BY MATTHEW HUTCHINS
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Has America lost its way during the tumult of the financial crisis, driven to government excess by angry populism? Or has the sobering effect of instability and loss lifted a fog that had obscured the debate on policy objectives? To former New York Governor Eliot Spitzer ’84, the crisis has revealed the fundamental necessity of government involvement in the marketplace as an enforcer of transparency, integrity, and competition, as a regulator of externalities, and as a source of core social values that will not be guaranteed by the market. “Only government can force rules related to transparency and integrity upon the market.” But Spitzer sees the present moment as full of both opportunity and hazard. “Angry populism is no better guide for rational intervention than is Ayn Rand libertarianism.”
Spitzer spoke at Harvard on Thursday, November 12th on an invitation from the Edmund J. Safra Foundation Center for Ethics, an ironic twist which, in light of his resignation from the governorship of New York in 2008, prompted heightened media attention to his appearance. But the central thrust of Spitzer’s remarks centered on his experience not as governor but as the Attorney General of New York. In that capacity, he conducted investigations of Wall Street that led to the Global Settlement in 2003 to resolve conflicts of interest in the investment banking industry and fines of over $1.4 billion.
After a brief introduction by Professor Lawrence Lessig, the director of the Safra Center, Spitzer outlined the parameters within which government intervention in the markets is a necessary component of economic stability and social justice. Looking back on his experience investigating the conflicts of interest in the investment banking industry, he said, “The market was driving them to a standard of behavior that was the lowest common denominator and it was unacceptable. It would destroy the integrity of the market, and the only way to resuscitate the market was for the government to come in and say something very simple. Tell the truth.” Because of the inherent pressures created by competition for market share, Spitzer believes that government involvement in markets is crucial for the maintenance of transparency, integrity, and competition. “Everyone in business wants to be a monopolist . . . If we don’t have government enforcing competition laws, then we as consumers, we as an economy, will lose the vitality and creativity that competition generates.” Indeed, the consequences of market concentration in the financial sector, combined with the implicit government guarantee of systemic security, has had the unintended consequence, according to Spitzer, of socializing risk and privatizing profit. “Too big to fail is too big, and in fact, too big to fail is too big not to fail.”
Spitzer cited the regulation of harm caused to society and third parties by legal market activities as another crucial component of government activity in private markets. As attorney general of New York he brought suits against electric utilities located in Mid-west states under the Clean Air Act for the harm caused to New York by pollution carried along the jet stream. Now he believes that debt itself has become a system-wide externality that is harming the market. “When you aggregate all of the excess leverage in our economy that has accumulated over the last decade, all of a sudden you have systemic risk.”
But beyond merely correcting for inefficient results of market participants’ behavior, Spitzer recognized a role of the government in molding the character of the economy to accord with shared “core values” that are identified through the political process.
Pointing to discriminatory practices, Spitzer noted that theorists had written extensively about the rational dynamics which should squeeze such behavior out of the marketplace. “The problem is … it just didn’t happen. Discrimination continued because the social values and social morays that drove discrimination based upon race or gender or religion overpowered the rational activity of economic actors.”
Likewise, in setting a minimum wage, the marketplace will not by itself set a lower limit on compensation that will allow individuals to support themselves while working a forty-hour week.
With respect to the current crisis, Spitzer believes it was inevitable that “an enormous sum of money was going to be spent creating both solvency and liquidity.”
Nonetheless, he advanced three primary questions: Who is going to pay for it? What reforms are going to be made? How are you going to create jobs?
The implementation of the bail-out programs, says Spitzer, has unfairly deleveraged private banks through creation of government debt and unwisely channeled taxpayer dollars to unregulated financial counter-parties and failing businesses. “There was absolutely no reason for [AIG’s] counterparties to get 100 cents on the dollar . . . Taxpayers were not a party to that contract.” Spitzer questioned the reasons for failure to renegotiate such contracts by the New York Federal Reserve Bank and the Treasury, pointing in particular to the $12.9 billion received by Goldman Sachs as a counter-party to contracts with AIG. To put this sum in perspective, he proposed the alternate possibility of spending $8 billion to fund high-speed rail infrastructure, or instead of a bailout of GM a possible government contract to purchase electric cars manufactured domestically from any willing producer. “The taxpayer picked up the whole bill, and that was wrong.”
Spitzer expressed dismay that despite his failure to zealously advocate for taxpayer interests, New York Fed Chief Timothy Geithner had been promoted into the lead role at the Treasury. He called this an example of the Peter Principle on steroids: an individual been promoted upward until surpassing the point of his competence, then his failure had been rewarded by a higher promotion, for the purposes of cleaning up the mess he created. Spitzer also scoffed at the proposals by the White House to make the Federal Reserve the national systemic risk regulator. “I hate to break it to you, but they already are and have been. That’s what they were supposed to be doing for the last twenty years. Where were they?” He characterized this as an example of the “regulatory charade”, whereby agencies that had the power to act earlier but shirked from responsibility clamor for greater authority to respond once a crisis occurs. “This is one big façade that should be shattered. They had the power; they didn’t want to use it.” He pointed to the Office of the Comptroller of the Currency’s regulation of mortgage-backed securities as a tragic example of this, stating that when he had sought to investigate the industry as a prosecutor his inquiries had been blocked under the exclusive regulatory authority of the OCC.
But despite his views on the role of government, Spitzer accepts that it is the private sector that has to take the reigns and lead the management of the economy. “The private sector creates wealth, not the government.” He indicated meaningful long-term change will depend on reforms of corporate governance that empower the private sector, such as the disentanglement of institutional investors’ voting powers and their jockeying for business as retirement asset managers. “We have denied ourselves the dynamism that we could get from the largest participants in the marketplace, the biggest repositories of equity ownership.”