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     Sep 4, '13

More glue in the works
By Martin Hutchinson

The Environmental Protection Agency has been pouring regulatory glue into the US economy since 1973. The trial bar has also been pouring litigation glue into the US economy for a similar period, and their colleagues in the New York financial bar have equally been adding to the sticky stuff with documentation glue (as a former corporate financier I would quickly find another line of work if faced with today's US-law documentation for the simplest transaction).

Now a series of federal agencies have banded together to launch wave after wave of lawsuits against the big banks, mostly relating to the same set of transgressions they committed in 2005-08. At some point, an economic system with so many dysfunctional activities ceases to work altogether, turning into a rent-seeking

mess. From the latest economic statistics, we may be nearing that point.

Last week's depredations against the big banks included a government order to JPMorgan to pay US$6 billion to the Federal Housing Finance Agency in relation to subprime mortgages underwritten during the bubble - about 20% of the $33 billion principal amount of subprime mortgages underwritten by Morgan entities during that period. JPMorgan has spent $5 billion in legal costs in each of the last two years, and raised its estimate of legal losses to $6.8 billion at the end of the second quarter - presumably after this piece of bad news it will have to raise them again.

The same week, a judge rejected Bank of America's bid to dismiss a similar-sized case relating to toxic mortgages, and the case will go to trial this month (to be fair, the toxic mortgages concerned were issued by Countrywide, which Bank of America acquired in January 2008 - surely one of the worst M&A deals ever done). The same day, a judge threw out Bank of America's lawsuit to recover $1.7 billion in losses related to the 2009 $2.9 billion Taylor Bean collapse (no, I'd never heard of Taylor Bean either - in the collapse of the housing market $2.9 billion was a mere rounding error).

The previous week a judge allowed the use of a specialized fraud law against Bank of America, Wells Fargo and Bank of New York Mortgage Corp. - and with it a 10-year statute of limitations instead of the normal five years, thus prolonging the banks' legal jeopardy until 2018 instead of ending the creation of new cases in a month or so. Last week also a New York court revived a $2.5-billion case against Barclays that had previously been dismissed relating to an April 2008 offering of shares.

That's within just two weeks. You have to remember that five banks last year paid a settlement totaling $25 billion, which was supposed to cover all their liabilities in relation to the mortgage market's bubble-era shenanigans. Bloomberg reported Wednesday that the six largest banks' legal bills since the financial crisis totaled $103 billion, around 40% of which has arisen since January 2012, as the pace of extortion accelerates.

And yet none of the big banks' top managements have gone to jail. (Fabrice Toure, who faces a jail sentence, was strictly small fry, while Raj Gupta, a Director of Goldman Sachs, was sentenced in relation to unrelated insider trading.) So presumably criminal activity was not significantly involved - after all Enron's Jeff Skilling was sentenced to an excessive 25 years simply for selling his Enron shares after he left the company but before its bankruptcy occurred.

The only penalties in relation to the mortgage disaster are being borne by the banks' unfortunate shareholders - and they are being subjected to triple, quadruple and quintuple jeopardy in relation to the same offenses through suits brought by innumerable state and federal authorities seeking a piece of the action.

Banking is generally a decently profitable business, but having seen the pattern of jeopardy applied to the United States' largest banks I have to say I wouldn't invest in them, and I suspect many of the largest investment institutions are coming to the same conclusion. Even with smaller banks subject to less extreme jeopardy, this has to reduce the growth in the US economy, as well as making its biggest banks' foreign and corporate businesses subject to potential takeover by foreign banks not subject to the same pillage.

Since financial services represents around 10% of GDP these days, the tsunami of uneconomic activity forced on the sector by the regulators and legal community is a serious drag on US economic performance. Yes, of course it allows innumerable lawyers to live high on the hog, but their activity is a classic example of rent-seeking; it merely extracts money from the productive economy and devotes it to the welfare of the rent seekers. That's only partly true of financial services itself, though I quite grant you that a substantial percentage of the businesses invented in the last 30 years serve little genuine economic purpose.

When you add up all the spurious drags on the US economy from regulators and lawyers, it's a wonder the thing functions at all. As I have discussed before, big infrastructure projects cost in real terms about 10 times what they did in 1925. New businesses, if they have any kind of environmental angle, get interminably delayed, while costs are added - the Keystone pipeline, with the State Department decision on it now delayed into 2014, is a recent example of this.

Entire industries, such as coal-fired power stations, are in danger of being closed down by regulators, with billions written off. Other industries, such as corn-based ethanol, spring up from nowhere, with no economic or environmental rationale other than a collection of regulations and subsidies dreamed up by lobbyists and fed to Congressmen. Other industries, such as solar power, have their birth pangs gigantically subsidized, then to the surprise of cynics become successful, after which they disappear to China on cost grounds, with the subsidies to US solar panel manufacturers having achieved absolutely zippo.

Then there is the unfortunate Binghamton, NY, a depressed medium-sized town whose main economic activity currently appears to be processing income tax returns, which sees in the distance the mirage of the Marcellus Shale oil and gas deposits, and unimagined riches (by Binghamton standards) for its inhabitants as a major center of the fracking business. Alas, this vision recedes ever further into the distance, as New York Governor Andrew Cuomo refuses year after year to authorize fracking in the state.

However the unemployed frackers of Binghamton need not worry - Cuomo has authorized a casino to open there, so they can gamble away their welfare checks. Of course I can't help thinking that giving the town two economic activities, income tax return processing and a casino, is asking for an unpleasant mutual interaction between the two.

As I have said before, I'm an optimist. One day, the United States will again have a vibrant economy. New discoveries, such as self-driving cars, genetic engineering and sophisticated online education will hugely increase US wealth and productivity. However to regain the growth levels of the 20th century, a major pruning will need to take place:

Financial regulation must be cut back, with a simple division between deposit-taking institutions (assuming deposits are guaranteed) and deal-doers, and tight monetary policy used to burst bubbles before they really get going. Each financial institution must have one regulator, and thus be subject to only one pocketbook raid when things go wrong.

Environmental regulation must be incorporated into the Department of Commerce, and the Department of Energy abolished, so that any necessary environmental regulations will be drafted with the care and attention to business's needs currently enjoyed by product standards and trade regulations.

Contingency fee lawsuits and outsize settlements must be outlawed. However, as a London-based banker for many years, I have no idea how one suppresses today's grotesque document bloat, other than by re-creating the London merchant banks, who dealt with each other and with customers on the basis mostly of trust. That's a much more efficient way to run a financial system than the current one, but it unfortunately takes 200 years to create.

Without such pruning, US economic growth will become ever more sluggish, or possibly disappear altogether. Ships encrusted with too many barnacles eventually sink.

Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found on the website www.greatconservatives.com - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on Amazon.com, Great Conservatives only in a Kindle edition, Alchemists of Loss in both Kindle and print editions.

(Republished with permission from PrudentBear.com. Copyright 2005-13 David W Tice & Associates.)




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