Is Big Government Back? the Political Economy of Activist Government Policy
Gallagher, Tom, Business Economics
For most of the past twenty years there has been a trend toward smaller government, but now it appears that the trend has reversed. Such trends and their reversals appear to have more to do with society's perceived needs than with electoral politics. Although there might appear to be a political cycle that drives periods of greater and lesser government activism, it is more likely that a dominant trend toward relatively little government activism is periodically countered by periods of crisis. The dominant contemporary "crises" are the war on terrorism and the collapse of the stock market bubble. Also, although not a crisis, the aging of America is an emerging structural problem that poses challenges for expenditure and regulation. This paper describes these issues and their likely long-term implications.
Republicans are regarded as the party of small government, yet consider what happened after they triumphed in the 2002 elections:
* The main order of business in the lame duck session immediately following the election was passing the party's top priority, the creation of a new cabinet department, the first in over a decade.
* The first order of business in the New Year was an extension of unemployment benefits.
* One of the next priorities was funding the government for FY2003. The omnibus spending bill added $330 billion to the ten-year baseline.
* And one of the most important domestic priorities for the Republicans this year is to expand Medicare by adding a drag benefit, which would increase
Medicare by about twelve percent.
My overall theme is that these are not isolated examples or aberrations in politics but represent a new phase for public policy. For the better part of the last twenty years, the prevailing approach to solving problems was to reduce the role of government. Now we are on a trend in which the predominant approach to solving problems will involve an expanded role for government.
Figure 1 shows the best measure of the government's economic role, federal spending as a share of GDP. This isn't a complete measure, since it omits new regulations and higher steel and lumber tariffs, for example, but it tells the story. Even the Bush Administration's own budget projections show no material decline in the government's share of the economy. Once the Iraqi war, occupation, and rebuilding costs are added, this line will continue to trend upwards.
[FIGURE 1 OMITTED]
The trend toward a bigger role for government means that government actions will take on a more central role in the economic and financial outlook for the United States.
A Long Political Cycle?
It seems odd to postulate about a return of activist government with an all-Republican government in place. But my argument has to do with the direction of policy, not partisan politics. The two can be linked to the extent this means one party or the other has the home field advantage in elections. I would argue that the Republicans were successful last year despite, not because of, their image as the party of smaller government.
While we tend to think of Democrats as favoring a bigger role for government and Republicans a smaller role, it's better to think of that statement relative to a trend line.
* Clinton gave us a bigger role for government after the 1992 election than George H.W. Bush would have, but the trend line was pointing down, so his two terms were characterized by his famous statement that "the era of big government is over," for welfare reform, for continued economic deregulation (of banks and telecommunications), and for budget surpluses.
* Nixon gave us smaller government after the 1968 election than Hubert Humphrey would have, but the trend line was pointed up, so we'll remember his domestic policy for the creation of the Environmental Protection Ad-ministration (EPA), Occupational Safety and Health Administration (OSHA), CETA (the temporary public jobs program), for wage and price controls, and for the indexing of Social Security benefits to inflation.
* That each of these presidents faced for most of their tenures a Congress controlled by the opposition party is an indication to the extent to which the party on the "wrong" side of public opinion must accommodate that agenda to win.
If one was looking for a chart to explain the last two decades in U.S. politics, Figure 2 shows the trust in the government in Washington to do what is right. The very high level of trust in the late 1950s and early 1960s took a beating from both social disorder of the 1960s and high inflation of the 1970s. This pattern largely set the pattern of both U.S. politics and U.S. economic policy of the last twenty years.
[FIGURE 2 OMITTED]
* If it's odd that Republicans are presiding over a period of government activism now, the policy trend toward a smaller role for government began in the all Democratic government under Jimmy Carter--there was the capital gains tax cut of 1978 and the deregulation of key industries (airlines, trucking, and railroads).
* This declining trust in Washington essentially explained the two Reagan landslides (he won ninety three out of one hundred states in his two presidential elections), the need for Clinton to run as a "New Democrat" to win the presidency in 1992, and the big GOP sweep in the 1994 elections.
* There are interesting parallels in the presidencies of Eisenhower and Clinton--each reconciled his party to the prevailing mood. In the 1950s voters identified progress with an expanded role for government in Washington. Unlike the previous Republican presidential candidates, Eisenhower did not oppose the New Deal but instead, as Mark Shields has commented, said he could do it ten percent cheaper and with guys who went to better prep schools. In so doing, he reconciled Republicans to an expanded role for government. Clinton, unlike the previous Democratic candidates, ran on New Democrat themes and against big government and, in so doing, reconciled Democrats to a smaller role for government. For each president the success was more personal than party-oriented--each had a congress of his own party for just the first two years and faced an opposition Congress the remaining six years.
* The explanations get complex, but the 1994 tidal wave was essentially the result of Clinton governing more like an Old Democrat (health care reform, the 1993 tax increase, "midnight basketball" in the 1993 crime bill, for example), so that angry voters could now concentrate their anger on one party (it was the first one-party government in thirteen years), and that party was governing very contrary to the prevailing preference for limited government. That tidal wave of public opinion helped Republicans overcome incumbency advantages that had kept Democrats in the majority despite the prevailing public mood.
* The GOP sweep of Congress in 1994 appears more like a late-cycle surge than the start of a new trend toward smaller government. Trust in government began ticking up, and just as Clinton had moved too far left for public tastes, the Gingrich era typified a shift too far to the right. Clinton was the more nimble in capturing an emerging public mood for a selective increase in the role of government and captured the center.
* Bush's compassionate conservatism is a direct response to Clinton's success with a centrist message. Just as Bush was running as the anti-Clinton on morality, he was paralleling Clinton's centrism. No longer was the GOP presidential candidate endorsing eliminating the Department of Education but instead wanted to spend more. Bush was for a patients' bill of rights, and so forth.
* Table 1 shows how Bush's budget proposal contrasts with those approved by the GOP Congress after the 1994 election. Bush proposes a net increase in non-defense discretionary outlays of $16 billion over five years, while the FY96 and FY97 budget resolutions contemplated cuts relative to the baseline of $123 billion and $105 billion, respectively. In entitlement programs, Bush's five-year request would add $183 billion, while the earlier budget would have cut below the baseline by $332 billion and $244 billion, respectively. It's instructive to put this last cycle toward smaller government into a broader historical perspective. In his book Cycles of American History, historian Arthur Schlesinger, Jr. has written about thirty-year cycles in the United States, with swings between an emphasis on public purpose versus private markets, between an emphasis on democracy and on capitalism, in a healthy process that keeps democracy and capitalism vibrant.
His thirty-year cycles correspond roughly to generations in politics. While they could be extended back further, in the twentieth century there were periods of public activism starting in the 1900s (Theodore Roosevelt and the Progressive Era), the 1930s (Franklin D. Roosevelt and the New Deal), and the 1960s (Kennedy/Johnson and civil rights/Great Society). This led him to predict a return to activism in the 1990s that failed to materialize.
A good reason that it failed to materialize is that expansions of government tend to coincide with crises--usually wars or severe economic downturns. Depressions preceded both the Progressive Era (1896 and 1907) and the New Deal (the 1930s). So possibly what historians have seen is less a swing in the public mood every thirty years and more the periodic nature of crises. What held off the return of a more activist government in the 1990s may have been the lack of a crisis to trigger that reaction.
In the rest of this article, I outline two good candidates for "crises" that have expanded government's role: the war on terrorism and the stock market bubble of the late 1990s and mention a third candidate, the aging of the population--a clear factor, if not meeting the narrow definition of a crisis. These factors will shape the nature of the expanded government role in the years to come.
The War On Terrorism
No other public good arouses more support than national and homeland security, and war has been a dominant factor in the growth of government. The attacks of September 11, 2001, have given rise to many direct and indirect increases in government's role in ways that draw parallels to the impact of the Cold War. Here are several observations:
First, the war on terrorism has led to sizeable increases in government spending on defense and homeland security. In the 2000 presidential campaign, candidate Bush had already proposed, as candidate Gore had, significant increases in defense spending. A rough measure of the impact of 9/11/01 is to compare the defense spending request for, say, 2006 (the last year covered by Bush's initial budget request), made at the outset of Bush's Administration with the current 2006 request (Table 2). Bush's request for 2006 grew by about $70 billion, or twenty percent, over his first two years in office.
Figure 3 shows the trend in homeland security spending. Bush's request for 2004 is $41 billion, which compares to $16 billion prior to the emergency supplemental in 2001.
[FIGURE 3 OMITTED]
Looking down the road, a common source of funding for increased domestic spending has been a draw-down in defense spending following a war. Figure 4 shows how the drop in defense spending following the Korean War build-up didn't translate into a decline in overall spending.
[FIGURE 4 OMITTED]
Second, another measure of the growth of government is the growth in the number of government departments. The creation of the Department of Homeland Security at the outset of the war on terrorism closely parallels the organizational response in the early days of the Cold War. Starting in 1947, a dozen different security and defense-related departments were created that were ultimately folded into the new Department of Defense in 1949.
A third example is the shift of airport safety personnel from the private to the public sector. This was a classic example of a collective decision that a particular function should not be left to the private sector.
Fourth, war has also caused significant government regulation of specific industrial sectors. Major wars create the need for the government to mobilize significant amounts of resources quickly, and the result often has been new regulation for previously unregulated sectors. World War I, for example, led to the regulation of shipping, railroad, telephone, and telegraph industries, to name just a few sectors.
Almost all of these were dismantled at the end of the war but were reconfigured in World War II. The combined experience of the 1930s depression, World War II, and the Cold War produced long-lasting regulatory structures for many industries.
Some examples of this phenomenon are evident in the war on terrorism. The federal government now has a role in terrorism insurance. And the airline companies, having had one bailout already, received further federal assistance in the form of the government paying for some of the additional security-related regulations imposed by the government.
Beyond these limited examples, though, this war doesn't seem likely to expand government's involvement in specific sectors very much. A simple reason for that is that the mobilization of resources needed to fight the war on terrorism or the specific military actions that will be part of it, such as the war on Iraq, don't require that much mobilization of resources. As Table 3 shows, wars now don't cost as much as a share of GDP as they used to. The encroachment of government into private industry should be commensurately less.
Fifth, yet another indirect effect is the need for a "small government conservative" president to devote political capital to the higher priority of fighting the war on terrorism. Bush's signing of the budget-busting farm bill last year may be one example of this.
Sixth, beyond the scope of this article, but clearly relating to an expanded role for government, is the non-economic impact of the war on terrorism, namely the swing of the pendulum from civil liberties to police powers.
Seventh, there is an international counterpart to a war-on-terrorism-based expansion of the role of government. If the government is assuming a greater role domestically to provide security, it is also assuming a greater international profile. Table 4 is from a recent Financial Times article listing the countries in which the United States now has military personnel stationed, in addition to longstanding commitments with Japan, S. Korea and Western Europe. The new U.S. doctrine of pre-emptive strikes as a means to prevent the spread of weapons of mass destruction implies the real possibility of more wars beyond the current campaign against Iraq. One element of the war on terrorism, or an extension of it, is the more controversial plan Bush apparently has for an extended period of involvement for the United States in Iraq, perhaps as part of a larger plan for introducing democratic, capitalist reforms in the Arab world. United States willingness to go in without multilateral backing suggests that the costs of these campaigns would largely be borne by the United States.
Eighth, one might think that the need to fight a war would lead to cutbacks elsewhere in government, but history suggests the opposite is closer to the truth. In a very broad sense, a common enemy or a common threat creates much more of a sense of a collective fate. During the Cold War this sense of interdependence carried over into a support for collective action in other areas, as voters become more receptive to security rationales for government projects. Recall that the name of the act creating the federal highway program was the National System of Interstate and Defense Highways, enacted during the Eisenhower years.
Finally, the pattern of increased government activism during the Cold War seems to be repeating itself. During the Cold War the public sector expanded at the expense of the private sector, Washington expanded in importance relative to state and local governments, and within Washington the executive's importance expanded at the expense of the legislative branch. During the interregnum between the Cold War and the war on terrorism, basically the 90s, these trends largely reversed--there were swings toward the private sector, toward states, and toward Congress. The lack of an overarching threat meant devolution of power away from central authorities. In the short time since 9/11/01 these trends have retraced the Cold War patterns.
Post-Bubble Economic Policy Imperatives
The post-bubble paradigm rivals the war on terrorism as an organizing principle for policy and politics. One lesson of the 2002 election was that security trumped economics as a factor driving the results, but the post-bubble prism is the most useful way to understand current economic policy debates.
Bubbles are not just financial phenomena; social, cultural, and political factors play a role. The government's role in the bubble of the late 1990s is variously cited (deregulation and excess credit produced overinvestment, lax enforcement, or simply poor rulemaking facilitated speculation). My point isn't to debate this but to state that just as the government played a role in the creation of the bubble, the bursting of the bubble affects economic policy fundamentally. It affects it at two levels--greater regulatory efforts at the micro level and more active policies at the macro level.
At the micro level, just as the government played a role in the system-wide adoption of lax financial reporting and corporate governance standards (e.g., no expensing of options, etc.), so too is it playing a role in the system-wide move to more conservative financial reporting and corporate governance standards.
There is a ladder of policy response evident in the financial/corporate wrong-doing debate--tougher enforcement of existing laws and regulations, tougher regulations under existing laws, and tougher new laws. When it looks as though enforcement of existing laws isn't enough, regulators try to control the policy process, based on the notion that they can act more quickly, more knowledgably, and more precisely than can legislators. So the agencies hope to pre-empt Congress, in part to preserve their own discretion.
This was evident on the accounting reform effort last year. The Securities and Exchange Commission's initial effort appeared to have provided the necessary political cover for congressional Republicans, whose limited government instincts led them not to want to pursue sweeping statutory reforms. Accounting reform seemed dead on Capitol Hill until the WorldCom failure, which then created a need for Congress to appear to be doing something. So the Sarbanes-Oxley bill was passed last summer.
Accounting reform was essentially the first phase of the post-bubble reforms. Wall Street conflicts of interest are another phase, but here the regulators and the litigators are in charge, not the legislators. If the last election had produced big gains for Democrats, the interpretation would have been a popular mandate for more reforms. Since voters didn't send that signal, the GOP-controlled Congress doesn't feel the pressure to act, leaving the discretion to regulators.
Table 5 is a summary of the various reforms that have been implemented so far. But even this isn't comprehensive. For example, the tax bias in favor of retained earnings has been cited by Jeremy Siegel as the root cause of earnings manipulation, and the market forces pushing companies to increase dividends gives a timeliness to President Bush's dividend tax cut proposal.
But that's a snapshot of where things stand now. Historically there has always been a reform response to burst bubbles. The magnitude of that response has depended on the severity of the economic damage caused by the burst bubble, and it's safe to say the jury is still out on that score. If the current economic and stock market doldrums are due to more fundamental factors than just Iraq uncertainties and the bear market and below-average growth continue, we may look back on this as merely the initial stages of the post-bubble reform process.
The economic impact of these reforms will always be a source of controversy. In addition to deciding the optimal structure of regulation, there are the competing needs to restore investor confidence (some think that an essential part of the capitulation process in the stock market is a strong government figure standing up to "wrongdoers and malefactors," such as Theodore Roosevelt against JP Morgan and Franklin D. Roosevelt against "economic tyranny") versus the cost of over-regulation. (Some view the New Deal reforms and the related congressional investigations as causing uncertainty among business managers and thus raising the hurdle rate of return for investment.) These examples call to mind what House Majority Whip Tom Delay (R-TX) said last July, "We're taking the mansion. We're draining the account. We're going after the yacht."
So far it would seem that the reform process is falling short of over-regulation. The biggest concern has been on whether the reforms will discourage risk-taking by top corporate management. But limiting over-regulation in turn depends on the success of macro policy in arresting the economic hit caused by the bubble, so that's a good segue into the post-bubble macro policy dynamic.
The argument here is that the post-bubble drags on the economy are requiring more activist monetary and fiscal policies. On monetary policy, a frequent characteristic of bubbles is low inflation, so the economic slowdown following a burst bubble can threaten deflation. As the widely discussed Fed paper on Japan highlights, faced with the threat of deflation the challenge to a central bank is to cut rates more aggressively than normal, which the Fed has done in this round of easing. (Ahearne, et al., 2002) The pace of easing in this cycle versus the cycle surrounding the 199091 recession is illustrated in Figure 4. If this isn't sufficient, the Fed can embark on unorthodox easing.
Figure 6 shows that according to the Congressional Budget Office (CBO) there has been more fiscal stimulus in the last recession than in any other in the last sixty years. Greater fiscal activism is appropriate for two reasons. First, it's an essential complement to monetary easing. During the bubble households and corporations leveraged up their balance sheets as the federal government began to de-leverage its balance sheet. The post-bubble process involves households and corporations shoring up their finances, but monetary easing works by getting consumers and businesses to spend more by borrowing more. As Paul McCulley, managing director of PIMCO, has put it, it makes sense for the public sector to lever up through discretionary fiscal stimulus as the private sector is de-leveraging.
[FIGURE 6 OMITTED]
The second reason is that the post-bubble nature of the current economic environment takes away one of the strongest arguments against an activist fiscal policy, namely the lags involved in developing, legislating, and implementing fiscal stimulus. The typical post-war recession was caused by high interest rates hitting interest-sensitive sectors, so monetary policy was all that was needed. Interest-sensitive sectors naturally responded to lower interest rates, recessions were relatively short, and a good signal that the recession was over was the enactment of a fiscal stimulus package by Congress.
But this recession wasn't led by interest-sensitive sectors, and even if the recession was brief the post-bubble period is likely to be characterized by weak growth, due to consumer and business retrenchment. In this environment fiscal stimulus isn't likely to arrive too late.
The question of the moment is how amenable the post-bubble dynamic is to macro policy. There aren't many modern examples of bubbles to study, with the 1930s in the United States and the 1990s in Japan the most prominent examples. But in those cases there were clearly macroeconomic and probably microeconomic policy mistakes. If the markets and the economy fail to register sustainable lifts, more macro policy activity and micro regulation are likely. Figure 7 gives some grounds for optimism that the real economy in the United States may be recovering faster than Japan's did, but the parallels in the stock market reversals are striking.
[FIGURE 7 OMITTED]
Just as many argued that the inflation of the 1970s was the result of excessive government intervention in the economy, now some argue that the current economic malaise is the result of the instability of private markets. This possibility could lend credence to the cycles of history notion that Schlesinger advocates.
Aging Of The Population-The Face Of The Leviathan Has Gray Hair
This argument is simple--as baby boomers retire, they will draw more government benefits. Figure 8 shows what share of GDP Social Security and Medicare will each take over the coming decades.
Figure 9 takes the CBO projections for total federal spending over the next seventy-five years and puts it into a historical perspective, and the visual impact is fairly staggering. By the end of this period, the government will absorb almost as much of the economy as it did at the height of World War II. Of course it's doubtful that voters in the future will feel the same sense of urgency that war-time voters felt.
[FIGURE 9 OMITTED]
Also, even though boomers don't start turning sixty-five until 2011, the graying of the population is affecting politics right now. Compare the debate over Medicare now versus when the Republicans took over Congress in the 1994 elections. Then the debate was over how much Medicare might be shrunk; now the debate is over how much it should be expanded. One party wants to expand it a lot, and that's the Republicans. Democrats want to expand it by even more.
The impact can also be seen in the debate over drug pricing. The demographic argument has often been cited as a reason to be bullish on drug stocks, but demographic trends also increase the constituency for controlling drug prices.
It's best to resist the temptation to describe this as a swing of the pendulum, since that implies that this swing toward a more activist role for government will be just like the last one. In the United States, pro-government sentiments will rarely be as strong as antigovernment sentiments.
The preference is for limited government and reliance on markets, and government's role expands only when markets are inadequate, either to confront a national emergency or to deliver prosperity. Right now the nature of the challenge of the war on terrorism looks to be on a much smaller scale compared to earlier conflicts, including the Cold War, and a resumption of economic growth would limit further regulation. Furthermore, with Republicans having the edge on the issue voters care about most, national and homeland security, the policy responses to the post-bubble and aging challenges will be tilted toward smaller-scale initiatives.
So a better metaphor is a change in seasons--we have a good idea that the seasons are changing, but right now it looks like a mild winter. But if anything this could underestimate how government's role might change. Should the terrorist or international challenges prove greater, or if the economy remains weak for some time, then initiatives that seem unlikely now could move into the mainstream quite easily. Political fortunes can shift, too. In August 2002, amid voter disgust over corporate scandals, a flagging stock market, and tepid economic growth, there were many predictions that Democrats would take over the Republican-controlled House. (As it turns out, they didn't.)
So the role of government is likely to expand to deliver more security, to threaten and possibly fight pre-emptive wars, to restore confidence in financial and corporate practices, to restore economic growth, and to tend to the needs and desires of an aging population.
TABLE 1 REPUBLICAN BUDGET PROPOSALS FOR NON-DEFENSE SPENDING Reagan 1982 budget proposal -$226 billion over 3 years Discretionary: GOP 1996 budget resolution -$123 billion over 5 years GOP 1997 budget resolution -$105 billion over 5 years Bush 2004 budget proposal +$16 billion over 5 years Mandatory: GOP 1996 budget resolution -$332 billion over 5 years GOP 1997 budget resolution -$244 billion over 5 years Bush 2004 budget proposal +$183 billion over 5 years Source: "Budget Deficits and Reductions in Spending: A Historical Perspective." Republican Study Committee, February 25, 2003. TABLE 2 IMPACT OF 9/11/01 ON THE BUDGET President Bush's Defense Budget Requests 2006 Budget 2006 Authority Outlays FY02 Budget $363 $355 FY04 Budget $440 $423 Source: "Budget of the United States Government, Fiscal Year 2002," OMB; Fiscal 2004 Department of Defense Budget Release, Department of Defense TABLE 3 AMERICAN CASUALTIES AND COSTS FROM MAJOR WARS Total Per capita cost Conflict Fatalities Direct Cost of Wars Cost % of Numbers, annual (% of pop) 2002 $ 2002 $ GDP Revolutionary War 4,435 (.13%) 2.2 447 63 War of 1812 2,260 (.03%) 1.1 120 13 Mexican War 1,733 (.01%) 1.6 68 3 Civil War Union 110,070 (.42%) 38.1 1,357 84 Confederate 74,524 (.92%) 23.8 2,749 169 Combined 184,594 (.54%) 62.0 1,686 104 Spanish-Ameri- can War 385 (.00%) 9.6 110 3 World War I 53,513 (.05%) 190.6 2,489 24 World War II 292,131 (.22%) 2,896.3 20,388 130 Korean War 33,651 (.02%) 335.9 2,266 15 Vietnam War 47,369 (.02%) 494.3 2,204 12 First Persian Gulf War 148 (.00%) 76.1 306 1 Source: Al Nofi, Statistical Summary: America's Major Wars. http://www.cwc.lsu.edu/cwc/other/stats/warcost.htm TABLE 4 RECENT INCREASES IN U.S. PRESENCE AROUND THE WORLD 1) Middle East United States forces are located in Turkey, Saudi Arabia, Oman, Kuwait, and other countries in addition to the surrounding seas. 2) Afghanistan 9,000 U.S. troops and civilian advisers. Continued security role, plus training 1,300 troops for Afghan national army's first five battalions. 3) Yemen United States special forces have trained approxi- mately 200 Yemeni special forces in counterterrorism tactics. The Pentagon has also set up Office of Defense Co-operation to provide additional training and equipment. 4) Djibouti Set up Joint Task Force-Horn of Africa, with appro- ximately 900 troops at Camp Lemonier and an addi- tional 300 command staff aboard the USS Mount Whitney off Djibouti. 5) Georgia Trained ministry of defense staff and land forces command staff as part of Georgia Train and Equip Program, aimed at combating al Qaeda activities in Pankisi Gorge. U.S. Marines to restart training of four battalions and one armored company this month. 6) Philippines More than 1,300 U.S. personnel, including 160 spe- cial operations advisers, trained Philippine armed forces to target Abu Sayyaf. A new force of 1,750 was planned as of May 2003. 7) Colombia United States troops are currently training the Colombian military to protect pipelines, and this year additional personnel will be sent to selected Colombian units to assist in counterterrorism operations. 8) Argentina/ Pentagon working with all three governments in so- Brazil/Paraguay called "tri-border area," site of increased arms trafficking, money laundering, and Islamic terrorist-supported activities. 9) Bosnia and U.S. forces continue to be part of NATO's stabili- Kosovo zation force in Bosnia and Kosovo, where they have also conducted anti-terror operations. Source: Financial Times. TABLE 5 WHAT'S CHANGED--A SUMMARY OF POST-BUBBLE POLICY REFORMS ISSUE POLICY RESPONSE Accountants Auditing, quality Accounting firms must keep work papers and infor- control mation related to audit reports for a period of not less than 7 years. Conflicts of There is a one-year ban on former audit firm interest employees serving as CEOs, CFOs, controllers, chief accounting officers, or equivalent posi- tions of an audit client. Independence Accounting firms must rotate auditing partners among clients every five years. Auditing firm may not provide eight specific non-audit services to a company it audits, and the new oversight board may prohibit additional ones. Research Analysts/ Investment Banks Compensation Prohibits analyst compensation from being tied to specific investment banking business. Conflicts of Investment banking department cannot supervise interest research analysts; investment banking employees cannot discuss research reports with analysts prior to distribution unless legal staff monitors communications; analysts cannot share draft research reports with target companies unless they are checking facts and have their legal department's approval. Analysts cannot participate in investment banking "pitches" and "roadshows." Comptroller General (GAO) must conduct a study and submit a report on whether investment banks and financial advisers helped manipulate earnings for and concealed the true financial condition of companies. The ten firms involved in Wall St. settlement agreed to not practice "spinning"--offering IPOs to certain CEOs and directors to gain investment banking business. Disclosures Firm must state in research reports whether it managed or co-managed a public offering for the subject company or if it has received compen- sation for investment banking services from the company in the past twelve months. The firm must also state whether it expects to receive compen- sation within the next three months. Analysts must state whether they own shares of recommended companies. Firms must disclose if they own one percent or more of a company's stock as of the previous month end. During public appearances, analysts are required to disclose whether they or their firm have a position in the stock, if the company is an investment banking client, and if they\or a household member are an officer or director of the recommended company. Research reports Analysts are required to certify in writing that their research reports are accurate and truthful, plus disclose any compensation they receive that may influence their recommendations. The SEC approved this rule February 6, 2003. Firms are prohibited from providing favorable research or specific price targets to encourage investment banking business. If a firm is acting as a manager or co-manager of a securities offer- ing it may not issue a report within forty days of initial public offering, or ten days after secondary offering for an inactively traded firm. Analysts are required to provide explanation of ratings, percentage of ratings assigned to each category (buy, hold, sell), and historical prices and ratings charts in reports. As part of the Wall Street settlement, firms must provide research from three independent companies to their customers. Trading Analysts are prohibited from trading contrary to their most recent rating recommendation (i.e., analyst cannot sell a stock if they rate it a "buy"), but the rule is subject to exceptions. Analysts are barred from trading a company they follow thirty days before and five days after they issue a research report on the company. SEC Reviews, new SEC must review public companies' filings at authority least once every three years. SEC has authority to prohibit individuals from becoming directors or officers if they violate securities laws. SEC also has the power to more quickly remove offi- cers and directors. Will appoint five full-time members to the Public Company Accounting Over- sight Board in consultation with the Fed Chairman and Treasury Secretary. Public Companies Corporate Companies must have an audit committee comprised governance of independent, outside directors. Disclosure Companies must disclose in periodic reports whether they have established a code of ethics for senior financial officers, and if not, then why not. Financial reports must disclose all material off-balance sheet transactions, and the SEC must conduct a study of special purpose entities. Additionally, pro forma accounting statements must be reconciled with GAAP in company reports. Must report on a "rapid and current" basis any material changes to financial conditions or operations. Expensing FASB tentatively agreed to have companies expense stock options. It plans to issue a draft rule by the end of the year, followed by a final rule in early 2004. Fees Required to pay annual fee to fund new oversight board (based upon relative market capitalization) and a fee to fund FASB. Penalties Maximum penalty for securities fraud is increased to twenty-five years. Statute of imitations on securities fraud is extended to five years. Destroying key financial-audit documents and email is a ten-year felony. Officers Certification CEOs and CFOs must file certifications with the SEC attesting to the accuracy of the firm's most recent financial statements. Compensation If a company must restate its financial reports due to misconduct, the CEOs and CFOs must re- imburse the company for any bonuses, other incentive-based compensation, and profits from selling the company's securities that were received during the twelve-month period after the first publication of the financial documents that had to be restated. Conflicts of A company is prohibited from giving personal interest loans to any director or executive officer of the company. Companies may maintain loans that have already been made, but they cannot modify or renew them. Disclosures Directors, officers, and individuals holding more than ten percent of company stock must report company stock transactions within two business days. Trading Directors and executive officers are prohibited from trading during a pension fund blackout period any company stock that they acquired through their employment. Boards of Directors Auditing National security exchanges and the National Association of Security Dealers are prohibited from listing any company unless its audit commit- tee meets certain requirements. If a company does not establish such a committee, the board of directors will fill the role and be required to meet the requirements. Sources: New York Stock Exchange, Securities and Exchange Commission, Sarbanes-Oxley Act of 2002, Wall Street Journal, Economic Report of the President 2003.
Ahearne, Alan, Joseph Gagnon, Jane Haltmaier, and Steve Kamin. 2002. "Preventing Deflation: Lessons from Japan's Experience in the 1990s." International Finance Discussion Papers. No. 2002-729. June. http://www.federalreserve.gov/ pubs/ifdp/2002/729/default.htm.
Tom Gallagher is a senior managing director of International Strategy and Investment Group Inc. (ISI). ISI is an institutional brokerage firm specializing in economic and political research. He runs ISI's Washington, DC office, which analyzes the implications of global political developments for financial markets. He has been ranked in the Institutional Investor's Washington research category for the past nine years. He is also a regular panelist on "Louis Rukeyser's Wall Street." Prior to joining ISI, he was managing director and political economist for Lehman Brothers. He spent eight years in economic policy-related jobs in the federal government. He graduated from the University of South Dakota in 1976 and from the Kennedy School of Government at Harvard University in 1978. He is also a Chartered Financial Analyst.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Is Big Government Back? the Political Economy of Activist Government Policy. Contributors: Gallagher, Tom - Author. Journal title: Business Economics. Volume: 38. Issue: 3 Publication date: July 2003. Page number: 25+. © 1999 The National Association of Business Economists. COPYRIGHT 2003 Gale Group.
This material is protected by copyright and, with the exception of fair use, may not be further copied, distributed or transmitted in any form or by any means.