naked capitalism

As readers may have noticed, I grumbled over the weekend about the decision by federal prosecutors not to bring charges against Countrywide’s Angelo Mozilo. I attributed it to two causes: extreme deregulation (you can’t prosecute if virtually nothing is a crime) and timid prosecutors. A lively debate arose in comments, with our Richard Kline contending that the real reason no Big Name had been brought to justice is that a trial would make it all too evident that there were plenty of other powerful people who had committed equally heinous acts. Can’t expose how widespread corruption is, now can we?

Other readers argued the revolving door issue, which was (in essence) don’t ruffle the law firms that will be your prospective employers. I begged to differ, in that tough, effective prosecutors were magnets for new law school grads precisely because they were great training grounds. Someone who came out of those boot camps would be more valuable than a largely untested staff member at a regulatory agency.

I got this e-mail from someone who has seen the SEC from the inside:

You are correct on this one:

If you were a REAL kick-ass, they’d have to hire you to get you on their side! I can’t tell you how many times attorneys get hired by clients because the client winds up seeing the lawyers on the other side of the table in action and realizes they are better than the attorneys he engaged.

That is correct, but it is also part of the problem. SEC lawyers have a strong incentive to win cases, as it builds their resume, but it is far easier to win cases by way of settlements on minor charges, than by way of judgments on major charges, for obvious reasons, namely that the charged parties are much more likely to cooperate in the former case than in the latter.

Yes, major cases that set precedent are fantastic. Following the disastrous Congressional hearings on Bernie Madoff, any reasonable person would have asked how Linda Thomsen ever got to be appointed head of Enforcement at the SEC. Simple answer: she litigated Enron. Big cases are enormously important for moving careers forward, and every lawyer inside and outside of the securities industry knows that.

The problem is that litigating cases is costly, particularly in terms of time; and it is also very risky. Too many lawyers at the SEC are looking to pad resumes before moving on to private practice, and quite simply, a half a dozen cases can quickly be settled out of court in the time it takes to litigate one major case. Not only that, but the outcome of a settlement is guaranteed, the outcome of a court proceeding is not.

The commonly held perception expressed by readers on your blog as elsewhere–that SEC staff have an incentive to go soft on industry in order to land cushy jobs–is not entirely fiction, but is much less widespread than outside observers believe. And in general, that dynamic tends to apply to policy making, not enforcement, which are separate functions–and it is, in my view, a much more serious problem in Congress, where the laws are actually made, than at the regulator, where they are enforced.

The solutions are actually not difficult, in my view. The most simple is to provide more resources for litigation, which would give stronger incentives to look for more cases and carry them through. Enforcement staff are overwhelmed, and it’s easy to dismiss difficult cases while focusing on more clear-cut cases that are easier to settle.

The other solution is to provide stronger leadership direction in pushing for higher profile cases going to court. The Commission readily accedes to Enforcement’s preference for quick settlements; that certainly could change. And more (civil) cases going to court would likely lead to more criminal prosecutions, as criminal authorities seem to be reluctant to bring action on cases that are settled out of court.

One other welcome change would be to bring SEC lawyers’ pay more into line with that in industry; but that is more of a problem of industry pay being too high than SEC pay (which is reasonably generous, all things considered) being too low. That would lead directly to longer tenure among lawyers at the SEC, and better lawyers looking for jobs here, both of which would contribute to stronger enforcement. But given a severe oversupply of lawyers in the industry, I expect salaries to deflate, so that may be something that happens on its own.

Regulators get recognized only when they fail their job, not when they do their job. That’s why they pay us the big . . . oh. Wait. :( But that’s how it works for the regulator. I have several friends who work for the Nuclear Regulatory Commission–when was the last time anyone has recognized them for the work they have done?

The underlying issue is that there is no such thing as a free lunch. Americans (at least certain Americans) love to grumble about their taxes. Yet Europeans and Australians are more heavily taxed and are happier with the services they get from their governments (I heard no complaining in Oz and I circulated pretty widely; surveys confirm my impressions re Europe).

One wag remarked that maybe the reason Europeans aren’t unhappy with their government services is that their countries are better at that than the US is. That could actually be true, particularly since the game plan here over the last 30 years seems to have been to make government less competent as a justification for shrinking it further.

But a second reason is our system has become deeply corrupt, and having failed to be attentive to safeguards early on, it is not clear how to reverse that. The US has long been suspicious of career bureaucrats (even though they are the backbone of important agencies like the Department of Defense and the Department of State), yet when the are seen in their societies as an elite (think of the status held by federal judges), they can attract people with a sense of professionalism who are willing to take a bit less than private sector pay to have a stable career, demonstrably important work, and respectability. That may sound simplistic (and there are plenty of cases where the mandarin model falls short of its promise) but right now, even the not-that-successful implementations look a ton better than the revolving door between agencies of the Executive Branch and power broker law firms.

Ironically, a simple model for clean government comes from Singapore. When the island got its independence from the United Kingdom, by any objective standards, it had nothing going for it. Lee Kwan Yew recognized that. His national strategy for Singapore was for it to have a very well educated workforce and to stand out among emerging economies by being tough on corruption. He was very deliberate about the carrots and sticks he provided. Senior civil servants were and still are paid at the level of top private sector professionals (think NY or DC white shoe law firm partner). That way they would have little in the way of incentives to cheat. And it would also assure that those roles would attract the caliber of individual who could deal with major private sector players on an equal footing. The stick was that the internal audit functions were powerful and punishments for abusers draconian.

But with the new belief system that public sector workers should be paid dramatically less than their private sector counterparts (tell me again why this makes sense, absent a modest discount for a presumably lower risk career?), the odds of changing career paths and pay programs in DC or at the state level to reduce the susceptibility of bureaucrats to the siren calls of powerful private sector prospective meal tickets is zero.