Standard & Poors: Internal Controls Enabling a Conflict of Interest

After the financial crisis of 2008, rating agencies reassured the public that additional “internal safeguards” would prevent the sort of over-stated ratings that had contributed to the crisis. Congress did not deconstruct the structural conflict of interest wherein a rating agency is tempted to overstate the rating on financial security such as a corporate bond because the agency’s revenue would be higher if more of the bonds are sold. I contend that reliance on a company’s internal “fire walls” is naïve, given the strong, sustained temptation that exists as long as an institutional or structural conflict of interest is in place. To obviate the problem, the conflict itself must be deconstructed.

The full essay is at "Standard & Poors."

Police Snatching Property: A Conflict of Interest While American Federalism Sleeps

The U.S. Justice Department halted its adopted-forfeitures program in early 2015 out of a sense that state and local law-enforcement agencies had been using the federal program to retain a greater portion of seized property, including cash, than state laws permit. Asset forfeiture had grown since the 1980s largely as a strategy in combatting drug traffickers, yet the agencies themselves benefited in being able to spend the cash. Besides this conflict of interest, the federal-state dynamic here demonstrates federalism in action, though perhaps not as strongly as the system of government allows.

As police departments collected more and more in involuntarily forfeited property, an increasing number of people complained that their property had been seized without there being any evidence that they had committed any crime. In other words, the police were getting away with dismissing the “innocent until proven guilty” mantra of American justice. The ACLU, for instance, issued a statement saying the forfeitures violate the due process clause in the U.S. Constitution.[1] If so, then the Justice Department could have gone further than merely refusing to allow police departments to collect property at levels permitted only by federal law. Specifically, the federal agency could have sued police departments to contest even the state laws as unconstitutional. Presumably taking the property of anyone charged but not convicted of a crime, even of drug-dealing, violates constitutional rights. In a viable federal system, moreover, the federal government is obliged to act as a check against state and local abuses of power. That the Justice Department fell short of this function suggests that American federalism had already been compromised rather than fully functional.

Were the Federal Government acting as a viable check on the state (and local) governments in the U.S., surely going after governmental conflicts of interest would be on the federal radar screen. That the departments could spend the money from the forfeited property (whether under state or federal law!) points to a conflict of interest wherein a department’s own financial interests trumps or eclipses the wider protection inherent in the doctrine of presumed innocence.  Put another way, police could get away with exploiting a public benefit for private gain (that of the police). Of course, no police administrator would admit to it.

Ron Brooks, for example, headed the National Narcotic Officers’ Associations Coalition at one point. “While the money is helpful to us, that’s not the reason forfeiture occurs,” he explains. “It occurs because it removes the most critical component of these criminal organizations: the capital to operate.”[2] He claims that the helpful money is not even a temptation even though it is entirely reasonable to assume it is; he is dismissing the motive out of hand when it is anything but reasonable to do so. Typically, such an attempt to hide a conflict of interest is a subterfuge—meaning that one does in fact exist and it is being exploited. Put another way, if police administrators really were indifferent to the helpful money, why not admit that it could be a temptation?

Therefore, we can conclude that the departments’ discretion in forfeiture cases is problematic, given the active temptation to exploit the conflict of interest. Were the U.S. Government to have been acting as a check on the states, the Justice Department lawyers would have gone after that discretion, at the very least. Of course, going after the relevant state laws permitting the forfeiture practice would go even further in deconstructing the institutional conflict of interest, and thus evince a stronger federal system wherein the two systems of government—federal and state—act as checks against abuses in the other at the expense of the People.

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[1] Devlin Barrett and Zusha Elinson, “Holder Moves to Curb Asset Seizures,” The Wall Street Journal, January 17-18, 2015.

[2] Ibid.

Behind the Lower 2014 U.S. Federal Budget Deficit: A New Default

The U.S. Government’s fiscal deficit of $483 billion for fiscal-year 2014 is the lowest since 2007.[1] At a preliminary 3% of GDP, that deficit is much better than the 2010 deficit, which came in at 10% of the GDP. To be sure, the American economy was larger in 2014. Also, the federal government’s overall fiscal improvement masks changes “behind the curtain” that may not be so palatable.

In 2014, the federal government’s revenues first crossed the $3 trillion level.[2] Had the spending level of 2007 been that of 2014, the government would have run a budget surplus for the year. To be sure, going back to pre-recession spending-levels would ignore the gradual upward slope of spending since at least 2000; based on this slope, and assuming the actual revenue, the deficit for 2014 would have been appreciably more than $483 billion.

So, is the spending side to be lauded or criticized? In large part, this depends on the person’s political ideology. The same goes for the revenue side. What I find interesting about the spending is that a steeper upward slope (from that from 2000-2007) in from the fourth quarter of 2008 (the credit freeze having occurred that September) to mid-2009 is followed by flat-lined spending through 2014.[3] Put another way, spending departed from the gradual upward-sloped pattern to reach a new plateau. That it held from 2009 to 2014 explains why the spending level in 2014 is lower than it would have been had the gradual upward-sloped pattern continued unabated. Sequestration worked.

Even so, the jump in spending in 2008/2009 pushed it to a new, higher plateau. Even though spending might have been higher, fixing spending around roughly $35 billion represents a higher mark for revenue to reach, even during recessions. In short, the fiscal “new normal” after the 2008 financial crisis and the ensuing recession involves higher spending and more revenue in absolute terms. An alternative might have been to spike spending during the recession then peg the spending after 2009 to the level it would have been consistent with the previous gradually-ascending slope. That amount would have been roughly $30 billion (rather than $35 billion), and the U.S. Government would have shown a slight surplus for 2014.

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[1] Josh Zumbrun, “Budget Deficit Reaches a Seven-Year Low,” The Wall Street Journal, January 14, 2015. The budget deficit for the calendar year came in at $488 billion.

[2] Ibid.

[3] Ibid.

Relaxing State Deficit Restrictions: Power-Grab by the European Commission

As the World Bank came out with its revised prediction of 1.1 percent economic growth for the E.U. (“eurozone”) in 2015, down from the earlier estimate of 1.8%,[1] the European Commission announced that it would allow states more leeway in meeting the federal requirement that state budget deficits be no more than 3 percent of their respective economic outputs. Lest this appear as a sign of political impotence, the “strings” demonstrate the opposite.

The full essay is at "Essays on the E.U. Political Economy."