By Robert Reich
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.
Get Evonomics in your inbox
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 structure. 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 directors, 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.
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.
Excerpted from Saving Capitalism: For the Many, Not the Few by Robert B. Reich. With permission of the publisher, Alfred A. Knopf