Timothy F. Geithner, former U.S. Secretary of the Treasury and savior of the free world, has lamented the intractable paradox of financial crises: government must lend freely to actors who by all rights should bear the price of their own reckless conduct and be wiped out. The post-crisis years have been marked by a related but somewhat different paradox: On the one hand, the government has recapitalized financial institutions, subsidized them, and drawn them closer to its ample bosom. On the other, it has hit those same institutions with an avalanche of prosecutions. Settling these cases is very costly; one estimate puts the largest six banks’ litigation costs since 2009 at over $160 billion.
A strategy of re- and de-capitalizing firms at the very same time does not make much intuitive sense. And, conservative pundits seem torn. They have harshly criticized the government’s bullying banks into multi-billion-dollar settlements. Poor J.P. Morgan, poor Jamie Dimon. But they also inveigh against “crony capitalism,” which happens to be what Mr. Dimon practices for a living.
I suggest that the conflicting policies and laments converge on a single phenomenon. Prosecutorial aggression and “crony capitalism” are two sides of the same coin. Let’s call it “adversarial corporatism.”
In a 2001 book, Berkeley professor Robert A. Kagan described America’s regulatory style as “adversarial legalism”. The term was, deliberately, slightly oxymoronic. “Legalism” suggests a Weberian, hierarchical bureaucracy. But that is not “the American way of law” (the subtitle of Kagan’s book), for we combine an emphasis on lawfulness and a fear of agency “capture” with a highly decentralized, rights-based, litigation-driven mode of regulation. The mismatch, wrote Professor Kagan, comes from combining grand social ambitions that require a high degree of social control with fragmented governmental institutions and public distrust of government.
Kagan hoped that those rival forces might yet be domesticated with a bit of good will and restraint on all sides. What has actually happened is the opposite. Grand ambitions have become grander yet. The environmental laws of the 1970s—Kagan’s paradigm—look quaintly modest compared to contemporary efforts to govern the entire health-care market, the financial markets, and indeed the planet. Meanwhile, agency “capture” has become an even more fully symbiotic relation between government and private interests. At the same time, the Naderite public interest lawyers of the 20th century cannot hold a candle to today’s adversarial forces: government prosecutors of all stripes, and trial lawyers. What was once hard-fought civil litigation has become (criminal) prosecution, largely conducted outside the judicial process. Over a wide range of economic activity, adversarial legalism has evolved into an actual oxymoron: “adversarial corporatism.”
“Corporatism” is often associated with Benito Mussolini’s forms of industrial organization. But there is also a more benign, democratic form of corporatism, practiced by postwar Germany, Austria, and other (mostly Western European) countries. Corporatism in this sense seeks to lock representative and democratic interest groups—“peak associations”—into binding agreements over, for example, labor conditions or workplace standards. The agreements may be embodied in legislation, or they may be produced through routinized negotiations (as with labor “tariffs” or prevailing wages). In that fashion, democratic corporatism seeks to dampen social conflict and bring economic stability.
The United States came uncomfortably close to importing Mussolini’s corporatism; the New Deal’s National Industrial Recovery Act was explicitly modeled on it. The Supreme Court unanimously struck down the act in Schechter Poultry v. United States (1935). And yet, in the postwar era, we still ended up with something akin to democratic corporatism. Regulatory agencies such as the Federal Communications Commission, the Securities and Exchange Commission, and the Food and Drug Administration superintended sectoral industry cartels, shielding them against “ruinous competition” and against attack by state regulators or private parties. Transportation, agriculture, and utilities were regulated in the same fashion. The National Labor Relations Board maintained a rough balance between labor and capital. Banking and finance, too, were organized along corporatist lines.
New Deal corporatism pursued the same objectives as its European counterpart: social and economic stability. Here as in Europe, it rested on a rough social consensus—in our case, the New Deal consensus. The law that organized this universe was not the Constitution but the Administrative Procedure Act of 1946 (APA). The APA governed an array of (typically) bipartisan, “independent” agencies. For traditional rule-of-law protections, administered by independent courts, the APA substituted administrative process and deferential judicial review.
That system crashed and splintered in the 1960s, for well-rehearsed reasons: misgivings about the capture of regulatory agencies; the system’s inability to accommodate broad but diffuse demands for environmental and consumer protection; a lack of transparency and accountability. The system became more pluralistic. A much wider range of interests gained access to agencies, as the courts and the Congress pried the doors open for consumer advocates, environmental groups, and competing economic actors. The APA underwent a radical transformation, and the administrative process became much more contentious and judicialized. This, roughly, is the world described by Robert Kagan in 2001.
That world is no longer ours. We have acquired a new style of regulation—adversarial corporatism. Its most pristine embodiment is the Wall Street Reform and Consumer Protection Act of 2010, otherwise known as Dodd-Frank for its main congressional sponsors.
In an instructive overview of Dodd-Frank, law professor David A. Skeel has argued that the statute is a throwback to New Deal-style corporatism. It establishes “(1) government partnership with the largest financial institutions and (2) ad hoc intervention by regulators rather than a more predictable, rules-based response to crises.” Adds Skeel: “The partnership works in both directions: special treatment for the Wall Street giants, new political policy levers for the government.”
Evidence is not hard to come by. The ultimate government “partners,” Fannie Mae and Freddie Mac, played a key role in the meltdown that the reform law was supposed to address. Still, after a brief period in federal receivership, Fannie and Freddie emerged largely unscathed and are making money again (which the U.S. Treasury siphons off). Moreover, to these old-time Government-Sponsored Enterprises (GSE’s), Dodd-Frank has added a stable of new ones. They are called “Systemically Important Financial Institutions” or “SIFIs” for short. They, too, operate with a huge embedded subsidy. (By some estimates, their advantage vis-à-vis smaller institutions works out to close to 100 basis points.) A lot of money can be made by being systemically important. But you must stay close to the regulators and be nice to them. Former Morgan Stanley CEO John Mack famously articulated the new first law of finance: “Your Number One client is the government.” Goldman Sachs CEO Lloyd Blankfein has chimed in: “We’re not against regulation. We partner with regulators.”
Of course they do: they always have. There’s a serious argument that the relation between government and banks must be corporatist. On one side, the government needs to borrow money. On the other side, fractional reserve banking requires a lender of last resort—the government. Hence the mutual embrace. The use of regulatory and lender-of-last-resort leverage is called “fiscal repression.” It is a pristinely corporatist mode of operation; but it is old hat. So what is new?
It is that the partnership is a pact among devils, or at any rate an arrangement that is calculated to make the parties look that way. The government is every bank’s number one client because it is the true source of profits. Those come in the form of embedded subsidies and of regulatory goodwill, which a bank may cultivate by, for example, serving as a holding pen for former and future government officials. (This is Citigroup’s business strategy.) But there is a second reason to cultivate the government: it, unlike most clients, can destroy you. It will threaten to do so on a regular basis, and it will shout from the rooftops that you (banker) ought to be in jail. Instead of charging or prosecuting individuals, however, the government prosecutes firms and exacts large sums of money. Billion-dollar settlements have become almost routine.
These shake-downs are a perplexing feature of what is, after all, supposed to be a “partnership.” Several features are worth noting:
First, while settlements are haggled out behind closed doors, the results are the stuff of press releases and newspaper headlines. The opposite is true of conventional corporatism, which operates on the principle that publicity is what happens when the system breaks down.
Second, the settlements and fines in these proceedings bear little, if any, relation to the supposed abuses. While there was a lot of bad behavior in the run-up to the financial crisis, the practices that did the real harm had much more to do with horridly misaligned incentives than with the sudden emergence of a criminal class. And no one seriously pretends that the prosecutions or the settlement amounts correspond to culpability, mens rea, or demonstrable harm to consumers. The settlements usually take place far away from any courtroom, and long before any trial. They are political bargains.
Third, and most strikingly, “settlements” settle virtually nothing. In New Deal corporatism, as noted, administrative agencies and congressional subcommittees shielded regulated industries from legal and political attack. Adversarial corporatism, in contrast, resembles a protection racket that exacts payment and then invites rival gangs to open fire on the local saloon. A settlement with one federal regulator will rarely stop investigation and prosecution by another federal regulator; or prosecutions by state attorneys general and treasurers; or consumer class actions or derivative shareholder actions; or actions by those allegedly hapless victims of mortgage shenanigans, Fannie and Freddie and the Federal Housing Administration. State and federal agencies compete for the spoils. None of them has the means or the motives to bring closure.
It seems highly unlikely that Dodd-Frank’s architects deliberately designed a grand profits-for-pariah-status bargain. Congress does not work that way, least of all under tumultuous conditions like those that obtained in 2008. Moreover, it is misleading to think of “the government” as a unitary actor. The U.S. Department of Justice could not get a U.S. attorney in New York or Sacramento to stand down even if it wanted to, and the federal government’s ability to block enforcement proceedings by officials in the 50 states is nil.
For all that, adversarial corporatism does have a functional logic. At the time of Dodd-Frank’s enactment, the political system could see no way to bury GSE’s, to break up SIFIs, or to wring the subsidies out of the system. Corporatism, however, requires a private quid for every government quo, especially in the wake of a financial crisis that was widely viewed as Wall Street’s fault. The quasi-criminalization of an entire area of the private sector was the only quid that the political system could exact, and so it did.
Is government-by-prosecution really a new regulatory style, or just a temporary banking thing? As noted, the banking sector is and has always been a particularly likely candidate for corporatism. And perhaps the adversarial climate will give way to corporatist comity once the post-crisis mop-up is over and the bankers have been cured of their mistaken belief, acquired in “de-regulatory” times, that they are independent actors. However, that prospect seems unlikely.
Adversarial corporatism extends far beyond the financial sector; it has taken hold across a wide range of industries. The tobacco industry, for example, operates under a state-sanctioned cartel and an explicit profit-sharing agreement with state governments (called the 1998 “Master Settlement Agreement”), in exchange for de facto immunity from private lawsuits. The pharmaceutical industry is another example. It operates under a regulatory regime with strong oligopoly tendencies. The firms pay for regulatory approval at the front end; at the back end, state and federal regulators, along with trial lawyers, capture a big portion of the rents by means of “law enforcement.” (Many of the largest settlements on record have been between pharmaceutical firms and federal agencies, especially the Departments of Justice and Health and Human Services.)
The Affordable Care Act works on a similar principle with respect to health insurers. The act turns health insurance into a product that cannot survive in an open market and then promises to keep that product viable by means of subsidies and compulsion. That, too, is a “partnership” between business and government. It, too, will become a permanent perp walk.
All these arrangements reflect the reality that every corporatist system must have some way of recapturing an acceptable portion of the government-produced rents. For de jure GSE’s, the arrangement is made explicit: Fannie and Freddie must kick back their profits to the Treasury. De facto GSE’s aren’t subject to that requirement. Thus the need for some other way to siphon off the profits. That is where law enforcement, so-called, comes in. Legal action is, it appears, more convenient than conventional methods such as taxes or rate regulation. Financial settlements and payments are in lieu of penalties in name only. They are better viewed as dividends, payable to the banks’ number one client. And like any investor-client, the government will insist that dividends be paid promptly and reliably.
Is this a stable institutional arrangement? There are reasons to think not. The key arguments for corporatism, as mentioned, are economic stability and social consensus. (New Deal agencies were supposed to protect and stabilize their industries, not destroy them.) A corporatism that is adversarial is incompatible with either goal. It aims, after all, to keep financial institutions and their investors in a state of permanent uncertainty, and to stir up resentments.
The difference between conventional corporatism and its adversarial cousin is reminiscent of Mancur Olson’s famous distinction between “stationary” and “roving” government bandits: Stationary bandits seek to enforce exclusive dominion and will exploit their base only to the point of maximizing long-term gains. Roving bandits have a much shorter time horizon. They come, loot, and leave the scraps to the next occupier. That, roughly, is our system: once multiple federal agencies are through with J.P. Morgan or Glaxo, state AGs and trial lawyers pick over the remains. Such a regime simply isn’t built for the long haul.
Even so, there are potent reasons to suspect that adversarial corporatism may be here to stay:
- Regulatory agencies at all levels of government have become profit centers for cash-strapped legislatures, and returns on agencies’ law-enforcement investments have become an important margin of regulatory competition. Agencies will be loathe to surrender their legal powers; legislators will be reluctant to demand they do so.
- Adversarial corporatism rests on broad political coalitions. The architects of the tobacco cartel were careful to cut trial lawyers and public health groups in on the bargain. State AG settlements routinely divert funds to a coterie of advocacy groups. Health insurers and providers “partner” with Medicaid and Medicare lobbyists. And in a truly breathtaking account (cited in note 4), Charles W. Calomiris and Stephen H. Haber have documented the unholy coalition of big banks and an entirely bank-financed non-profit “fair housing” sector. Like all such coalitions, that between Wall Street and urban interests is firmly entrenched in Congress. (In the 1970s, my friend Alex Pollock has noted, the Senate Committee on Banking and Currency became the Committee on Banking, Housing and Urban Affairs.) And the coalitions are well connected to both major political parties. President Clinton promoted the banking-fair housing coalition as did President Bush. President Obama does, and the same will be true of the next President.
- As an economic matter, multi-billion dollar legal liabilities have become part of firms’ overall profit picture. At one level, this seems odd since government-imposed liabilities are almost random events. But then, stock markets find no great difficulty in pricing legal risks, and an entire cottage industry has grown up to arbitrage them.
- As a matter of elite social mores, profits-for-prosecution has become accepted. At Baltusrol Country Club, moving your ball in the rough remains a grave offense. Running a quasi-criminal enterprise may be more like a condition of admission. (If the government isn’t after you, you’re probably not very rich or important.)
- Adversarial corporatism is self-reinforcing in public opinion terms. The Wall Street Journal’s editorialists have summed up Dodd-Frank and its implementation with the headline, “Government Has Won.” Meanwhile soi disant progressives are just as convinced that the capitalists have won. Not one culprit in the 2008 meltdown has gone to jail, they cry, and the banks are raking in unprecedented profits. Both camps are in a way correct, and both can marshal mountains of evidence. Both choose to see only one side of a fiendish bargain that is not easily explained.
The Corporatist Conundrum
For any number of reasons—economic, political, social—adversarial corporatism is a very bad way to run a country. Can anything be done about it?
Law and courts?
Excessive hope on this front is probably misplaced. True, many government prosecutions of alleged corporate misconduct would not pass muster with a jury or judge. However, few if any targeted companies can afford to play hardball. Thus, the parties bargain in the shadow of the law, and over time, the deal-making becomes routinized. To paraphrase the divine Tina Turner, “What’s law got to do with it?”
That might not work, either. The 2007-2009 financial crisis should have been a wake-up call. Yet the forces that knowingly walked us into the disaster—banks, housing advocates, Fannie and Freddie and the FHA—walked away from it with more money, power, and privileges than before. Dodd-Frank did not retard adversarial corporatism; it enshrined it.
A call to reason, social responsibility, and the greater collective good?
That was Robert Kagan’s proposed cure for adversarial legalism and its ills. It went unheeded. Adversarial corporatism will likewise prove immune to appeals to the greater good, and for the same reason: for the professional players, it’s a positive-sum game. As has been said, they have a friendly dealer (the government) and a few hundred million suckers at the table, who can’t get up: taxpayers. For the pros, the rational strategy is to pretend that it’s a real fight and a competitive game; to raise the stakes; and to squabble over the proceeds among themselves, somewhere down the road.
Will the game end when all the suckers sit naked?
No. The house will print money and lend it, as it does whenever there is a crisis and, nowadays, even when there isn’t one. The game will end only when the card sharks start shooting each other—in other words, when the coalitions that sustain adversarial corporatism break.
I’ll entertain any reasonable proposal conducive to that end. But I’m not holding my breath.
 Timothy F. Geithner, Stress Test: Reflections on Financial Crises (Crown, 2014).
 Robert A. Kagan, Adversarial Legalism: The American Way of Law (Harvard University Press, 2001).
 David A. Skeel, The New Financial Deal: Understanding the Dodd Frank Act and Its (Unintended) Consequences (John Wiley and Sons, 2011).
 Charles W. Calomiris and Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (Princeton University Press, 2013).
 If you must know the gory details, see Michael S. Greve, “Compacts, Cartels, and Congressional Consent,” 68 Missouri Law Review 285 (2003).