The JOBS Act and Green Slime
We learned recently about the secret adulteration of our hamburgers with “pink slime.” Agribusiness companies created pink slime from ultra-fatty beef tissue that was more likely to harbor salmonella and e coli. They processed it with ammonia (Mr. Clean) in a partially successful effort to reduce the risk of infecting the consumer. Pink slime, unbeknownst to the public, comprised up to 15% of our hamburgers.
The financial sector is far worse. Pink slime represented a relatively small portion of each burger and generally did not make the consumer sick. In the financial sector, “green slime”—slime with the color of money—came to dominate entire sectors, and it always caused severe damage. “Liar’s loans,” made without the lender verifying the borrower’s actual income, were 90% fraudulent. Collateralized debt obligations (CDOs), securities giving their owners claim to a part of debtors’ interest payments, were typically composed overwhelmingly of fraudulent liar’s loans. It was lenders who overwhelmingly put the lies in liar’s loans, issuing loans that were nothing more than “green slime” and then turning around and selling them as Grade A Prime cuts.
The production of “green slime” has thrived—indeed, can only exist—in the shadows of an unregulated financial system. The United States’ deregulated and fraud-friendly “shadow banking” system produced over a trillion dollars in green slime and set off a global depression. Only four years later, the Jumpstart Our Business Startups Act (JOBS Act) seeks to create a shadow stock (equity) system where the green slime can multiply once more.
The JOBS Act purports to create jobs by giving entrepreneurs easier access to start-up capital. But the new law does so by eliminating protections for investors. It extends, from two years to five, the amount of time that a new public company has before it is subject to key regulations and disclosure requirements. But such regulations were put in place to prevent fraud and protect investors. So in place of a real jobs bill, we have an invitation to fraud. The JOBS Act reduces transparency, which makes fraud harder to spot, and directly encourages fraud by exempting smaller companies from requirements to ensure that their internal controls work and reducing the requirement for audited financial statements. It allows frauds to target the most vulnerable potential investors by allowing stock issuers to raise money through “pre-prospectus” presentations. These glorified commercials would deliberately target the least financially sophisticated investors and allow the sale of securities to be made without providing even the most unsophisticated investors of modest wealth with the information essential to make a prudent investment decision. Your grandmother and your kids will be leading targets of the frauds who are certain to exploit the anti-regulatory provisions of the JOBS Act.
For four years of severe crisis and mass unemployment, Congress has failed to do anything constructive about creating jobs. Now, the Obama administration and members of Congress are trumpeting the JOBS Act as a way to promote small business and spur job creation. The bill, however, is a sham. For any “jobs” bill to pass, it has to be a sham, because the Republican members of Congress are universally opposed to any real bill to spur job creation. They have locked themselves into absolute opposition to any further stimulus spending or direct job creation by the federal government, and are celebrating vast government job destruction at the state and local level.
Cynical incumbents of both parties realized that there was one way to build a bipartisan consensus for something that could be labeled a “jobs bill.” Congressional Republicans are universally in favor of deregulation. Their fondest goal in the financial sphere is to gut the Sarbanes-Oxley Act, the 2002 financial regulation law that, in the wake of Enron other similar fraud scandals, overwhelmingly passed both houses of Congress and was signed into law by George W. Bush. If enough Democrats joined the Republicans on deregulation, and if the Democrats were willing to call the resulting atrocity a “jobs” bill, then the bill was certain to pass with strong majorities in both houses.
To its undying shame (if it were capable of such), the Obama administration pushed this cynical, sham deal through its “competitiveness” council. This is a non-partisan group composed overwhelmingly of business executives who share one common desire—to gut regulation faster and further than other countries, to “win” the “race to the bottom.” The token labor representative on the council, AFL-CIO President Richard Trumka, denounced the JOBS Act for what it is: “The bill ...,” he argued, “will do nothing to create good jobs and stabilize the U.S. economy. Instead, it will deregulate Wall Street—voiding investor protections put in place after Enron and the 2008 financial crisis to protect the retirement savings of America’s workers from fraud and other risks.” The anti-fraud community—the nation’s top criminologists studying financial fraud, the Securities and Exchange Commission, the Commodities Futures Trade Commission, the state securities supervisors, and accountants—likewise, all opposed the JOBS Act. That is why the administration and the congressional leaders refused to hold real hearings on the bill.
President Obama’s signing ceremony speech on behalf of the Act is eerily reminiscent of his predecessors’ statements when they signed the deregulation laws that have created one crisis after another. In particular, he claimed that modern times require us to deregulate: “Right now, you can only turn to a limited group of investors—including banks and wealthy individuals—to get funding. Laws that are nearly eight decades old make it impossible for others to invest. But a lot has changed in 80 years, and it’s time our laws did as well.” This rhetoric channels the same claims by supporters of the Clinton-era financial deregulation. The titles of both of the Clinton-era deregulation laws include this modernization motif: the Commodities Futures Modernization Act (which deliberately created a regulatory black hole for credit default swaps (CDS) that Enron and AIG promptly exploited) and the Financial Services Modernization Act of 1999 (which repealed the 1933 Glass-Steagall Act’s prohibition on commercial banks’ participation in risky stock speculation).
The claim that, because we live in modern times, we no longer need financial regulation to prevent fraud is absurd on its face. If anyone made that claim in the context of “street” crime—we no longer need police because we are modern—we would know that they were delusional. There is nothing “modern” about deregulating the financial sector and allowing elite frauds to commit their crimes with impunity. We just ran this experiment in the shadow banking system and produced an epidemic of green slime that brought the global financial system to the brink of catastrophe. It was saved only by government intervention. Now, the Obama administration and Congress are creating a similar fraud-friendly (or “criminogenic”) environment by allowing those issuing equities to operate in the shadows.
For millennia, the normal rules typically did not apply to elites—clan leaders and nobles. They often used that impunity to loot the public in order to enrich themselves and their kin. Allowing elites to act in a rules-free environment is actually an antiquated, discredited idea that always leads to disaster. The modern, effective approach that America, at its best, champions is the exact opposite—that no person is “above the law.”
WILLIAM K. BLACK is an associate professor of economics and law at the University of Missouri-Kansas City.
SOURCES: CNN Money, “JOBS Act Opens Fundraising Doors for Small Firms,” April 6, 2012 (cnn.com); “Small Biz Jobs Act Is a Bipartisan Bridge Too Far,” Bloomberg News, March 18, 2012 (bloomberg.com); “Statement by AFL-CIO President Richard Trumka on So-called ‘JOBS Act,” March 22, 2012 (aflcio.org); “Remarks by the President at JOBS Act Bill Signing,” April 5, 2012 (whitehouse.gov).