With renewed controversy over the nature & extent of any proper Governmental role in the regulation of economic decisions that influence or control commercial activity, some comments are in order. Unfortunately, a background in which America may be on the cusp of economic chaos, is not a time when sober & reflective analysis is the "order of the day." The recent panic in Washington has set a tone both here and abroad; and while the focus there, notwithstanding the imposition of new "regulations" in financial markets, has been primarily on creating more liquidity by "appropriating" new funds out of fiat money; our focus here will be confined to the question of regulation. The consequence of purchasing assets with funds that do not exist, needs little additional comment.
The question, of course, is not one of regulation or no regulation. But the subject requires a recognition of both psychological and economic reality among human types in general, and, in the specific context of the United States of America, an understanding of the functional intent of our written Constitution.
The market economy works best in all advanced human societies, because--correctly understood--it puts every individual on his mettle, both to be personally responsible and to find what he can do best, with whatever talents he may have that others value, if he would enjoy material success. The issue, then, is not necessarily between the market and regulation, but between the "market" and regulations that impair rather than facilitate the free, voluntary and dynamic interaction of law-abiding individuals. The issue is between proper and improper regulation.
If one steps back from the rhetoric of the Left, which implies an inherent conflict between free markets and desirable regulation, clarity is more easily obtained. Among those operating within a social order that allows & encourages self-motivated individual pursuits, the presence of politically directed restraints that deal with those who would steal from a market participant within that social order, create no problem. Yet while prohibitions on theft--whether overt or by fraud or deception--as State laws on rape or arson, certainly seek to regulate behavior, they may not seem as "regulations" of business in the sense of the current debate. Certainly they are not antagonistic to private property. They tend, clearly, to facilitate, not restrict, economic freedom. They aid, rather than inhibit, the production of real wealth--indeed to protect the individual accumulations of capital that are the essence of the Capitalist system.
The Constitution of the United States, as we have frequently observed, deals primarily with commerce and defense. While it also sets forth rules intended to promote amicable interaction between the several States, these must be viewed as ancillary to fundamental purposes: A common basis for dealing with the world at large, while achieving the economic benefits from a commercial & monetary union; the ultimate goal, always, "to secure the Blessings of Liberty" to an ongoing "Posterity."
Taken in this context, it is wholly consistent that the Federal Government was granted no power to alter social values or cultural variations among the diverse communities of the constituent States; yet all powers, reasonably needed, to provide an optimum climate for a flourishing commerce. Basically, the latter fall into two categories:
1. Affirmative duties to provide a predictable foundation for markets, with uniform weights and measures, a strong currency, and a judicial mechanism for resolving disputes across State borders.
2. Problem prevention in agreed limitations on direct Federal taxation of individuals, and in provisions that the States can not impair the obligation of contracts, pass ex post facto laws, place tariffs on goods from sister States, or cheapen the medium for the payment of debts, etc.
To treat unanticipated problems with the free flow of commerce, Congress was given a general--as opposed to a particular or functionally specific--power to regulate commerce among the States and with the Indian Nations. We stress the general nature of the power to distinguish what was actually delegated, from the gross abuses of the interstate commerce clause over the past 100 years, which have contributed immensely to the present financial crisis. It is important that the reader understand the essential distinction between the Constitutional focus on General Welfare and the never intended, but now common, contemporary focus on the special or particular needs or desires of favored groups or subsets of the population.
There is a brilliant--"cut to the chase" to avoid the past excesses of human folly--balance & symmetry in the Federal Constitution, which is completely undermined by special interest legislation. There may, indeed, be implied powers in the Commerce Clause, but only such as are consistent with both the letter and spirit of specifically focused, enumerated, powers & limitations that deal with economic issues. The very concept of implied power at variance with, or to defeat, the purpose of a clear, consistent & cohesive structure--every provision of which having general applicability, intended to provide a predictable, defensible, legal foundation for those making voluntary bargains in a free market--is absurd. In brief, the Framers of the Constitution sought to achieve a mechanism to prevent the very commercial "melt-down," which two generations of social theory, run amok in Western nations, have now brought down upon the World.
The point is that the Federal Government of the United States, both by action and inaction (by not meddling in many of the areas that it has), could have done a great deal to head off the present "melt-down" in financial institutions, within both the letter & spirit of the Constitution. In discussing considerations & the parameters, which should have governed what ought to have been done and what ought to have been avoided, we will attempt to offer a constructive program, while clarifying the dynamics involved.
One could be flippant--yet perfectly correct--to suggest that the first thing that Congress & the Executive should have regulated (or restrained) was a reckless inclination to abuse their offices and sworn duties in pursuit of personal wish lists, intended to curry favor with targeted constituencies; behavior in violation of their oaths of Office. But that subject would be better addressed in a Bill of Impeachment, or an essay solely focused on what should not have been done--on the ways commerce was hindered with inflationary public debt & idiotic social theory. Our more precise focus, here, will be on what regulation might have accomplished to arrest the critical misbehavior of those in commerce:
1. If not primary from an historic perspective, obvious in the present context; there should have been more regulation of the interstate marketing of financial instruments--whether "derivative" or pure quackery--to the public or to publicly traded corporations, where there was no meaningful way to accurately measure what was involved. Under the intended Federal system, one who sells Kansas wheat by the bushel in Maryland must use the same standard measure as in Kansas or Ohio. Yet what has been offered in contemporary financial markets has included items for which no one can determine, with any clarity, what is actually involved. In the instance of the recent mass bundling of home mortgages into interstate commerce--each home mortgage being both unique and inherently local in nature--it is difficult to imagine how such practice should ever have been considered acceptable, either in law or usage.
Every home derives its particular value from a host of variables peculiar to its physical condition, its immediate neighborhood (including ongoing developments, demographic changes & perceptions of such), the local economy, schools, etc.. Compared even to the often confusing problem in evaluating prospects for one of today's vast international conglomerates, a large bundle of home mortgages is infinitely more obscure.
In the case of the conglomerate, management actively interacts with the workings of its diverse units. It also collects data to report quarterly performance. But the only meaningful gauge, likely from a large bundle of diverse mortgages in widely scattered communities, is on those "current" and those in default. A host of possible, unmeasurable, factors, which might at any moment be moving a completely indeterminate percentage of the previously compliant mortgages towards default, can never be accurately quantified. As compared to our constant measure of a bushel of Kansas wheat, mass mortgage bundling would be analogous to a grain merchant seeking to market standard bushels containing a totally undefined admixture of wheat, rye, hay, lawn seed and a wide variety of weeds.
If wealthy speculators, in a privately funded equity group, want to speculate on such folly, it is one thing. But a public, conditioned by long usage to expect accurate (reliable) measures in a free market, must have the means (reliable information) to protect itself from exchange traded companies that follow suit. Of course, the amount of weed material, in our metaphorical bushel, is almost totally the result of leftwing ideological pressures from the same gaggle of Washington politicians, who now denounce the idea of unregulated free markets: Men & women who have failed in their Constitutional stewardship to maintain predictable measures & sound money--those who have indulged unproven sociological theories & personal wish-lists to force a major lowering of credit standards & requirements in the home mortgage market, the direct precipitant of the present crisis.
Lacking understanding or respect for the Constitutional purpose, they failed to recognize or deal with a developing threat to the intended legal foundation for a free market, provided in the Constitution. Undisciplined, even to a recognition of the limitations on their own legal authority, they have indulged the fantasy that one can create real wealth out of market manipulation or by subsidizing human under-achievement. The crisis results not from market economics, but from a substitution of ideological fantasy for the maintenance of traditional concepts of law & order in the political realm.
2. An at least equally critical area, with respect to legitimate Federal regulation of interstate security markets (as also to State regulation of permissible structures for large, publicly traded, corporations), depends upon a recognition of fundamental changes in the effective control of major corporations over the past two generations. One can judge the perceptive level in Congress from the fact that while members have publicly assailed the absurd level of compensation received by Managers of certain failed corporations--including outrageous retirement benefits for some of the worst mismanagers in corporate history--few, if any, have addressed the functional dynamics that have made what they decry, possible. We will try to fill the void:
In the first half of the 20th Century, America had many large, publicly traded, corporations still under the effective control of entrepreneurial families; owners able to effectively bargain with both their white collar and blue collar employees; owners able to control managerial salaries. "Managers," even in the head office, had to answer to ownership no less than did laborers working in the shop. Then, a gradual sea change took place, which called for changes in Corporate Law that have not taken place.
As those corporations expanded, often by issuing additional shares of stock to new holders; as entrepreneurial nest eggs were further diluted by confiscatory inheritance taxes, or fragmented among the heirs of the founders; the corporations gradually morphed into entities, where the entrepreneurial family was fortunate to have even a seat on the Board of Directors. Virtually total control passed to hired Managers, as a class; Managers, now largely in a position to select sympathetic Managers from other corporations for the Board of Directors; yet other Managers to serve on such self-serving devices as "peer review" committees, to justify astronomical pay raises & absurd retirement benefits.
Bearing critical relationship to the present meltdown--as often an incentive to reckless behavior--have been increasingly generous awards of "performance based" bonuses and stock options, in most cases allowing inflationary distortions, caused by irresponsible Government, to work for the Managers and against ownership. Yet, while such Managers derive an unearned benefit from inflation, they never have to repay any part of previous benefits if, through blunders, the corporation loses rather than gains, in real terms, during their tenure. Although shareholders may get to vote on whether to approve such "incentives," they are presented as a package, with little or no opportunity to modify, and only a very slight chance to reject; for management will vote all unmarked proxies on the issue, in favor. Managers can also usually rely on proxies controlled by Managers of other corporations for support.
What most Legislators appear not to grasp, is that higher levels of American corporate management now act more like Masters, rather than Servants, of the corporations they are supposed to serve; that, functionally, a condition analogous to a form of legalized embezzlement has evolved, which must be addressed. To dramatize the effect of letting one class of employees define their own value without effective challenge from an employer, consider the exponential increase in the ratio of the pay of upper management to that of "blue collar" workers--who must still bargain over their pay rates--in major American corporations.
The situation not only deprives the shareholders in a corporation. It stirs envy & resentment among the fellow servants of the Managers, both in the office and in the shop, who--unlike the Managers--are not able to effectively appropriate corporate resources in their own interest. The effect on general morale has to damage the enterprise as a whole, while stirring not so subtle political tendencies that undermine support for the free market, intended by the Constitution: The key to American prosperity.
Use of the corporate mechanism is a legal privilege. As such, it is more subject to regulation and restriction than any individual, operating on his own behalf, would be. Incorporating States need to set up mechanisms, within the authorized corporate structure, to reestablish effective shareholder control overcorporate Managers. But if Congress can act to prohibit use of the Mail to defraud, or the interstate marketing of unregistered securities, it can certainly deal with interstate marketing of securities to innocent buyers, where there is no effective mechanism to rein in self-serving Managers. The reform needed could take one of several forms, so long as the mechanism, established, was independent of control by the existing management--or those with a kindred contemporary interest in other corporations--and the fiduciary duty, clearly defined. The mechanics could be the subject in another article. Our purpose, here, is merely to identify a need.
3. There are two other areas, with respect to Congressional regulation of markets & business behavior in publicly traded corporations, which must be considered: Excessive corporate bonus packages--incentives to reckless behavior--and reform of Chapter 11, Bankruptcy procedures. While we addressed the first in the context of Managers running wild against ownership, above, there is a concern not fully met, even if theManagers were reined in as suggested. The strike prices of employee, incentive intended, stock options need to be indexed for inflation, even if brought more effectively under the control of ownership. And possible means to recapture benefits obtained by Managers for apparent success, which later--as in situations recently spotlighted--has turned out to be illusory, should be investigated. (Yet please note: We certainly do not advocate punishing anyone, where no fault has been established.)
The problem with current Bankruptcy procedures, is that not only do shareholders lose out in relation to the bond & other debt holders--which cannot be helped, legally. The shareholders also usually lose out in relation to the very Managers who ran the corporation into insolvency. In instance after instance, a corporation emerges from Bankruptcy with the former common stock worthless, but the failed management still in place. Ways to more effectively balance loss, between management & ownership, would be only fair.
4. For the long term stability of our economic system, nothing is more essential than for Congress to grasp the need to return to sound money. The day when Keynesian manipulation might be tolerated is past! Indeed, if the Central Bankers of the West have accomplished anything in recent weeks, they have demonstrated a new corollary to Gresham's Law (that bad money drives good into hiding): Flooding a market, already saturated with bad (Fiat) money with more of the same--at least temporarily--sends even bad money into hiding! Or, perhaps stated another way, the Keynesian mechanism for confusing labor into believing that real wage levels are being maintained, when cheap money is actually driving them much lower, just doesn't work so well, when applied to those more experienced in banking and finance.
Nothing was more essential in the Constitutional mandate for the intended free market--nothing more central to the vision of a prosperous America--than a sound currency. It profits us little, if all other weights & measures are "uniform," if contracts are certain in every other particular, if the medium of exchange--the medium for the payment of debts both current and deferred--is uncertain in value and subject to political manipulation. The specific prohibitions on State action in Article I, Section 10, with respect to private bargains in a free market, are clearly in point:
No State shall . . . coin Money, emit Bills of Credit, make any Thing but gold and silver coin a Tender in Payment of Debts; pass any . . . ex post facto Law, or Law impairing the Obligation of Contracts.
We do not suggest a reckless effort to restore predictability and a hard, gold-backed, currency by decreeing a return to a specific former exchange rate. The British made that mistake in the late 1920s, and their error has been used as an argument by those advocating the continued soft money & fiscal irresponsibility, that has now taken the developed world to the cusp of chaos. Yet the great Austrian economist, Ludwig von Mises, added an essay on "Monetary Reconstruction" to the 1952 edition of his Theory of Money and Credit (New Haven, Yale, 1953). In Chapter III, Sec. 4 of the essay (pp. 448 - 452), von Mises sets forth a step by step approach to letting the market set the new exchange rate in a manner that would avoid the British error. He concluded the section with a comment rather apt in the present context:
"The classical or orthodox gold standard alone is a truly effective check on the power of government to inflate the currency. Without such a check all other constitutional safeguards can be rendered vain."
It is unfortunate that so few of our home grown economists have so clear an understanding of the relationship of monetary integrity to Constitutional purpose. But the future may be very bleak unless we come again to understand that relationship, so essential to the maintenance of a free society.
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