Regulation Takes Its Place: Second Place

06/28/2010 03:08 pm ET | Updated May 25, 2011

Regulation has its place and that place is and always will be of secondary importance to the character of the society it intends to govern. The past months have provided moments of despair and hope. At the end of the day, more than nothing was achieved. I'm not sure how else to put it. The post Conference Committee reports range again from hopeful to disgusted.

Even the most mainstream of media has declared the bill only a partial success even while the President declares it a home run.  I guess given his options, home run or strike out, he must call it a home run.

From Bloomberg:

The overhaul, which still requires approval from the full Congress, won't shrink banks deemed "too big to fail," leaving largely intact a U.S. financial industry dominated by six companies with a combined $9.4 trillion of assets. The changes also do little to solve the danger posed by leveraged companies reliant on fickle markets for funding, which can evaporate in a panic like the one that spread in late 2008.

From CNN:

Zombie banks, take comfort: The zombie regulatory system lives on.

The financial reform legislation hammered out Friday morning on Capitol Hill closes many of the loopholes that led to the last crisis. But it stops well short of breaking the bad habit that has fed outlandish risk-taking for almost three decades: too big to fail.

There are several excellent pieces providing more perspective. Robert Johnson sums it up well.

The financial reform legislation is both disappointing and inspiring. The legislation is the product of a broken government process where dollars overwhelm voters. Lobbying in the gazillions predictably stopped the needed major structural reforms that were revealed by the scope and scale of the financial crisis. As a result we still have "too big to fail" firms with the perverse incentive (subsidy) that their default-free status confers upon them. We still have many practices that are not transparent and many off balance sheet problems that disguise the conditions of our financial firms. We are also still a society that tolerates usurious interest rates on credit cards and payday loans. That is deplorable.

What is heartening is to see how so many people and organizations -- who had little knowledge of this arcane subject matter two years ago -- have contributed the energy to learn and engage and push relentlessly for reforms against the monied odds. Notions such as consumer financial protection, the Lincoln attempts to separate OTC derivatives from the protective umbrella of the balance sheet of taxpayer protected banks, (and she did it in response to a primary challenge, please do not lose site of that fact), and efforts to remove risky activities from the guaranteed funding protections are a tribute to this energy.

It is also heartening to see people like Michael Greenberger, Elizabeth Warren, Damon Silvers, Dennis Kelleher, Matt Stoller, Jane Hamsher, the AFR team, Bob Kuttner and Senators Cantwell, Dorgan, Levin, Kaufman and Merkeley leading this formidable effort.

So after time to reflect, I would declare a partial victory.  More was accomplished that was originally hoped by all but the most ardent reformers.  Less was accomplished then might have been hoped at the high water mark of the negotiations.

Once the bill is passed and signed into law, the primary issue will return to what Simon Johnson and James Kwak pointed it out to be so early in this discussion, Regulatory Capture. Much has been turned over to regulators to study, implement, and oversee. Failure here will be failure of the potential of the bill, and let's face it, the bill does not have that much potential. The epic battle financial firms have waged over this regulation will be continued, with much less fanfare, in hearings and in strategy sessions on how to circumvent the spirit of the legislation, invent now products that render it meaningless or assess new charges to pass costs right back on to consumers and businesses. The big banks will not easily relinquish their share of GDP or corporate profits.

To return to my original premise, regulation was not going to fully solve our problems no matter what was passed. Ultimately we must have a civilized free enterprise system based on integrity, justice, fairness, transparency and moderation in many forms. Otherwise, we risk the fall of capitalism as the ultimate consequence of exploitation. Do not disregard the fault lines in our system. Regulation (if it is effective) can facilitate some measure of these essentials. But sophisticates can often work in the nuances or vaguenesses of the regulatory system.

In fact, just this week arch villain CEO Jeff Skilling of Enron infamy drew some hope from a Supreme Court decision that might vacate a key part of his conviction. The timing could not have been more tragically ironic. Within 24 hours Christopher Dodd had in a legislative payoff removed a key provision of the Financial Regulation bill that would have provided some clarity to what is a financial crime.

Regarding the Supreme's ruling, the vagueness of the applicable statute called into question whether it provided sufficient basis in law for most of his criminal convictions.

In an opinion written by Justice Ruth Bader Ginsburg, with varying support from other justices, the court found the honest services law used against Skilling covers only bribery and kickback schemes, and Skilling was accused of neither.

The court found that Skilling did not violate the honest service statute as the court interprets it.

"There is no doubt that Congress intended (the statute) to reach at least bribes and kickbacks," Ginsburg wrote. "Reading the statute to proscribe a wider range of offensive conduct, we acknowledge, would raise the due process concerns underlying the vagueness doctrine."

From Jim Cox, Duke Law Professor posting at TheParetoCommons:

Shame on you Christopher Dodd. You had a chance to address one of the serious weaknesses in financial reporting - the lack of individual accountability for fraud - any you deftly steered away from the problem and into the hands of those who have only their interests to be served.

The issue at hand is that there is white collar crimes, even those of great import, are very difficult to prosecute.  The most obvious fraudsters can often escape the administration of justice under a variety of legal shortcomings.  Here are some examples:

The Supreme Court's narrow view of who can be a primary participant under the antifraud provision has prompted the lower courts to repeatedly reach results at odds with imposing just desserts on violators. For example, Pugh v. Tribune Co held the Supreme Court's reasoning insulated from responsibility the senior executive who inflated his subsidiary's revenues and income. In re Nature's Sunshine Products Sec. Litig. holds that the CEO who falsely represents facts in a letter to the firm's auditor so as to obtain an unqualified audit opinion is not liable under Rule 10b-5. And, most recently, in Provident Investment Management LLC v. Mayer Brown LLP, the Second Circuit absolved the attorney who fraudulent participated in his Refco's financial gimmickry that fraudulently concealed the depth of Refco's financial problems.

So it falls to our culture to not singularly focus on government as the solution. We must call upon the highest instincts or our own humanity and draw that out in others as well if we are to prevent future crisis and provide a measure of security to all our citizens. We are fortunate to have many able leaders who can help guide the way. Keep the conversation going.