Scott Harshbarger & Goutam U. Jois, Turning the Page on the Global Financial Crisis: Civic Capitalism and a Blueprint for the Future

• Citation: Vol. 24 No. 1
• Publication year: 2010
• topic: Business of Law,Banking and Finance Law,Corporate / Commercial

TURNING THE PAGE ON THE GLOBAL FINANCIAL CRISIS: CIVIC CAPITALISM AND A BLUEPRINT FOR THE FUTURE

Scott Harshbarger^*

Goutam U. Jois^**

Freedom and obligation, liberty and duty-that's the deal.¹

We were wrong.

INTRODUCTION

In 2007, the two of us explored, at length, the Sarbanes-Oxley Act of 2002²and the then-recent corporate scandals, concluding that the path forward in the face of crisis was rather straightforward.³We argued for an increased focus on an ethical corporate culture on the part of business leaders, regulators, and citizens.⁴We also suggested that this path forward would be relatively simple to achieve because the areas of common interest and potential for collaboration were widespread.⁵

We did not foresee 2008-or its dysfunctional governance aftermath.

As everyone knows by now, the global financial system came to the brink of collapse a year and a half ago, thanks to the housing market bubble, subprime mortgages, securitization, deregulation, and greed. In March 2008, Bear Stearns was sold to JPMorgan in a fire sale.⁶A few months later, the U.S. government let Lehman Brothers collapse,⁷and only over $100 billion in bailout money saved insurance giant AIG from the same fate.⁸The bottom fell out of the real estate market; by late 2008, home prices in the United States had fallen by 18% year-over-year.⁹The stock markets, which were at or near their all-time peaks in late 2007, came tumbling down with the Dow Jones Industrial Average falling to a twelve-year low by early 2009.¹⁰Governments around the world enacted hastily planned stimulus programs in an attempt to shore up markets.¹¹Some countries, such as Iceland, that were over-exposed to the types of financial products that precipitated the crisis experienced major financial crises.¹²Only a European Union-financed bailout has saved Greece from utter financial disaster.¹³The global financial system and the rest of the global socio-economic system teetered on the brink of an abyss.

The question today is how to chart a course forward that will lead to a proper balancing of the regulatory, governance, and market interests, in turn leading to a more stable and higher global standard of living. Certainly, there are a lot of lessons to be learned from this game-changing crisis, and plenty of blame to go around. But we begin with a stark assessment: The recent global economic crisis unfolded because of a failure of accountability as well as checks and balances on all sides. We call this point "stark" because it is the result of a decade's worth of lessons not learned. Lest we forget, we began the

2000s with the dot-com boom and the subsequent bust. Just a year later, accounting scandals rocked corporate America as Enron, WorldCom, HealthSouth, Adelphia, Tyco, and many others collapsed while firms around the world faced similar problems. Sarbanes-Oxley came soon thereafter, but this did nothing to prevent the housing and credit bubbles of the late 2000s.¹⁴

The economy's transition through boom-and-bust cycles is nothing new. Rather, the surprising thing is that, at each turn, we seemed to learn nothing. We missed the mark in our 2007 article not because we were fundamentally wrong about the problem or solution-we still believe that regulation must be strong but limited, that firms must be allowed to operate within a generally free market, and that business and government leaders need not be incestuously connected nor unnecessarily see each other as enemies. We missed the mark because we assumed that after the dot-com and accounting scandals, we would see the errors of our ways and recognize the need for regulation that established a firm baseline for corporate and government action. Those things, in fact, did not happen.

Other scholars have explored how the financial crisis came about, both from a big-picture perspective and a more close-up vantage point.¹⁵And virtually every day, the news brings stories relating how public and private actors are dealing with the fallout from the crisis.¹⁶In this Article, we are not looking to address the hottest issues of the day or respond to specific policy proposals. With the field changing so rapidly, this Article will surely be outdated by the time of publication. But we do hope to fill a gap in the literature on a crucial point: elaboration on a framework that is applicable not only to the current financial crisis and its aftermath but also to related future issues. We do not intend to have the final word and forever synthesize socialism and capitalism into a socially acceptable hybrid. However, we do assert that there is a way forward that avoids the two extreme ends of socialism and capitalism and offers practical guidance to decision-makers.

The various market events in 2008 and 2009 have highlighted problems on many fronts; we argue that these problems, however disparate, stem from the same fundamental issues. The global financial crisis grew out of a breakdown in both individual and institutional accountability. We can only properly reintroduce accountability into our system by fundamentally rethinking the relationship between governments and markets.

That is why, today, commentators are calling for a major change. Richard Posner titles his book A Failure of Capitalism, thus putting the blame for the debacle on the capitalist system itself.¹⁷New York Times reporter Andrew Ross Sorkin suggests that a broad-scale, systemic reform is necessary.¹⁸Political philosopher Amitai Etzioni has called for a "radical change" away from consumerism in society.¹⁹Economist Joseph Stiglitz writes that the crisis was the result of a system gone "horribly awry,"²⁰and Michael Lewis suggests that the problem was not that "Wall Street bankers were corrupt" but "that they were stupid."²¹

In 2007, we revisited the Sarbanes-Oxley Act,²²five years after its implementation.²³We concluded that business leaders, regulators, and citizens alike were not sufficiently focused on the importance of an ethical corporate culture.²⁴We argued that these entities had become overly, and unnecessarily, antagonistic toward each other, and we believed that the sizable areas of their common interests were sufficient to spur reform.²⁵But these lessons have not been learned, and today we conclude that more than a mere common interest is needed. Markets may have corrected themselves relatively quickly after their fall from 2008 through early 2009.²⁶Nevertheless, we must rethink the fundamentals of how we make legal and economic policy in the United States. It is this process of rethinking that we aim to provide here.

This kind of rethinking is necessary for several reasons. First and foremost, the financial crisis has laid bare the rift between the high and low ends of the income distribution in the United States as well as worldwide. For example, the median income, in real U.S. dollar terms, has basically stayed flat or even decreased in most developed countries over the last decade.²⁷At the same time, executives, investment bankers, lawyers, and others in related professions have seen their incomes increase-in some cases, even after the crisis.²⁸In fact, some major investment banks' compensation levels in 2009 were higher than the levels reached at the height of the 2007 boom.²⁹This "dual track" system is fundamentally unsustainable and threatens not only the viability of the financial system but also the very ability of a citizenry to engage in productive economic, civic, and social intercourse.

Moreover, recent years have exposed the close relationships between businesses and governments. In general, we do not oppose movements between the private and public sectors; we both currently work in the private sector and have been government employees in the past. We firmly believe, however, that the regulators and the regulated must be two distinct entities. It is not surprising to us that years of success might have lulled Wall Street into a false sense of security. (As Sorkin points out in his book, one of the problems as the crisis unfolded was that Richard Fuld, the former CEO of Lehman Brothers, simply could not believe that the venerable investment bank could- or would be permitted to-fail.)³⁰But there is no justification for regulators to share that sense of complacency. Of course it is important for private firms- including investment banks-to do well, but we also believe that the government cannot "drink the Kool-Aid." Most importantly, it must maintain an independent perspective on when and if private firms' actions pose risks to society at large. This does not mean knee-jerk reactions imposing regulations in every circumstance; it does mean that the government must be aware of the need for regulation, even when times are good. In this paper, we set out a framework that can drive such decision-making.³¹As Nobel laureate Joseph

Stiglitz points out, we cannot have a system that privatizes gains but socializes losses.³²

In the context of executive compensation, Jay Lorsch and Rakesh Khurana, professors at Harvard Business School, write that a solution must re-examine not only compensation but also the assumptions and values underlying the economic system we have created. Our present condition offers us a unique opportunity to re- envision our journey and our ultimate destination. Re-thinking [these issues] may enable us to create a new model of compensation rooted in a more realistic recognition of the social context within which firms operate.³³

Our framework is simple, but (in our humble opinions) its simplicity belies its important implications in the "markets vs. government" debate. A regulator asks: Will the situation, if left unregulated, pose a threat to the social, political, and/or economic system (defined as civil society generally)? If yes, the action should be regulated. If no, the market should be permitted to work on its own. Note what this does: First, it creates an important space in which markets operate without regulation. Second, it...