Read Why Government Fails So Often: And How It Can Do Better Online
Authors: Peter Schuck
White-collar defendants are often represented by highly skilled attorneys who previously worked as prosecutors and know how to create “reasonable doubt” in criminal cases. Some violators try to cover their tracks by destroying evidence, intimidating hostile witnesses, and creating smokescreens by attacking the government. The government’s evidence or tactics may be inadmissible or, as in the case of complex accounting and financial data, hard for the jury to follow. Juries uneasy about the government’s tactics, such as relying on testimony by informers who are themselves convicted criminals, may sympathize with the defendant. This is particularly true if the defendant is a small fish compared with other offenders whom the government is not prosecuting for one reason or another.
Second, the officials who run the regulatory agencies tend to be mindful of the need—both political and bureaucratic—to cultivate and sustain the regulated industry; they seldom are militant opponents or radical reformers of that industry. In the rare cases in which they are aggressive critics—for example, Craig Becker, a recess appointment to the National Labor Relations Board (NLRB), they are not renominated. The formal confirmation process and the informal norms of reciprocity that surround it practically assure that top regulators will be cautious and compromising. The protracted battle over the nomination to the Federal Reserve Board of the superbly qualified Nobel laureate economist Peter Diamond, led him to withdraw his name in frustration and disgust. Republicans’ refusal to confirm Richard Cordray, a former Ohio prosecutor, as director of the recently
established Consumer Financial Protection Bureau caused President Obama to make a recess appointment of him, which took two years for the Senate to confirm. Recess appointments to the NLRB have been challenged in the courts.
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Sometimes firms can in effect select their own regulator and supervisor. Banks, for example, may choose federal or state charters, and may decide (within limits) whether to operate as a savings institution or a commercial bank, subject to somewhat different regulatory schemes.
Third, congressional appropriations for enforcement, as already noted, tend to be woefully inadequate. This point is vividly illustrated by ineffective policing of the vast and politically powerful securities industry by the SEC and federal prosecutors.
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Arthur Levitt, SEC chair from 1993 to 2001, claims that congressional overseers constantly threatened him with budget cuts if he was too aggressive.
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The agency notes that while other financial regulators have close to parity between the number of staff and the number of entities they regulate, SEC staffing and funding have not kept pace with industry growth in recent years.
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Congress and the courts, sometimes abetted by the agency itself, have limited the availability of private class actions and other legal remedies against market malefactors, remedies that could augment the agency’s own meager enforcement budget and use the formidable self-interest of plaintiffs’ lawyers to strengthen the enforcement process. Nowhere was this clearer than in the Private Securities Litigation Reform Act of 1995, in which Congress, while remedying some abuses in private securities class actions, also made it much more difficult for such actions to be brought at all.
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A fourth reason for weak enforcement is that the enactment and administrative implementation of regulatory statutes is always shaped by a process in which industry lobbying plays an important role. Lobbyists provide valuable services to legislators and their staffs—technical expertise about the industry; political intelligence; anticipating how particular provisions will operate; rebutting opposition arguments; drafting statutory language and speeches; proposing compromises; testifying at hearings; creating legislative history; and mobilizing political support through grassroots organizing, coalition building,
public persuasion, and other forms of advocacy. In exchange, they expect the final version to protect their clients with language that will reduce the incidence of future violations, prosecutions, penalties, and private lawsuits. One example is the extensive participation by financial industry lobbyists in writing laws that regulate their clients.
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Another is attorney-client privilege protection legislation, which the white-collar defense bar promoted to limit prosecutors’ access to their clients’ legal and financial transactions. When it bogged down in Congress, the Department of Justice agreed to incorporate much of it into its enforcement policy.
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Fifth, the specific regulations that agencies promulgate to implement such statutes (a process described in
chapter 2
) tend to be highly technical and intricate. They are drafted by the agency’s policy specialists and lawyers, often after consultation with business lobbyists. The regulators try to anticipate their industry counterparts’ evasive tactics by eliminating possible loopholes and foreclosing even low-probability evasions. Their adversaries, however, tend to be more highly trained and paid, better supported organizationally, and more knowledgeable about how their markets work, and are often a step ahead of the regulators. Ironically, for reasons discussed in
chapter 9
, regulations’ complex architecture may actually make them easier to evade. Indeed, no level of detail can entirely eliminate ambiguities, which sometimes are inadvertent but which drafters, often guided by lobbyists, may insert intentionally to conceal policy conflicts or to give leeway to market actors or government enforcers. This process shaped the much-heralded rules issued by the Consumer Financial Protection Bureau in early 2013 to reduce the risk of future home foreclosures.
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Industry lawyers can use these ambiguities to craft plausible arguments about the words’ meaning and purposes, how they could and should be applied to specific situations, inconsistencies engendered by the larger text, and the way that different interpretations advance or retard putative policy purposes. These arguments, if plausible, make it harder for government lawyers to prove a criminal or even civil violation.
A sixth reason for weak enforcement inheres in the complex, protracted negotiations between the government and the target entities that may both precede and follow a decision to go forward with the case. The cost of government enforcement, and uncertainty about how judges and juries will assess the strength of its legal, factual, and policy arguments, often weaken prosecutors’ negotiating position—a vulnerability that industry lawyers are trained to detect and exploit to great effect. For example, federal banking regulators, embarrassed by having paid more than $1 billion to consultants for a deeply flawed review of foreclosed home loans, accepted a settlement with major banks that reflected this weak bargaining position.
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If the prospect of a protracted jury trial with an uncertain outcome daunts prosecutors more than their adversaries, it may accept a plea bargain in which the industry pays a fine but acknowledges no guilt.
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Such pallid “go and sin no more” rebukes may in turn reduce deterrence of other possible violators. (Although this practice continues, some federal judges, led by Judge Jed S. Rakoff, have begun to insist that settling defendants in such cases acknowledges their guilt.
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)
Then there is the sheer force of incompetence, whose effect on enforcement should never be underestimated. The SEC’s inspector general issued a scathing report detailing the agency’s failure to investigate epic fraudster Bernard Madoff’s $65 billion scheme despite complaints by securities experts going back to 1992 that raised red flags.
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In April 2013, for another example, the Government Accountability Office (GAO) detailed a botched effort by the Federal Reserve and the Comptroller of the Currency to review the implementation of federally mandated payments by banks and other financial institutions to homeowners subjected to illegal and abusive mortgage foreclosures. The GAO report found that the regulators had designed a flawed review of the troubled loans, including requiring the institutions
to hire independent consultants who then did delayed, shoddy work at very high fees and sometimes with conflicts of interest under contracts that were poorly designed, inconsistent, and unenforced. As a result, many homeowners did not receive the relief to which they were entitled.
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Finally, politicians sometimes seek to restrain enforcement against putative violators who are their constituents, allies, or favored interests. After the government has brought formal charges against a company, and perhaps even earlier, when an investigation is actively pending, such interventions or even subtler pressures may be unethical or possibly even constitute obstruction of justice, but they still sometimes occur.
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Politicians, however, seldom need to go so far. They have other ways to signal both their intense opposition to an investigation or prosecution and their willingness to raise the political cost to the government of going forward with the case.
In sum, markets frustrate government enforcement efforts in their initial design (the proindustry frame of the authorizing legislation), their implementation (the forces that limit appropriations and enforcement authority), their senior staffing (the often politicized confirmation process), and their broad prosecutorial discretion (immunities from review). As a practical matter, a program cannot be effective, even in its own terms, unless two conditions are met: (1) almost all market actors voluntarily comply with its requirements, and (2) the relatively few violators are either brought into compliance quickly or punished sufficiently to deter future violations. To a great extent, condition 1 depends on condition 2 being fulfilled. These two conditions fail in some important programs. The Internal Revenue Service estimates that the incidence of noncompliance with the tax laws was about 17 percent, amounting to $385 billion in lost revenues in 2006 (the most recent year studied), the vast majority of which was personal income tax.
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The failure to prevent widespread fraud in federal programs also undermines these two conditions.
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Indeed, massive
fraud, waste, and abuse by market actors, discussed in
chapter 6
, continue despite a host of independent inspectors general, government audits, congressional investigations, and perennial “get-tough” campaigns.
Rational expectations
. The elaborate “dance of legislation,”
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followed by the complex process of agency implementation described in
chapter 3
, combine to create long lags between the time when a legal change becomes likely and the time that it actually goes into effect. During this interregnum, market actors affected by the change can take steps to reduce the ultimate burden (or increase the benefit) that it will impose on them. Such law-anticipating, cost-reducing actions are ubiquitous, even routine (as with tax planning). Within days of the school shooting tragedy in Newtown, Connecticut, for example, gun sellers reported a surge of purchasers anticipating tighter regulations in the future.
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This exemplifies an exceedingly important phenomenon: what economists call “rational expectations.” They posit not only that market actors will behave in profit-maximizing ways when government attempts to implement new policies (
chapter 8
details such behavior), but also that the same will occur once they predict that changes will be adopted in the future. Economists who analyze, for example, market adjustments in anticipation of monetary policy changes by the Federal Reserve and fiscal stimuli proposed by other policy makers often disagree about the size, timing, and effects of such anticipatory market adjustments. To the extent that these adjustments do occur, however, they can seriously reduce the effectiveness of the impending policy change, sometimes even rendering the change counterproductive.
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Lack of good substitutes for market ordering
. Social anthropology teaches that three kinds of institutions or practices are most useful for organizing and motivating human activity: legal rules, social norms,
and markets. This chapter has analyzed why markets resist government controls, rendering many public policies ineffective. Social norms—the shared beliefs, common practices, and mutual expectations among members of a group—play an important, even essential, role in all social ordering. Informally and often unconsciously, they coordinate an immense amount of conduct and thought, including much market behavior.
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Yet for reasons that I have explicated elsewhere, they are not realistic alternatives to markets.
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This leaves law as the principal regulator of markets. Yet law’s limitations—both the internal, structural ones to be analyzed in
chapter 9
and the external, empirical ones detailed in the rest of the book—frequently render it ineffective under the best of circumstances.
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BP’s record-setting criminal fines in the Deepwater Horizon disaster case were unusual, but represented only a small percentage of the company’s profits in 2012. See Clifford Krauss & Stanley Reed, “BP to Admit Crimes and Pay $4.5 billion in Gulf Settlement,”
New York Times
, November 15, 2012.
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Here are two of countless examples. GAO audits of Amtrak’s food and beverage services found losses of $834 million since 2002, “largely because of waste, employee theft and lack of proper oversight.” The GAO reported on this in 2005; seven years later, it was continuing unabated. See Ron Nixon, “Amtrak Losing Millions Each Year on Food Sales,”
New York Times
, August 3, 2012. A federal audit finds that one in four nursing homes overbill Medicare $1.5 billion each year. See Thomas M. Burton, “Nursing Homes Said to Overbill U.S.,”
Wall Street Journal
, November 12, 2012.