Capturing the Regulator

The original vampire squid: Standard Oil.

We continue to experience fallout from the banking crisis and see that many of the problems were caused by captured regulators. Problems with Fannie Mae were ignored by Barney Frank and the House committee appointed to oversea the mortgage giant’s activities. The NY Fed under Timothy Geithner appears to have been closer to Goldman Sachs and other large banks that its regulatory charter demands. We’ve seen this at the SEC also, as investment banks were able to convince the agency and the senators and congressmen who oversee its activities that deregulating risky activity was a good thing that wouldn’t led to market meltdowns as it had in the past.

We’re still seeing the fall out from continued rent-seeking activity by huge megalocorporations and their captured regulatory agencies and politicians. It’s in more industries than just the financial ones. Since the Reagan years, we’ve seen ongoing defunding of agencies and capture of agencies by the regulated who find ways to buy politicians through lobbyist activities. All of this had led to huge messes in nearly every sector.

Bloomberg.com has further examples of this public-welfare destroying behavior in Regulators Hired by Toyota Helped Halt Investigations. We learn in this piece that many lives were lost because Toyota insiders at the National Highway Traffic Safety headed off “at least four U.S. investigations of unintended acceleration by company vehicles in the last decade, warding off possible recalls, court and government records show.”

Christopher Tinto, vice president of regulatory affairs in Toyota’s Washington office, and Christopher Santucci, who works for Tinto, helped persuade the National Highway Traffic Safety Administration to end probes including those of 2002-2003 Toyota Camrys and Solaras, court documents show. Both men joined Toyota directly from NHTSA, Tinto in 1994 and Santucci in 2003.

While all automakers have employees who handle NHTSA issues, Toyota may be alone among the major companies in employing former agency staffers to do so. Spokesmen for General Motors Co., Ford Motor Co., Chrysler Group LLC and Honda Motor Co. all say their companies have no ex-NHTSA people who deal with the agency on defects.

Possible links between Toyota and NHTSA may fuel mounting criticism of their handling of defects in Toyota and Lexus models tied to 19 deaths between 2004 and 2009. Three congressional committees have scheduled hearings on the recalls.

“Toyota bamboozled NHTSA or NHTSA was bamboozled by itself,” said Joan Claybrook, an auto safety advocate and former NHTSA administrator in the Jimmy Carter administration. “I think there is going to be a lot of heat on NHTSA over this.”

Another corporate whistle-blower is showing how corporate negligence may cost cities and states millions of dollars to replace exploding and cracking PVC pipes. This is from the NY Times. It’s typical corporate behavior. The certification agency here was not ‘informed’ of the changes used to increase production, decrease costs, and of course, feed the bonus class kitty.

JM Eagle was created in 1982, after the bankruptcy of Johns Manville, the first major corporation to seek protection from asbestos claims by filing for bankruptcy. The elder Mr. Wang bought the pipe division out of bankruptcy that year, renamed it JM Manufacturing and added it to his empire. (The company became JM Eagle after acquiring PW Eagle in 2007.)

PVC pipe had been just a small part of Johns Manville’s business, but Mr. Wang made his acquisition at a time when the plastic was fast catching on among cities replacing their older, decaying water systems. For several years, managers stayed on at the company and participated in the development of new standards for plastic pipes.

Mr. Hendrix said in his complaint that after Walter Wang became chief executive in 1990, many of the longtimers resigned or retired, and people who had minimal backgrounds in engineering or failure analysis replaced them.

JM Eagle also put a premium on cutting costs, Mr. Hendrix said, hiring people like him straight out of college. It even maintained a boarding house near Livingston for Taiwanese employees who could not afford suburban New York housing on their modest salaries.

One of his first jobs was to field customer complaints, which he said came in at the rate of at least one a day. He said he was trained to look for ways to attribute leaks and ruptures to the governments and contractors who installed and maintained the pipes.

Only when he was assigned to oversee certain tests did Mr. Hendrix begin to think the complaints stemmed from the company’s own cost-cutting measures. He said he realized JM Eagle had started buying a lower grade of raw materials from Formosa and had speeded up its production lines without reporting the changes to the certification agencies as required.

Republicans continue to label these instances of corporate malfeasance as pending “junk lawsuits” while lives and taxpayer monies indicate they are anything but nuisance. Who is going to pay for these faulty pipe systems? (These are problems economists study and we find the costs of “externalties” usually go to the taxpayer.) Will it be the same folks that are paying for the financial industry meltdown; the U.S. taxpayer? It most certainly will not be the C.E.O. whose short-sightedness and cost reducing behaviors are firmly rooted in bonuses present and past. They cannot be held legally accountable with either their personal network or their freedom because, the corporation is a legal entity all to itself. The worst we can do is watch them go bankrupt and then re-organize to avoid the financial penalties. You can’t put Toyota in Jail. You can see that JM Eagle was a corporation that formed out of the ashes of an earlier corporation that folded to avoid lawsuits from asbestos deaths. They are not unique at all in that behavior. It’s been going on since the courts decided that corporations get limited liability treatment.

One of the stories that I use for my economics class to illustrate these problems is the Radium Dial painting women whose jobs were basically to paint the luminous paint on watch and clock hands back in the 1920s. The original paint contained incredible levels of radioactivity. I saw the documentary about them and the horrible cancers that killed them in a documentary released in the mid 1980s. Many of them died so full of tumors and so full of radio-activity from licking the tips of the brushes or decorating themselves with the radioactive paint–because they were never told of the dangers–that the government has had to go back to their graves and encase them in led boxes because they emit high levels of radioactivity. The company folded to avoid all the costs of clean-up and the survivor lawsuits. The sites of the old factories continue to be problems in places where the factories were located.  The most famous was located in Ottawa, Il.  Many of our regulatory agencies were formed to avoid situations just like this. There’s a book that you may want to read if this interests you also. Here’s a quote from the link provided above.

It isn’t clear how well known the dangers of radium were in 1917 but no warning was given to the workers. The radium companies denied the dangers of imbibing radium despite the consensus of opinion among most medical experts and government officials that it was dangerous. The dialpainters were such a minority and lacked any financial resources to have any clout in dealing with industry. The battle for recognition of this health hazard to these women went on for many years.

A book titled “Radium Girls: Women and Industrial health reform, 1910-1935” by Claudia Clark was published by The University of North Carolina press, Chapel Hill and London in 1997 (ISBN 0-8078-2331-7 cloth and ISBN 0-8078-4640-6 paperback.) This is an excellent source of information on the subject. It is well documented with many references and an extensive bibliography.

A 1-3/4 hour film titled “Radium City” was made in 1986 about the aftereffects of two radium dial painting companies based in Ottawa, Illinois. The city of Ottawa, IL is about 80 miles southwest of Chicago. The Radium Dial Company (RDC ) moved from the East Coast to Ottawa in 1922. Joseph Kelly was president. The first problems of radiation exposure occurred with the young women who applied the radium paint to the dials. According to the film, RDC went out of business in 1934 after being faced by many lawsuits. Luminous Process Incorporated (LPI) started soon after also headed by Kelly. It operated from 1932 to 1978 when the NRC shut it down. Both factories were demolished, RDC in 1969 and LPI in1984 and much of the material was used as land fill. As a result there are 13 areas today with above normal radiation in Ottawa. The major contaminant is radium-226 and the by-product, radon-222. For more information see the Petitioned Public Health Assessment, Ottawa Radiation Areas, Ottawa, Lasalle County, Illinois

It isn’t known if the radium dials used by Jefferson starting in 1949 were painted by their employees or even done by Jefferson at all. They may have been sent out to be painted. In any case, working conditions were improved by that time but use of the paint was eventually banned.

This is the primary problem with granting corporations their own legal status. Investment bankers used to be mostly be professional partnerships. Recently, they switched to the corporate structure and many are saying that the limited liability (in other words if you screw up they can’t come after your net worth) is one of the reasons they took on so much risk. They no longer have “any skin in the game”.

There is, however, a better solution: expose players in the financial game to greater personal loss if their risk-taking fails. When you worry that a mistake will cause you to lose your second home, your stocks and bonds and your club memberships, then you’re less likely to take the kinds of risks that expose the rest of society to your failures.

A simple mechanism exists to achieve this purpose: the private partnership. Partners face liability that extends to their personal assets. They aren’t protected by the corporate shield that limits losses to what the corporation itself owns (as well as the value of the stocks and bonds the corporation has issued). Unfortunately, the partnership is a legal form of business organization that was largely abandoned by banks over the past quarter-century. Our advice is to bring it back. In other words, don’t nationalize; partnerize.

Even John Gutfreund — the man who kicked off the dramatic change in investment-banking culture and structure when he took Salomon Brothers, a longtime partnership, public in 1981 — confirms our thesis. Michael Lewis wrote in the December issue of Condé Nast Portfolio that Mr. Gutfreund now believes “that the main effect of turning a partnership into a corporation was to transfer financial risk to the shareholders. ‘When things go wrong, it’s their problem,'” said Mr. Gutfreund.

But when the personal wealth of executives is put at risk, as it is in a partnership, their behavior changes. Risk aversion increases. Few partnerships would leverage themselves to the hilt to load up on risky subprime loans.

Not only do these corporations give their management cover for bad decisions, they can raise tons of money in public markets and then use that money to buy political influence and now, after the supreme court decision, to buy ads to further influence elections. These giant corporations whom we give too-big-to-fail status, will in fact place themselves into bankruptcy or collapse to avoid the costs of their externalities. One of the biggest costs is the overproduction of products and services because they don’t reflect the true costs of doing business until it’s usually too late for any one to do something about it. This is exacerbated by neutered or captured regulators. Something that buying the political class achieves.

We need to take a serious look at what many folks are peddling out there as free market capitalism because it’s not free market capitalism. Regulations are there to protect us from bullies just like laws are supposed to do. Third party payers and huge megalocorporations in highly concentrated markets with huge market powers and the ability to influence the market are not what Adam Smith had in mind when he spoke of the invisible hand. Regulation exists to even the playing field when these power players exist,to ensure that markets function under proper conditions, and to hold entities responsible for the costs they create when they make messes.

Since the Reagan years, we’ve gotten one mess after another in one market after another from not realizing and acting on corporate malfeasance. Yes, they create jobs and products but those are by-products of their real purpose which is to maximize profits. They may run ads about loving fuzzy animals, but that is to create an image to help them further their profits. We need major changes in laws that recognize that not all byproducts of economic enterprise by businesses are positive. Most of the good stuff does not come from the huge bully boys. It’s time to evaluate and change the laws surrounding incorporation and to enforce the Sherman Antitrust law again. If we can’t lock them up in jail for doing harmful things to people, then they shouldn’t be granted the same status in the courts as people.