California’s deregulation efforts
were watched closely by other states. They suffered immediate effects of spiraling costs
and inconsistent supplies of power. They were not alone as coast to coast, consumers were
trying to figure out why deregulation was not providing the competition that would
improve the market and lower the costs. Here is one example:
Those Shocking Electric Bills Published: August 8, 2000
Many New Yorkers stared at their electric bills this month in confusion and
disbelief. The cost of electricity…went up about 40 percent over last year…all
despite a summer so temperate…But the main underlying cause is the deregulation
of the power industry in New York and many other states in the last few years…
(NYT editor, 2000)
In Texas, Enron grew into a powerhouse and then collapsed amid scandal and dismay as
thousands lost their investments and/or their jobs. This is one of the most amazing stories
of corruption and illegal business practices ever documented. Please refer to Appendix B
for articles detailing the Enron collapse; at this point, I will present a timeline showing the
completely unethical practices Enron followed and how these were hinted at within New
York Times articles.
September 2000: Electricity industry deregulation blamed for spiraling costs in
multiple areas of the U.S. increasing 43% year to year in New York.
November 2000: Although Enron has been “cooking the books” and implementing
intricate false companies and unreported loans between them to hide losses from
auditor’s eyes, when the markets began detecting discrepancies and issued
warnings, Enron boldly and unethically announces that the warnings are not true.
All of their businesses are reported as performing extremely well – Enron shares
closed up $2.25 to $77.75.
December 2000: Enron names Jeffrey Skilling as CEO and projects that revenue
will more than double this year, largely because of efforts to exploit deregulation.
December 2000: Enron buys back stock it sold 18 months earlier in Azurix
Corporation, for less than half of what it was sold for. All of the Board of
Directors of Azurix are also Enron directors.
June 2001: California is demanding electrical power companies refund billions of
dollars in overcharges.
July 2001: Enron claims it does not overcharge states and that selling power to
California is not an important part of it’s business, confidently saying that it makes
more money from expansions into other markets. Enron profits are reported as
rising 40%; all the while Enron leaders could see the beginnings of the breakdown.
Enron would collapse completely within six months.
August 2001: Jeffrey Skilling resigns as CEO after only six months on the job,
citing personal reasons. Enron’s investments into broadband telecommunications
and power plants in India are failing to generate profits or offer further cover for
the exploits of the business charades being propagated.
August 2001: Ken Lay writes the Time’s editor in response to accusations of
unethical dealings within the electrical industry, defending free markets and stating
that government regulations caused the market’s recent problems. Commenting
that he does not trust the integrity and good faith of government institutions.
August 2001: Leo Montagna, average citizen, responds to Mr. Lay’s editorial with
his own insight that “With all its faults, regulation and oversight by a
democratically elected government are a much more sensible way to control and
ensure the long-term success of our system. The suggestion that we should rely on
the self-interest of corporations, whose charters are primarily focused only on
making a profit, is a recipe for disaster. The power of the will of the people is no
match for the self-interest of corporations unregulated by government.”
September 2001: California regulators vote to immediately suspend consumers'
direct access to independent power retailers.
November 2001: SEC intensifies its investigation into Enron. debt ratings cut and
shares fall to half what they were.
December 2001: Enron files for bankruptcy protection for itself and 12 affiliate
companies, listing assets of $49.8 billion and debts of $31.2 billion, but these debts
do not include many items not listed on its financial statements.
It would take several months to sort out the books, and years to complete the legal
due process.
New Regulations for an Old Problem
Following the outrage of the Enron scandal and similar accounting exploits from huge
corporations like Tyco and WorldCom, a new breed of regulations was created that
crossed industry borders. The Sarbanes-Oxley Act of 2002 put forth requirements for
CEO's to take personal responsibility for their company’s financial reports as well as
limiting the accounting tactics that provided loopholes for unethical business leaders. But
even in the wake of an incredible stream of exposed scandals, the political regulatory
engine was fueled mostly by election results. The motivation of the legislature was clearly
driven by the upcoming election and political opportunities (Oppel, 2002). Please see
Appendix C for an interesting account that details the fevered pitch of legislative activities
related to the development of the Sarbanes-Oxley law .
Conclusion
Initially, it was not my intention to argue for or against regulations, only to investigate
what the motivations were to regulate or deregulate. I have been objectively swayed to the
side that honest regulations are absolutely necessary to control the unbridled greed of the
marketplace. As a secondary purpose, I wish to point to the historical tendency of change,
often with amazingly radical position changes occurring within a matter of decades. The
changes have no apparent ethical consistency or “good old American values” upon which
to base them. Rather, whatever the moral theme of the decade that which increases the
number of votes received during the next election is what seems to motivate the politicians.
I assert that these regulatory swings will continue. A corrective pendulum of more, then
less, then more regulations can be seen if one steps back far enough. This pendulum effect
seems driven by overcompensating decisions designed to pull the program back to center
but always missing the middle and swinging too far the other way. Two general rules
seem to be followed for this effort: Rule 1 is that adjustments should be repeated when
necessary; Rule 2 is that adjustments will always become necessary.
There is a strong need for honest regulations within US mixed economy. I do not hope to
offer an insight in how to accurately determine the proper balance. Indeed, with corruption
swirling on both sides of the regulatory pendulum, it is most difficult to determine when a
regulation was increased or decreased in an ethical manner. Therefore, a significant lesson
from this research is to recognize that the efforts will continue for generations to come, so
expect many iterations of the “pendulum of corrective adjustments.”
As brief as my tour of history is, it would seem to only uncover knowledge that everyone
had in 1935 and earlier. As Leo Montagna stated so simply when he wrote the editorial in
2001 in opposition to Ken Lay’s (Enron) opinion about a completely free market, “With
all its faults, regulation and oversight by a democratically elected government are a much
more sensible way to control and ensure the long-term success of our system” (Montagna,
2001). Indeed, Leo’s insightful comments, as pointed out in the introduction, paralleled
the forefathers of Capitalism who recognized the need to keep the industries supporting
the common community controlled and protected from the risks of the marketplace and
from the risks of exploitive unethical business practices.
Changes should be made when it seems appropriate, but they should be done very
carefully. When arguments are presented to relax or tighten regulations, no one can tell
what the true motivations are behind the requests, whether they come from the regulators
or the companies being regulated. Decisions have to be made based upon the information
at hand and hopefully with a review of recent and long term history. One thing seems
definite: industries, governments and their respective constituents will constantly wrestle
with the pendulum. There is a pattern to these changes; but whether a measurable cycle
can be detected, only time will tell. It seems that the trends take decades to unfold and in
the mean time, generations of leaders and capitalists will come and go.
Unethical business practices are always a possibility when humans are involved. This does
not mean to say that all humans are unethical; only that there will always be some humans
who are unethical. Unfortunately, it takes only a few of these in controlling positions
within corporate America to cause horrendous damage to the marketplace. Hence, the
need for the governmental role of the regulator and the auditor. These counterbalancing
factors work to minimize the impact of opportunists who exploit the trust of the ethical
practitioners. How the inevitable changes to the regulatory environment evolve and
change the market cannot be foretold. We can only hope that we won’t need too many
swings of the correcting pendulum before we find a balance we can live with.
Mortgage Industry Crisis in 2007
As I write this paper, I am hearing daily reports and reading articles about the pending fall
out of the sub-prime mortgage securities market. The impact will be known in the next
few years, when you can read books and other summary reports that explain how this
market fell on hard times. The domino effect of greed and the exploitations of previous
deregulatory efforts will be described in succinct detail. I further propose that you will
read about fraud and corruption among industry leaders and government officials.
However, allow me to point out that the root cause was the deregulation of the Savings
and Loan Industry, followed by deregulations allowing insurance and security industries
to do banking and mortgage business. Further, the regulations from the banking industry
did not follow to the other companies. The regulatory arm of the government controlling
banks can only make recommendations to non-banking businesses regarding asset-to-loan
ratios and other loan approval guidelines.
As summarized in a recent NYT article, written on March 11, 2007, by Gretchen
Morgenson, she analyzes the current state of the “sub-prime” mortgage market and makes
several comparative points to recent scandals:
Now as then: Wall Street analysts with ties to a failing company recommended
further investments into the company. Within days, the stock collapses and the
company fails. Now as then: investors had made fortunes on questionable
securities transactions. Now as then: average investors were lulled with excellent
reports, provided by seriously biased analysts, while the ballooning crisis was
already widely known within the industry. Now as then: regulators were unable to
act, only watch as the mayhem expands, “fed by lax standards and an anythinggoes lending.” (Morgenson, 2007)
Now, unlike then: the impact could have a staggering impact on the US economy.
Whereas we used to think we knew the meaning of “a staggering impact”, a new level of
understanding may be upon us. The housing industry has been an anchor point of stability
amidst the past scandals in the other industries. The dollars involved in the mortgage
securities industry dwarf all of the past scandals, now measured in trillions of dollars. At
issue is the availability to provide dollars to home buyers and a spiraling increase in
available property that drives down the market value of homes, further devaluing the
assets supporting the previously issued mortgages. This is an economic impact that could
shake the vary foundations of the United States as it exists today.
Fortunately, the Sarbanes-Oxley regulations and other accounting practices did keep these
companies from further hiding their poor business practices, rules that at least force the
issues to be dealt with now before the situation continues to worsen. Unfortunately, there
still are no rules protecting us against unethical practices of Wall Street investment firms
that recommend investment into failing companies to which they actually have lucrative
ties to. No regulations exist to stop business models that promote immediate profits for
either bad or good investment decisions. Huge short-term profits will always sway a
decision, regardless of the long-term results, especially if one can sell the problem to
someone else. How many times do we have to see that brilliant successful high risks in an
expanding market will always turn to unsuccessful moronic blunders if the market
contracts? How many of our past regulations will be undone, to staggering economic
repercussions, before we the people and our legislature enact proper laws to control the
greed of the marketplace? The laws that brilliant legislators of the past enacted to protect
their children’s children, and our children’s children, from scandals and unethical
practices have been systematically deconstructed over the last 30 years. How long will it
take before the words “to spur competition and economic growth in the market place”,
indeed - how long will it take before the word “deregulation” sends a cold shudder of fear
down the spine of every legislator listening to an industry lobbyist?
Appendix A: Savings and Loan Scandals
The following are abbreviated New York Times headline articles highlighting the S&L
scandal.
WASHINGTON, June 4, 1980--The trade group for savings and loan
associations…accused Federal regulators today of blocking a recovery in housing
construction this year with new rate decisions that it says will cost... (Farnsworth, 1980)
WASHINGTON, July 3, 1980--The Federal Home Loan Bank Board approved
regulations today [for] Federal savings and loan associations, giving them permission to
issue… (Gerth, 1980)
December 19, 1986-- [Warnings that allowing S&L institutions to diversify their business
activities and invest larger unsecured amounts of their assets into real estate] are highly
risky and can lead to excessive losses to the Government’s insurance fund [the FSLIC].
[The S&L industry counters that regulations] represent excessive Federal intervention and
overrides certain state laws that permit much higher levels of real estate investment. (Nash
1986)
December 31, 1986 A regulatory proposal that [appears corrupt] [sponsored by] a member
of the Federal Home Loan Bank Board has prompted a Congressional [investigation].
(NYT editor, 1986)
January 2, 1989 --The savings industry has been in trouble since the 1970s... But the
origins of the current crisis lie in the poorly conceived deregulation of the early 1980's,
which led to an orgy of speculative investments…But legislators conspired with the
Reagan Administration to postpone [the investigation] until the 1988 elections. The cost of
delay has been staggering. Today, one-third of all savings institutions are insolvent, and
the bankrupt units' liabilities to depositors exceed the value of their assets by at least $50
billion. (NYT editor, 1989)
January 3, 1989-- (Regarding a review of the past 18 months on the job as head of the
Office of Thrift Supervision and its predecessor the Federal Home Loan Bank Board, M.
Danny Wall, who took over to oversee the S&L bailout, is being reported on) …eighteen
months later, many in Washington are asking him more probing questions…as the savings
and loan industry needs a huge taxpayer bailout… He has come under fire from fellow
regulators… Despite the criticism of some of his actions…Mr. Wall seems to be
secure…in his position as bank board chairman. (Mr. Wall was forced to resign on Dec.
04, 1989) (Nash, 1989)
January 4, 1989 -- [Regarding Reagan’s budget for 1990, handed off to Bush] [includes
$10 billion to fix the S&L problems] [which] includes $5 billion a year for institutions that
have not yet been rescued and $5 billion to cover deals already struck….other estimates of
the cost... exceed $100 billion, and last week's year-end wave of closings…are likely to
lead to new calculations. (Kilborn, 1989)
December 31, 1989 --Five of the Senators… are accused of improperly intervening with
Federal thrift regulators in early 1987 on behalf of Charles H. Keating Jr. [who] had
contributed handsomely to each of the Senators' campaigns… (Rasky, 1989)
Appendix B: Electrical market corruption and the fall of
Enron.
The following are abbreviated New York Times headline articles tracking the fall of Enron.
September 15, 2000--Deregulation has faltered as surging consumer demand outstrips the
supply of electricity, and regulators and utilities scramble to cope with successive
summers of price volatility and power failures…Con Ed customers in New York paid 43
percent more for electricity this June than last year. Prices have spiked elsewhere as well.
(Banerjee, 2000)
COMPANY NEWS; ENRON SAYS IT WILL MATCH ANALYSTS' EARNINGS
ESTIMATES Published: November 25, 2000
[The rumors of a “profit warning” are not true…] …Jeff Skilling, president and chief
operating officer of the company…said… ''All of our businesses are performing extremely
well... Enron shares closed up $2.25, to $77.75. (Reuters, 2000)
Enron Rewards President with Promotion to Chief Executive Published: December 14,
2000
The Enron Corporation named Jeffrey Skilling as its chief executive today [credited with
making Enron] the largest competitor in the growing energy-trading business...Enron's
revenue will more than double this year, possibly topping $90 billion, largely because
of…efforts to exploit deregulation…investors said. (Bloomberg, 2000)
Enron to Buy Back a Stock Issue at Half What Public Paid Published: December 16,
2000
Only 18 months after it sold stock in the Azurix Corporation to the public, the Enron
Corporation agreed yesterday to repurchase the stock for less than half of what the public
paid…Azurix, a water company whose plans for global expansion did not work out, said
that the deal was unanimously approved by the board of Azurix, all of whom are also
Enron directors. (Norris, 2000)
California and Energy Providers in Talks over Electric Fees Published: June 26, 2001
…California and the companies that sell it electricity sat at the same table today to try to
resolve a multibillion-dollar feud over the state's energy bills…California is demanding
that power companies refund as much as $9 billion for what it says were overcharges,
while power companies say that the state's nearly insolvent utilities owe them billions of
dollars. (Kahn, 2001)
Enron Net Rose 40% in Quarter Published: July 13, 2001
The Enron Corporation, an energy trader, said today that its second-quarter profit rose 40
percent as its sales of natural gas and electricity surged in the United States and Europe.
Net income rose to $404 million…Revenue almost tripled to $50.1 billion.
Although electricity and natural gas prices surged in California, Jeffrey K. Skilling, the
chief executive of Enron, said the state ''is just not a big factor'' in Enron's increasing
profits. The company bolsters earnings by increasing sales of energy and other
commodities like lumber and steel rather than by raising prices…
Shares of Enron have dropped 31 percent the last year, despite steadily increasing earnings,
and sales that now rival those of Exxon Mobil. Shares of Enron rose 45 cents
$49.55…Enron was expected to make 42 cents a share in the quarter, the average estimate
of analysts polled by Thomson Financial/First Call. (Bloomberg, 2001)
Enron's Chief Executive Quits After Only 6 Months in Job Published: August 15,
2001
Jeffrey Skilling, the chief executive of the Enron Corporation, stunned Wall Street today
by announcing that he would quit after just six months in the job, calling the move a
''purely personal decision.'' But the abruptness of the departure left many analysts
questioning whether a series of setbacks the company has suffered played a part in the
decision.
Mr. Skilling, 47, had been at the heart of the transformation of Enron from an old-line
natural gas pipeline company to the biggest and most aggressive of the new breed of
unregulated energy traders that buy and sell billions of dollars of electricity and other
commodities daily.
…Enron has suffered from problems with its new broadband telecommunications trading
unit, its investment in a large power plant in India, and criticism from officials in
California, who blame Enron and other energy companies for the collapse of the state's
electricity market. (Oppel, 2001)
The fall of Enron begins…
Defending Free Markets Published: August 22, 2001
To the Editor:
Paul Krugman misunderstands Enron, the people who work here and the botched
California regulatory system (column, Aug. 17). The broader goal of his latest attack on
Enron appears to be to discredit the free-market system, a system that entrusts people to
make choices and enjoy the fruits of their labor, skill, intellect and heart. He would
apparently rely on a system of monopolies controlled or sponsored by government to
make choices for people. We disagree, finding ourselves less trusting of the integrity and
good faith of such institutions and their leaders.
The example Mr. Krugman cites of ''financialization'' run amok (the electricity market in
California) is the product of exactly his kind of system, with active government
intervention at every step. Indeed, the only winners in the California fiasco were the
government-owned utilities of Los Angeles, the Pacific Northwest and British Columbia.
The disaster that squandered the wealth of California was born of regulation by the few,
not by markets of the many.
KEN LAY
Chairman and Chief Executive
Enron Corporation
Houston, Aug. 20, 2001 (Lay, 2001)
To the Editor:
Re ''Defending Free Markets'' (letter, Aug. 22):
The chairman of Enron Corporation, in his response to Paul Krugman's Aug. 17 column,
misses a vital point. The success of free markets and a capitalistic economy in a
democratic society depends on the support of the people.
Even Adam Smith realized that a capitalistic free-market economy would run amok if left
to its own devices. With all its faults, regulation and oversight by a democratically elected
government are a much more sensible way to control and ensure the long-term success of
our system.
The suggestion that we should rely on the self-interest of corporations, whose charters are
primarily focused only on making a profit, is a recipe for disaster. The power of the will of
the people is no match for the self-interest of corporations unregulated by government.
LEO MONTAGNA
Northport, N.Y., Aug. 23, 2001 (Montagna, 2001)
California Moving Toward Re-regulating Energy Published: September 21, 2001
State utility regulators revoked the right of Californians to choose their power provider
today, tossing out the centerpiece of the state's failed effort to deregulate its electricity
industry. The California Public Utilities Commission voted 3 to 2 to immediately suspend
consumers' direct access to independent power retailers (Reuters, 2001).
Enron's Shares Fall and Debt Rating Is Cut Published: November 2, 2001
Late on Wednesday, Enron, the energy-trading giant based in Houston, said the S.E.C. had
intensified its inquiry into the company's finances, making it a formal investigation,
carrying subpoena power.
Enron's shares have fallen by more than half in the last two weeks because of the S.E.C.
investigation and worries about off-balance-sheet debts and transactions with investment
partnerships involving the company's former chief financial officer, Andrew S. Fastow,
who was ousted last week. Enron shares fell $1.91 today, to $11.99 (Oppel, 2001).
Published: November 4, 2001
Can Enron survive? The company, the nation's largest energy trader and a major backer
of President Bush, has been pummeled by a Securities and Exchange Commission
investigation and an unusual $1.2 billion reduction in shareholder equity from deals with
partnerships involving its former chief financial officer… (Oppel, 2001)
ENRON'S COLLAPSE: THE OVERVIEW; ENRON CORP. FILES LARGEST U.S.
CLAIM FOR BANKRUPTCY Published: December 3, 2001
Enron's bankruptcy filing…ends the company's downfall. Its stock, worth $90 at its peak
last year, is now nearly worthless, and other traders quit doing business with it last week
for fear they would not be paid. The filings by Enron and its affiliates included its energy
trading business and 12 of its other units, but not its pipelines. The company lists (Oppel,
2001).
Amazingly enough, Texas began implementing its own energy deregulation plans as
Enron was still in its death throes.
January 3, 2002. Less than a year after the nation's most-populous state, California,
endured blackouts and political and economic turmoil when it deregulated the power
industry, the second-most-populous state, Texas, this week began its own deregulation
plan with officials promising that there would be no reprise of California's chaos. (Yardley,
2002)
Appendix C: Sarbanes-Oxley passes the legislature
Here are excerpts from an excellent summary article, written by Richard A. Oppel Jr.
showing the scramble of activities to create the Sarbanes-Oxley legistation.
CORPORATE CONDUCT: THE OVERVIEW; NEGOTIATORS AGREE ON BROAD
CHANGES IN BUSINESS LAWS (Published: July 25, 2002).
House and Senate negotiators agreed today on a broad overhaul of corporate fraud,
accounting and securities laws aimed at curbing the rampant abuses that have shaken Wall
Street. Final approval in Congress is expected within days, and President Bush has said he
will sign the bill into law.
Lawmakers disclosed the agreement this morning, hours after postal inspectors arrested
the former top executives of Adelphia Communications, one of the companies whose
collapse helped galvanize support for tougher Congressional action… The measure…
closely tracks a proposal by Senator Paul S. Sarbanes, Democrat of Maryland, that
passed the Senate unanimously last week.
… it creates a regulatory board to oversee the accounting industry and punish corrupt
auditors... prosecuting corporate wrongdoing and gives broad new protections to corporate
whistle-blowers… [parties guilty of activities] designed to defraud investors would face
long prison terms.
The measure moved along quickly in the wake of the daily disclosures of corporate
scandal. Lawmakers said they hoped it would go a long way toward ridding…conflicts of
interest and greed-driven misconduct that till now have gone unchecked. Some
lawmakers called it the most sweeping securities legislation since the 1930's.
Representative Michael G. Oxley…added provisions that would lengthen prison terms
for certain crimes… monetary penalties levied by the Securities and Exchange
Commission….
… Republican lawmakers made it clear that they believe that the measure overreaches.
The bill reflects a ''stampede by members to get something done, regardless of what it is,
to cover them politically,'' ''Trust me,'' he added, ''this isn't about policy.''
White House officials, who only weeks ago had favored a much more limited approach,
embraced the far more aggressive remedies that are included in today's agreement.
The deal ''marks a day of action and accomplishment in the president's fight against
corporate corruption…' said Ari Fleischer, the White House spokesman.
Threats by some Republicans to water down crucial provisions of the legislation never
really materialized, as the slide in stocks and continuing corporate scandals -- including
new evidence Tuesday suggesting that Citigroup and J. P. Morgan Chase played a role in
burnishing Enron's financial condition -- kept up the pressure on lawmakers.
Lawmakers on both sides of the aisle postured today to gain the most advantage from
the agreement… the House Democratic leader, said that the corporate reform measure
survived efforts by Republicans and lobbyists to gut its strongest provisions.
The legislation has enjoyed extraordinary momentum in the last three weeks... as the
scandals at Tyco, Adelphia and WorldCom, …made it increasingly risky for any
politician to object to the measure.
''The focus of these kinds of debates is more on the sort of rhetoric and media response
than it is on practicality,'' Mr. Gramm said. ''That's just the very nature of the process
when you've got a crisis atmosphere.''
Tonight, at the conference meeting, Mr. Gramm added that he feared that the bill ''will
do more harm than it should,'' citing what he said were provisions that would encourage
''predatory'' lawsuits and other language that he said would prove onerous for thousands
of smaller publicly traded corporations.
The bill, which was renamed the Sarbanes-Oxley Act by the conference committee
tonight, includes a number of penalties that Republicans and some industry groups had
objected to as creating unreasonable burdens on business or a ''gravy train'' for trial
lawyers. (Oppel, 2002).
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