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By William K. Black. This article was first published on New Economic Perspectives.
Wikileaks has done the world a great service again by publishing a leak of an April 2014 (partial) draft of the Trade in Services Agreement (TISA).
Professor Jane Kelsey of the Faculty of Law, University of Auckland prepared an analysis of the leak that I recommend that everyone read. She, appropriately, emphasizes that any analysis must be tentative because we have only a partial, stale draft through the whistleblower(s).
My analysis is more limited in scope but is consistent with the thrust of her concerns.
Three TISA Paradoxes
Financial Deregulation is Criminogenic
The three “de’s” – deregulation, desupervision, and de facto decriminalization – has been critical to the three modern U.S. financial crises. The combination is intensely criminogenic and produces the fraud epidemics that drive our crises. The second, and vastly more destructive, phase of the Savings and Loan (S&L) debacle is a classic example. The criminogenic environment was the product of each of the three “de’s” and modern executive and professional compensation.
“The S&L crisis, however, was also caused by misunderstanding. Neither the public nor economists foresaw that the regulations of the 1980s were bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself” (George Akerlof & Paul Romer 1993: 60).
Elite insider fraud became the norm at expensive S&L failures. The National Commission on Financial Institution Reform, Recovery and Enforcement (NCFIRRE) investigated the causes of the S&L debacle and reported:
“The typical large failure [grew] at an extremely rapid rate, achieving high concentrations of assets in risky ventures…. [E]very accounting trick available was used…. Evidence of fraud was invariably present as was the ability of the operators to ‘milk’ the organization” (NCFIRRE 1993).
No one disputes that the Enron-era scandals were accounting control frauds. COSO’s (Treadway) report in 2010 stated: “[I]n nine out of ten cases the SEC named the CEO and/or CFO for alleged involvement in the securities fraud.” The criminogenic environment that produced the epidemic of accounting control fraud that drove the Enron-era scandals was primarily the product of desupervision and de facto decriminalization combined with modern executive and professional compensation.
The United States went through a process of examining the causes of the current financial crisis. The Financial Crisis Inquiry Commission (FCIC) concluded on the basis of its investigation that deregulation, aggravated the regulatory “race to the bottom,” was a major cause of the crisis.
“We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts …due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.
This approach had opened up gaps in oversight of critical areas with trillions of dollars at risk….
In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor” (FCIC Report:xviii).
Federal Reserve Governor Gramlich described his colleagues’ preferred level of U.S. desupervision as “no cops on the beat” (FCIC 2011: 95).
My articles and the updated edition of my book document in detail the resultant triple epidemic of accounting control fraud that drove the financial crisis. The same factors created the most recent criminogenic environment that produced the S&L debacle. Several EU nations suffered from similar criminogenic environments in the current crisis because of their eager participation in the regulatory race to the bottom and their embrace of modern executive and professional compensation.
The obvious question is why, since we know from repeated waves of the three “de’s” how disastrously this ends, we fail to “learn from experience” and finally follow the advice of effective financial regulators, white-collar criminologists, and top economists? The even more pointed question is why President Obama cannot “learn from experience.” It was his appointees to the FCIC who unanimously warned that the three “de’s” played a critical role in causing the crisis.
TISA is designed to replicate, indeed, optimize the criminogenic environment that made fraudulent financial CEOs wealthy by “looting” “their” banks. The (effective) “regulators in the field” figured this out by 1983 – over 30 years ago. We wrote up our findings in great detail. Top economists and top white-collar criminologists studying those findings a decade later (1993) agreed with the findings. Since the original findings in 1983, we have the (prevented) “liar’s” loans crisis of 1991 when federal S&L regulators based in California drove what were then a brand new product called “low doc” loans out of the regulated industry. That “second front” – while the S&L regulators were containing the S&L debacle – was dealt with so effectively that there was no resultant financial crisis. Indeed, it is only with the benefit of the current crisis that we can understand that the containment of the overall S&L debacle (driven primarily by fraudulent commercial real estate loans and investments) and the incipient crisis is liar’s loans prevented a crisis that would have become similar in scope to the current crisis. The S&L debacle was contained before it caused even a minor national recession.
In sum, we know not only that the three “de’s” are disastrous, but also that effective reregulation, resupervision, and restoration of effective prosecutions can be exceptionally effective and save tens of trillions of dollars in costs and 10 million American jobs by preventing the most destructive financial crises and resultant Great Recession. (Those savings would have been dramatically greater in the eurozone where one-third of the population is suffering from Great Depression levels of unemployment.)
The EU and Obama, therefore, should have several key areas of complete agreement in drafting TISA:
- It is essential, and urgent, to end the global financial regulatory race to the bottom
- It is essential, and urgent, to end the existing regulatory structure’s continuing hostility to effective regulation, supervision, and prosecution
- The systemically dangerous institutions (SDIs) (the so-called “too big to fail” banks) pose an intolerable global risk of financial crisis and should have been forced to shrink to a size where they no longer endanger the world’s economies and democracies
- It is essential, and urgent, to remove the perverse incentives created by modern executive and professional compensation
- Rehabilitate private discipline by requiring “independent” experts providing services to financial institutions to be owned in partnership form with joint and several liability and fully restore the fiduciary duties of loyalty and care that have been eviscerated by legislation and hostile judicial interpretations
I’ll discuss a limited aspect of what the draft TISA provides below, but it is sufficient for this paradox to make four points. First, none of the five vital and urgent reforms is contained in the draft. Second, there is not a single provision designed to make regulation, supervision, enforcement, or prosecution of private bankers and those that aid and abet their violations more effective. Third, virtually every provision is designed to make banking more criminogenic by increasing the three “de’s” and locking in the existing pathetically inadequate system. Fourth, the draft is designed as a one-way ratchet under which nations are only allowed to further loosen their already inadequate regulation, supervision, and prosecution systems.
The first paradox is that Obama, who cannot claim that he does not know better given the unanimous findings of his own FCIC appointees who investigated the causes of the crisis, is trying to recreate those causes, spur a race to the bottom among financial regulators, and make the causes of the past crisis global (rather than primarily limited to the U.S. and the EU). Obama, in the TISA draft, proposes to do everything that his own FCIC experts, white-collar criminologists, the top economists on the subject of criminogenic environments, and effective regulators with a track record of success have been telling Obama not to do for his entire term in office.
Even more insanely, Obama’s draft is designed to make it far more difficult for competent regulators to respond rapidly to a developing crisis and contain it as was done during the S&L debacle and during the surge of “liar’s” loans in 1990-1991 before it cause any crisis. The goal is to prevent a group of regulators from emulating our successful reregulation of the S&L industry and obtaining over 1,000 felony convictions in cases designated as “major” by the Department of Justice (DOJ). To obtain that result we made over 30,000 criminal referrals. In the current crisis, the anti-regulators who de-supervised banks made, at best, a handful of criminal referrals and the result is that six years after the collapse of the financial system not a single senior banker who led the three most destructive financial fraud epidemics in history has been prosecuted by DOJ. Bank CEOs love the three “de’s” because it allows them to become wealthy by “looting” with impunity. Looting, as Akerlof and Romer aptly emphasized, is a “sure thing” for the leaders of a bank.
“Transparency” for Bankers: Maximum Opaqueness for the Public and Congress
The TISA draft (Article X.16) is very clear about the second great paradox: bankers must be told everything that regulators are thinking about adopting and have ample opportunity to influence the regulators’ drafting of the rule. But TISA is an international secret that will remain an international secret for five years after it is adopted. Like the Trans-Pacific Partnership, the drafts are kept secret even from Congress. Indeed, TISA is “classified” so that those who might blow the whistle on the travesty may be prosecuted. The draft’s initial information contains this language:
“Declassify on: Five years from entry into force of the TISA agreement….
It must be stored in a locked or secured building, room, or container.”
I note this obvious, indefensible hypocrisy because it is illustrative of the entire draft. When the indefensible appears in a document like this it is because the drafters know that there is no one representing the other side and they can afford to be outrageously one-sided. It was clearly drafted by and for lobbyists for the SDIs. Any government officials involved in the drafting are simply scribes who will be rewarded on the other side of the revolving door. There is no pretense that the draft is a reasoned response to differing views. Only one set of views – literally the wish list of the largest, most criminal banks – is presented and it is presented in exceptionally extreme language. There is literally nothing in the draft designed to increase the regulatory protections afforded the public from private banks. There is literally nothing in the draft that increases restrictions on private banks.
As a lawyer I recognize exactly what happened because the draft reads exactly like how we draft a wish list. Obama is a lawyer. Mr. President, read the draft and it will be obvious to you that no one is representing the public. The President of Ecuador, Rafael Correa (an economist), was outraged when he learned of what the bankers were trying to achieve through TISA. Sadly, the U.S. played a disgraceful role in pushing TISA forward over Ecuador’s objections. If Obama were to admit that Ecuador was right, bring the U.S. back to representing the public rather than the looters, and make public the entire disgraceful draft TISA would collapse.
TISA’s drafting consists of a meeting of banking thieves who are successfully demanding a return to what Gramlich correctly described as “no cops on the beat.” If the street robbers of the world demanded that we remove the cops on the beat we would be enraged. Bankers and their neoclassical economist allies, however, regularly lobby for just such a boon to elite white-collar criminals. We have millennia of experience with what happens when we give the elites the power to loot with impunity.
The Paradox of Secrecy and “Prudential” Regulation
The third paradox is that as bad as the draft is I also know as a lawyer exactly how it will be defended. The defense will be simple: the draft will cause no harm because Article X.17 allows allow regulators to adopt rules for “prudential” purposes. Note that it does not require nations to adopt appropriate prudential rules to avoid creating the disastrous race to the bottom. As I explained, the TISA draft does not encourage or require any prudential measure. It does not even contain a vague and unenforceable suggestion that it might be a good thing to look for areas of regulatory or supervisory weakness and fix them.
“Article X.17: Prudential Measures
1. Notwithstanding any other provision of the Agreement, a Party shall not be prevented from [PA, EU: taking] [US: adopting or maintaining] measures for prudential reasons, including for:
(a) the protection of investors, depositors, [PA, US financial market users], policy-holders or persons to whom a fiduciary duty is owed by a financial service supplier; or
(b) to ensure the integrity and stability of a Party’s financial system.
2. Where such measures do not conform with the provisions of this Agreement, they shall not be used as a means of avoiding the Party’s commitments or obligations under the Agreement.”
The Paradox of Withstanding a “Notwithstanding” Clause
The defense of TISA is obvious. The “notwithstanding” clause means that regardless of “any other provision” of TISA every nation has the absolute right to take financial regulatory and supervisory measures “for prudential reasons.” Further, the examples of such “reasons” are broad. The obvious conclusion is that TISA poses no barrier to important regulatory or supervisory actions.
But there are three non-obvious problems with that interpretation. First, why does Article 17.2 exist?
“2. Where such measures do not conform with the provisions of this Agreement, they shall not be used as a means of avoiding the Party’s commitments or obligations under the Agreement.”
The “notwithstanding” clause means that “such [prudential] measures” “conform with the provisions of [TISA]” by virtue of that clause. Article 17.2, however, indicates that regulations that the U.S. finds vital to adopt to “ensure the integrity and stability of [our] financial system” can be found invalid by some (as yet unspecified entity) on the grounds that the entity thinks are being used to “avoid [our] commitments or obligations under [TISA].” The unspecified entity is supposed to decide what the motive of those involved in adopting the rule or taking the supervisory action was. Almost any new banking regulation that the U.S. adopted to stem an epidemic of the forms of fraud that drive our financial crises could be interpreted as not “conforming with [TISA]” absent the “notwithstanding” clause. That means that virtually any rule the U.S. found essential to adopt to prevent the imminent collapse of the “stability of [our] financial system” could be declared a breach of TISA under paragraph 2 of Article 17.
What entity will be deciding whether U.S. banking rules were adopted in order to “avoid … commitments … under [TISA]? Article 20 says that a “dispute panel” will consider alleged violations of TISA. If this clause follows recent U.S. practices under Obama, and the bankers are explicitly lobbying to ensure that TISA does so, this means that a group of so-called “arbiters” will decide such disputes. The panel, if it follows current practices, will be subject to no rule of law and no effective right of appeal. They will operate in secret and will be composed primarily of lawyers with glaring conflicts of interest. The same lawyers who bring claims against nations on one day then serve as the “arbiters” on the next day deciding cases brought by their counterparts. These panels have issued orders to sovereign nations demanding that they take unconstitutional actions – and then proposed to fine the nations for refusing to violate their constitutions (and any civilized concept of due process). Remember, any foreign bank can ask such a panel to declare a banking regulation invalid that we have adopted because we have found that the foreign bank has engaged in conduct that poses a grave and imminent threat to the “integrity and stability” of our Nation and even the global financial system. Under TISA, we will lose all control and can be stripped of our sovereign duty to act to protect the American and world economies. A group of fervently anti-American lawyers who are viscerally opposed to banking rules because they became wealthy by representing banks making attacks on banking rules will control our fate. The (faux) arbitral panels claim the power to issue injunctions ordering a sovereign nation not to adopt rules and not to take supervisory actions even against criminal enterprises – and to issue damages against nations that refuse to comply with such orders.
Taken together, subparagraph 2 and the Article 20 “dispute panel” provisions explain the third terrible TISA paradox. The “notwithstanding” clause was inserted to make it appear to the credulous that TISA would have no effect on the ability to regulate banks. But we can see that when read together the protections of Article 17’s “notwithstanding” clause are illusory. TISA can destroy America’s ability to take the reregulatory, supervisory prosecutorial steps essential against the elite frauds that drive our recurrent, intensifying financial crises. The worst fraudulent CEOs controlling foreign banks operating in the U.S. would happily bribe a group of already morally crippled (faux)arbiters to declare U.S. banking rules a violation of TISA and to order the U.S. not to enforce its laws against even the most fraudulent bankers causing a grave crisis.
TISA is awful for honest bankers. Effective financial regulators are the essential “cops on the beat.” Only we have shown the ability to break the “Gresham’s” dynamic (bad ethics drives good ethics out of the markets and professions) that fraudulent CEOs create. When we break that dynamic we make it possible for honest bankers to prevail. TISA is good for only one group – dishonest bank executives.
That brings us back to the reason the bank CEOs have demanded that TISA be “classified” and kept from the public and even Congress. Indeed, the plan is to classify its provisions for five years after TISA is adopted. That delay is meant to make it politically possible for TISA to be adopted and then continue to protect heads of state from being thrown out of office by their enraged constituents.
But the prior discussion raises other questions. What if Article 17’s “notwithstanding” clause really meant what it appeared to say? What if TISA imposed no restrictions on the adoption of banking regulations? U.S. banking rules are entirely prudential. All of our S&L rules, supervisory actions, enforcement actions, and prosecutions were “prudential” under TISA’s definition. If there were no paragraph 2 to Article 17 and no Article 20 “dispute panels” the TISA exercise would be pointless. The U.S. would be able to adopt any financial rule, take any supervisory or enforcement action, and prosecute anyone regardless of any TISA provision.
Ask yourself this question: why would the bankers and heads of state have demanded, and received, “classified” treatment of a document that did not have any confidential information (there are no state secrets, no privacy issues, and nothing of proprietary value in the leaked TISA draft) and made no meaningful restriction on regulation and supervision due to the “nowithstanding” clause of Article 17? The demand for classified treatment makes it inescapable that the bankers and government officials involved in drafting TISA are trying to hide something they believe would outrage the public. The paradox is that the bankers’ and politicians’ rabid fear of disclosure to the public and Congress of TISA’s assault on regulation confirms beyond any reasonable doubt that subparagraph 2 of Article 17 and Article 20 combine to make TISA a grave threat to the global economy, workers, and honest bankers by making the financial world even more criminogenic.