Magazine article The RMA Journal

Private-Sector Corruption Justifies Society's Clawback Demand; the Founder and Chairman of the Financial Standards Foundation Called for an End to the Enrichment of Management at the Expense of Stakeholders in a Recent Address to RMA's New York Chapter

Magazine article The RMA Journal

Private-Sector Corruption Justifies Society's Clawback Demand; the Founder and Chairman of the Financial Standards Foundation Called for an End to the Enrichment of Management at the Expense of Stakeholders in a Recent Address to RMA's New York Chapter

Article excerpt

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CAPITALISM IS UNDER attack and rightly so. Institutionalized shortsightedness, corruption, and greed, particularly in the financial sector, have led to the worst financial crisis since the Great Depression and a sharp deceleration of worldwide economic growth. Worse, trust in the system has been lost. And yet capitalism, that economic arrangement characterized by private ownership, free markets, open investment, and a liberal trade regime, remains the most powerful and reliable path for promoting development, creating wealth and jobs, and reducing global poverty. Wholesale rejection of capitalism would squander unprecedented economic progress achieved around the world in recent decades and the future progress on which justice and lasting peace depend. But the manner in which capitalism has been practiced in recent years must be rejected, and these practices must be reformed to ensure that people everywhere are reliably and equitably served.

Capitalism is chronically prone to boom-bust cycles. In the three decades prior to the Great Depression, accelerating prosperity went over the edge, and corporate and financial malfeasance contributed to the destruction of the U.S. financial system and the onset of the ensuing Depression. Many titans of industry and finance turned out to be ruthless, greedy, and often unethical (or worse).

Comprehensive new regulation and government involvement in the economy resulted. The financial system was restructured into protected silos. Each class of intermediary was restricted to performing specific functions: commercial and thrift banking, investment banking, and insurance. From time to time, direct controls on prices, exchange rates, and interest rates were established. The severity of the new regulatory regime resulted from public and Congressional outrage at the behavior of the private sector and its leaders.

A deviant private sector is a major cause of crises. Today, we can accurately stipulate that corruption in the U.S. private sector is the poisonous root that has contaminated the global economy. How did this happen? Several factors, which initially stimulated change for the better, were pushed too far and severe consequences resulted.

Loose regulation of nonfinancial enterprises resulted in pervasive fraud and malfeasance such as occurred at Enron and WorldCom. Excessive and uneven deregulation of the U.S. economy and the financial system bankrupted the self-regulation model. After pressing for passage of the Gramm-Leach-Bliley Act of 1999, which granted banking, securities, insurance, and related powers to financial holding companies (FHCs) regulated by the Federal Reserve, the large U.S. insurance companies (save one) and investment banks decided to avoid regulation by the Fed by not becoming FHCs.

Nevertheless, insurance companies entered the banking markets by establishing thrift holding companies, regulated by the Office of Thrift Supervision (OTS). No overall prudential supervision was established initially. Investment banks also entered banking markets through offshore banking vehicles, special-purpose domestic licenses (industrial holding companies and Article XII entities), and off-balance-sheet activities such as loan funds.

The Securities and Exchange Commission (SEC) remained the regulator of investment banks, but had no prudential or comprehensive oversight powers. In 2003, responding to a European Union directive requiring comprehensive supervision of financial conglomerates, the OTS and SEC became "umbrella" supervisors, but the initiative, though politically correct, was cosmetic and ineffective.

Large financial institutions lobbied successfully to avoid regulation of derivatives, hedge funds, private equity funds, and mutual funds. Consequently, a "shadow banking sector" emerged, free of adequate supervision and rife with greed-motivated, inappropriate activity.

Globalization caused markets to integrate and correlate. …

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