14   Untouchable Financial Structures Embedded in our Fiscal System

William Krehm

The New York Times (26/1, "U.S. Financial Sector Is Losing Its Edge, Report Says" by Jenny Anderson) informs us: "Adding to a chorus of concern that the United States is losing its edge as the leading financial center, Senator Charles E. Schumer and NY Mayor Michael R. Bloomberg will release a report today urging the country to improve its legal and regulatory environment.

"If not, the report warns, it could lose 4 to 7 per cent of the global financial services market over the next five years.

"‘The last thing that New York and the country, for that matter, need is to wake up one morning and find we no longer are the financial capital of the world,’ Senator Schumer, Democrat of New York said. ‘This report shows that could happen not just for IPOs (initial public offerings), but for all financial services, all too easily and all too soon.’

"The committee’s primary recommendations echo those of a similar report released in November, focusing on easing or eliminating provisions of the Sarbanes-Oxley Act for small and foreign companies – some steps that the Securities and Exchange Commission is currently undertaking – and curbing securities-related litigation. The latest report is one in a series commissioned in the public and private sectors voicing concern that the US is falling behind because of a burdensome legal and regulatory environment.

"The report adds some new dimensions to the debate, however, making recommendations to ease immigration restrictions facing skilled professionals from other countries, urging convergence on international accounting standards and recommending the adoption of Basel II on international accord on capital standards, without increasing capital requirements as some US regulators have suggested."

Is Crime Good for the GDP?

"Taking pre-emptive steps to address concerns about regulation and litigation might halt the country’s loss of market share and add $15 billion to $35 billion in revenue in 2011 alone, the study said. It would also allow the creation of 30,000 to 60,000 jobs in the securities sector.

"Like all reports focused on American competitiveness, the latest report, entitled Sustaining New York’s and the US’s Global Financial Services Leadership and conducted by McKinsey, addresses the fact that the US now commands a significantly declining share of the global market for IPOs.

"But it also examines the broader financial services arena, including the fast-growing derivative and structured-product markets, the gigantic loan market as well as the traditional markets in stocks and bonds.

"The report shows foreign markets closing in on the US in size and in certain product offerings. For example, in 2005, American investment banking and sales and trading revenue totaled $109 billion ($69 billion in sales and trading and $46 billion in investment banking) compared with $98 billion in Europe and $37 billion in Asia.

"The US remains the largest financial market in the world, as measured by what is called ‘financial stock’ – equities, private debt, government debt and bank deposits – with $51 trillion in 2005, but the pace of growth was significantly slower than in other markets, especially the Asia-Pacific (excluding Japan and Britain)."

However, "emerging markets will naturally grow faster than the more developed US market. But administration officials for Mr. Blomberg and Mr. Schumer said the report aimed to address the factors particular to the US, namely litigation and regulation, which might deter business from coming here.

"Critics of easing regulatory standards and the ability to bring securities class-action lawsuits point out that litigation have been unusually high because of settlements related to the frauds that caused the collapse of Enron and WorldCom."

One might as well argue for letting up on blue-collar crime, because the profits from foreign visitors in such specialties also may contribute to the GDP by stays in Las Vegas and New York, apart from using our banking facilities for their deposits, not to say their rackets.

Since Globalization and Deregulation were brought in by those who wanted a free market, its proponents must also allow for outsourcing our financial services, including the incidental rackets that do not seem to bother them.

"Europe has a 56 per cent share of the $52 billion global revenue pool from derivatives and a 60% or greater share of revenue in interest rates, foreign exchange, equity and fund-linked derivatives. The US leads only in commodity derivatives.

"Short-term recommendations suggest improved guidance on Sabanes-Oxley implementation, including the ability for small companies within certain ‘sophisticated’ markets to opt out of some requirements as long as it is disclosed.

"The report suggests that the SEC use certain exemption powers to limit liability for foreign companies to securities-related damages and impose caps on auditors’ damages. Like the Capital Markets Committee report in November, the latest study recommends that the SEC allow companies to mediate conflicts through arbitration rather than litigation.

"The pace of job creation in London far outstripped that of New York City, the report says. From 2002 to 2005, London’s financial services work force grew by 4.3% to 318,000 while New York City’s shrunk by 0.7%, or 2,000 to 328,000 jobs.

"London has been gaining an edge in attracting the largest hedge funds. In 2002, London was home to only 3 of the largest 50 hedge funds, compared with 12 today. New York had a decline: today 18 of the largest 50 hedge funds are based in New York compared with 28 in 2002. (Connecticut has gained two over that period, from 6 to 8.)"

In The Globe and Mail (2/01/07, "Sarbanes-Oxley: Window of truth in danger of slamming shut" by Barrie McKenna) sheds some calmer light on the campaign to tighten the morality of corporations listed on the stock market: "The drive to undo the post-Enron corporate reforms has officially begun. The US Justice Department is putting in place new guidelines to limit the power of prosecutors to play hardball in corporate corruption cases.

"Likewise the US Securities and Exchange Commission has proposed rule changes to the 2002 Sarbanes-Oxley Act that would lessen the auditing burden on smaller public companies to withdraw their US stock listings.

"The changes address some of what critics say was an excessive wave of corporate accounting scandals that began with Enron.

"But it’s only the beginning. Corporate America has vowed to step up the fight to radically overhaul – even dismantle – Sarbanes-Oxley in 2007. In late November, a Wall Street-sponsored-committee issued a list of recommendations to roll back financial regulation. Among other things, the Committee on Capital Markets Regulation called for better protection from regulators and lawsuits for auditors, company executives and outside directors. The group also wants to restrict the ability of the SEC to make new rules, and limit its prosecutions.

"Early next year, the US Chamber of Commerce will issue a report expected to be sharply critical of the regulatory burden on public companies.

"And Treasury Secretary Henry Paulson, a former Goldman Sachs executive, will host a conference on financial market regulation."

All this – and much else listed by Barrie McKenna in the offing "…is designed to get the attention of the new Democratic-led Congress that takes over next month.... Sadly what the anti-Sarbanes-Oxley crowd overlooks is that Wall Street was badly in need of a cleanup. And Sarbanes-Oxley helped do the job.

"Last year, 1,250 companies, or 8% of all listed stocks, were forced to restate their earnings. To some, this is a costly burden on companies. To investors, it’s a window of truth on corporate accounting that had begun to look more like alchemy than arithmetic.

"The law’s new reporting rules, forcing companies to report stock options grants more quickly is widely credited for largely undercutting unfair benefits of back-dated options.

"What’s wrong about a little accuracy in financial reporting? Nothing, it seems. US stocks have enjoyed a record-breaking run this year. So far this year IPOs have brought in nearly $40-billion (US), on par with last year’s pace.

"One could draw the conclusion that Sarbanes-Oxley has been a resounding success, helping to restore confidence in a troubled market. There’s little doubt that US reforms have sparked long-overdue crackdowns in other markets including Canada.

"At least, companies are spending their cash on producing more accurate books instead of outrageous options gifts and other perks."

And if our statesmen tire of straightening out the accountancy in corporate books, they could take a hard look at what passes for accountancy in our governments’ ledgers. For example it was only in 1996 that the US government realized that the two main policy innovations to bail the banks out of their massive capital losses due to their repeal of the essence of the Rooseveltian Bank Act of 1933, were incompatible with each other. (The story is told on page 4 of this issue of ER.)

To prevent the Mexican monetary collapse arising from the BIS’s contradictory policies from spreading throughout the world Clinton’s Secretary of the Treasury for the first time introduced serious accountancy into the government books.

Misleading Accountancy Cost Money

Clinton’s introduction of accrual accountancy still ignored government investment in human capital. Nor is money spent to restore the environment included as investment. And when such restoration does not occur, and when public health deteriorates as a result, that should be treated not as fiscal prudence, but as fiscal irresponsibility and entered on the government books as a capital liability.

Yet as late as 1999 then Finance Minister Paul Martin was wrangling with the Auditor-General of the day against even treating physical capital as such in the government books, let alone human capital. By 2000 a demeaning compromise was reached: government investments in physical capital were recognized but the Auditor-General was forced to issue a statement that befuddled rather than clarified the issue.

And when we start down this path, there is no stopping. Rather than bemoan the taxes lost to New York or Toronto because hedge funds might go to London or Bermuda to play their games, and cost the government taxes and the nation jobs, why doesn’t our government take a good look of the Bank of Canada Act that is still intact on our law books? In it are the detailed provisions for the central bank to lend the federal government an unlimited amount of funded debt, and up to 1/3 of its annual budgets in unfunded debt. Were it to make use of this power the interest paid on that federal debt would return to the federal government as dividends. For ever since 1938 when a liberal government bought out 12,000-odd shareholders of the Bank of Canada at a good profit some three years after the central bank had opened its doors, the federal government has been the lone shareholder of the Bank of Canada. In the mid-1970s more than 22% of the federal debt was held by the Bank of Canada on a virtual interest-free basis. Currently it is down to about 6%. We do not have to rely on speculators to practice their dubious arts while the government turns a blind eye on their misrepresentations to their shareholders to cover the government’s bills.

The Bank of Canada Act in its Section 18 also provides for loans to the provinces, but the interest paid on those would end up largely going to the federal not the provincial government for the provinces are not shareholders of the central bank. But that would open a new basis for understanding between our federal and provincial governments. In return for observing federal standards or some other concessions, Ottawa could agree to negotiate the return of part the total amount of the interest paid by a particular province to the central bank. Municipalities, too, as corporations can receive loans from the Bank of Canada, but only if the debt is guaranteed by either the federal or provincial government.

When the banks were bailed out so that they might continue their gambles on an ever great scale, the federal government lost little time in downloading the programs it no longer had the funding to support since it was now paying the private banks screechingly high interest rates for much of its funding that it had formerly been receiving at a near-free rate. Subsection 14(2) clearly sets forth that the Minister of Finance of the Government, in the event of a policy disagreement with the Government may give him in writing the policy that he must follow within 30 days.

The present campaign to do away with Sarbanes-Oxley in the US must be answered with a counter-campaign for the use of our central banks for the purposes assigned them in the 1930s.

William Krehm

– from Economic Reform, February 2007