“The only winning move is not to play”—the insanity of the regulatory race to the bottom

By William K. Black

The plot of the movie WarGames (1983) involves a slacker hacker (played by Matthew Broderick) who starts playing the game “Global Thermonuclear War” with Joshua, a Department of Defense (DoD) supercomputer that has been given partial control by DoD of our nuclear forces.  The game prompts Joshua, who has been programmed to win games, to trick DoD into authorizing Joshua to launch an attack on the Soviet Union so that Joshua can win the game.  The hacker and the professor that programmed Joshua realize that the only way to prevent Joshua from attacking is to teach “him” that no one can “win” global thermonuclear war.  The insanity is that the people who created the game “Global Thermonuclear War” thought it could be won.  Joshua races through thousands of scenarios and ends his plan to win the “Global Thermonuclear War” game by attacking the Soviet Union when he realizes that “the only winning move is not to play.”

The JOBS Act is insane on many levels.  It creates an extraordinarily criminogenic environment in which securities fraud will become even more out of control.   One of the forms of insanity is the belief that one can “win” a regulatory “race to the bottom.”  The only winning move is not to play in a regulatory race to the bottom.  The primary rationale for the JOBS Act is the claim that we must win a regulatory race to the bottom with the City of London by adopting even weaker protections for investors from securities fraud than does the United Kingdom (UK).

The second form of insanity is that the JOBS Act is being adopted without any consideration of the findings of the Financial Crisis Inquiry Commission (FCIC), the national commission to investigate the causes of the current crisis.  I am not aware of any proponent or opponent of the JOBS Act (other than me) who has cited the findings of FCIC.  Everyone involved has ignored the detailed finding of a huge investigative effort.  The FCIC report explained repeatedly how the three “de’s” (deregulation, desupervision, and de facto decriminalization) had produced the criminogenic environment that drove the financial crisis.  The FCIC report specifically condemned the “regulatory arbitrage” that the worst actors exploited by choosing to be (not very) regulated by the “winners” of the regulatory race to the bottom.  The FCIC report shows repeatedly how damaging the anti-regulatory fervor in general and the race to the bottom in particular proved.

The third form of insanity is that the JOBS Act was framed without any input from anti-fraud experts.  Anti-fraud experts uniformly condemned the bill.  We have ignored the experts.

The fourth form of insanity is that we have ignored the people who got past crises correct.  The people who were the first to identify prior crises, who designed and implemented successful means to limit the crises, who prevented problems through effective supervision from becoming crises, and who held the most elite fraudulent CEOs culpable for their frauds have all been excluded from the drafting of the JOBS Act.

The fifth form of insanity is that the people who got everything wrong by designing the anti-regulatory policies that drove our prior crises have designed the JOBS Act.  We are reinforcing failure and turning our back on what we know succeeds.

The sixth form of insanity is a counterfactual.  The unique aspect about this crisis is that it is the first one in modern U.S. history in which the CEOs directing the control frauds that caused the crisis have done so with complete impunity from the criminal laws and near impunity from civil suits and enforcement actions.  The worst, most destructive fraudulent CEOs have been allowed to become and remain wealthy through their frauds even though several of them caused greater losses than the entire S&L debacle.  The worst fraudulent CEOs who led the prior epidemics of accounting control fraud that drove the S&L debacle and the Enron-era crisis were prosecuted.  Not a single elite CEO from Wall Street or the largest fraudulent lenders has even been charged with fraud arising from such loans even though they, collectively, made over two million fraudulent loans in 2006.  Had the Bush and Obama administrations prosecuted and denounced these elite frauds it would have been politically impossible for an act as criminogenic and cynical as the JOBS Act to be promoted by the Obama administration and adopted by large Congressional minorities.  We are seeing with the JOBS Act the sick face of crony capitalism.

The seventh form of insanity is that there is no greater killer of jobs than elite financial fraud.  Such fraud epidemics can hyper-inflate bubbles (as they did in the U.S. and several European nations) and cause severe financial crises and recessions.  The resulting Great Recession has cost over 10 million Americans their existing or future jobs in this crisis.  It has cost over another 15 million people their existing or future jobs in Europe.  The JOBS Act is so fraud friendly that it will harm capital formation and produce additional job losses.  It may appear to be an oxymoron designed by regular morons, but that underestimates the abilities of the lobbyists that drafted this bill.  They are not morons.  They are doing faithful, clever service to their fraudulent clients.  That makes them more dangerous.

The eighth form of insanity is that all of this is occurring weeks after the death of James Q. Wilson, a prominent political scientist who became most famous for co-developing a criminological theory – “broken windows.”  The theory held that it was essential to elevate conduct in the public sphere by reorienting enforcement priorities to emphasize seemingly minor crimes and civil wrongs (e.g., cracking down on squeegee men).  Wilson and “broken windows” are near universal favorites of conservatives.  Wilson’s theories are controversial among criminologists in the blue collar sphere, but they are broadly accepted in the white-collar sphere.  The JOBS Act, however, totally repudiates any “broken windows” approach to minimizing elite white-collar crimes.  It encourages the kind of fraud-friendly conduct that has always proven severely criminogenic.  Conservatives are the strongest supporters of the JOBS Act, which allegorically hands out buckets of rocks to the bottom feeders of the world of securities and encourages them to break every window in sight.  Conservatives apply policies designed to prevent and repair immediately “broken windows” only to poor criminals, not the fraudulent CEOs who caused vastly greater financial losses that brought the global economy to its knees.

The ninth form of insanity is that the JOBS Act is being adopted at the same time that the Federal Reserve Bank of Dallas – the most anti-regulatory bank in the entire Federal Reserve system (which is a very large statement) warned in its recently released annual report that the largest U.S. banks drove the ongoing crisis and posed “a clear and present danger to the U.S. economy.”

The Dallas Fed used to object vociferously to all financial regulation because it claimed that markets were “self-correcting” absent regulation.  It now warns that market “incentives often turn perverse, and self-interest can turn malevolent. That’s what happened in the years before the financial crisis.”  Only effective regulatory “cops on the beat” can prevent frauds from creating a perverse “Gresham’s dynamic” (when frauds prosper, market forces become perverse and bad ethics drives good ethics out of the marketplace).  Effective securities regulation has led to U.S. equities trading at a significant premium compared to other nations, which aids U.S. equity issuers.  The JOBS Act threatens the continuation of that premium.  Even the Dallas Fed’s most senior economist and President – and the Dallas Fed has been the leading opponent of financial regulation – now agrees that effective regulation is essential to strong financial markets.  The Obama administration and Congress still worship at the temple of the faith-based economics that has caused our recurrent, intensifying financial crises.  When the temple’s high priests (the Dallas Fed’s leadership) become apostate the politicians should shed their dogma.                          

The tenth form of insanity is that the JOBS Act’s primary theme is dramatically reducing transparency in securities law.  If there is any nearly universal principle that writers about the ongoing global crisis emphasized that we needed to learn it was the exceptional virtue of transparency.  Greater transparency makes private market discipline possible, it greatly enhances regulatory effectiveness, it discourages fraud, and it aids investors in making decisions.  The JOBS Act repeatedly embraces opaqueness.  We have known for millennia that this increases fraud.

For every one that doeth evil hateth the light, neither cometh to the light, lest his deeds should be reproved.

John 3:20 – 1769 Oxford King James Bible ‘Authorized Version

William K. Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City.  He is a white-collar criminologist, a former senior financial regulator, and the author of The Best Way to Rob a Bank is to Own One.