By Simon Johnson, co-author of White House Burning: The Founding Fathers, Our National Debt, And Why It Matters To You
From the 1970s until recently, Congress allowed and encouraged a great deal of financial market deregulation – allowing big banks to become larger, to expand their scope, and to take on more risks. This legislative agenda was largely bipartisan, up to and including the effective repeal of the Glass-Steagall Act at the end of the 1990s. After due legislative consideration, the way was cleared for megabanks to combine commercial and investment banking on a complex global scale. The scene was set for the 2008 financial crisis – and the awful recession from which we are only now beginning to emerge.
With the so-called JOBS bill, on which the Senate is due to vote Tuesday, Congress is about to make the same kind of mistake again – this time abandoning much of the 1930s-era securities legislation that both served investors well and helped make the US one of the best places in the world to raise capital. We find ourselves again on a bipartisan route to disaster.
The Senate needs to slow down and do its job – we have two legislative bodies for a reason and the Senate’s historical role is partly to serve as a check on enthusiasms that may suddenly sweep the House. To pass this legislation on Tuesday would be a grave mistake.
The idea behind the JOBS bill is that our existing securities laws – requiring a great deal of disclosure – are significantly holding back the economy.
The bill, HR3606, received bipartisan support in the House (only 23 Democrats voted against). The bill’s title is JumpStart Our Business Startup Act, a clever slogan – but also a complete misrepresentation.
The premise is that the economy and startups are being held back by regulation, a favorite theme of House Republicans for the past 3 ½ years – ignoring completely the banking crisis that caused the recession. Which regulations are supposedly to blame?
The bill’s proponents point out that Initial Public Offerings (IPOs) of stock are way down. That is true – but that is also exactly what you should expect when the economy teeters on the brink of an economic depression and then struggles to recover because households’ still have a great deal of debt. And the longer term trends over the past decade are global – and much more about the declining profitability of small business, rather than the specifics of regulation in the US (see this testimony by Jay Ritter).
Professor Ritter, a leading expert on IPOs, put it this way:
“I do not think that the bills being considered will result in a flood of companies going public. I do not think that these bills will result in noticeably higher economic growth and job creation.”
In fact, he also argued that the measures under consideration “might be to reduce capital formation.”
Professor John Coates hit the nail on the head:
“While the various proposals being considered have been characterized as promoting jobs and economic growth by reducing regulatory burdens and costs, it is better to understand them as changing, in similar ways, the balance that existing securities laws and regulations have struck between the transaction costs of raising capital, on the one hand, and the combined costs of fraud risk and asymmetric and unverifiable information, on the other hand.” (See p.3 of this December 2011 testimony.)
In other words, you will be ripped off more. Knowing this, any smart investor will want to be better compensated for investing in a particular firm – this raises, not lowers, the cost of capital. The effect on job creation is likely to be negative, not positive.
Sensible securities laws protect everyone – including entrepreneurs who can raise capital more cheaply. The only people who lose out are those who prefer to run scams of various kinds.
Investor protection is good for growth and essential for sustaining capital markets. Experiments involving doing without such protections – as in the Czech Republic in the early 1990s, for example, have not gone well. There might be a temporary frenzy, but the subsequent fall to earth will be painful – and again hard to recover from.
Perhaps the worst parts of the bill are those provisions that would allow “crowd-financing” exempt from the usual Securities and Exchange Commission disclosure requirements. A new venture could raise up to $1-2 million through internet solicitations, as long as no investor puts in more than $10,000 (section 301 of HR3606). The level of disclosure would be minimal and there would be no real penalties for outright lying. There would also be no effective oversight of such stock promotion – returning us precisely to the situation that prevailed in the 1920s.
This might well pump up the value of particular stocks – that was the experience of the 1920s, after all. But ephemeral stock market bubbles are not without real consequences. The crash of 1929 was made possible by the lack of constraints on what stock promoters could say and do. Combined with excessive leverage, this led directly to the Great Depression.
We still have excessive leverage in our financial system today, despite the claims of the Federal Reserve. Allowing the unrestricted promotion of stocks in this fashion is a major step – again – down the path to economic self-destruction.
The legislation would also undo many parts of the 2002 Sarbanes-Oxley law, which was created in the wake of accounting scandals at the likes of Enron and WorldCom. The proposed new rules have been crafted hastily and pushed through in a great rush – presumably because the election season is upon us.
Where are the supposed guardians of our financial system?
The White House is reportedly taken with the idea of crowd-financing and wants a quick political win in the form of legislation; the Obama administration is poised to concede too much to financial sector interests, again. The Treasury Department likes to claim it provides “adult supervision” for all matters financial, yet it is conspicuously absent from serious conversation around this legislation. And he much-vaunted Financial Stability Oversight Council turns out, again, to be a meaningless paper tiger.
The securities industry special interests are naturally out in force – strongly supported by Senator Charles Schumer of New York and Majority Leader Harry Reid. Reports of the death of Wall Street lobbying power have been greatly exaggerated.
Financial deregulation was the result of decades-long delusion and bipartisan consensus. A major undermining of our securities law seems likely to take place on Tuesday – in a rushed moment of legislative madness.
The Baseline Scenario 
Crowd financing? Could this be the new term for small business ponzi scheme ?? Get back to mkt to mkt accounting in every way, or financial bust again.
I am a shortseller.
I am excited.
J
A jobs Bill? You have got to be kidding. This is parasite capitalism. Desperate for fees, the wall street will float paper supposedly based upon small business needs for capital? YIKES! Who will be next to be plundered? First the big corps es GM et al. Then swindle the “market” wth bogus home mortgage paper. Now plunder the small business. Who will be next. Is there anybody? Thanks RDW
http://www.msnbc.msn.com/id/37560195/#46763970
They just can’t stop themselves, which means that they need to BE stopped…
This is a public safety issue and just another move towards a total caveat emptor philosophy where the buyer’s ability to beware is extremely limited.
The only thing missing are the investment trusts of the 1920s. John Kenneth Galbraith’s “The Great Crash, 1929” is highly recommended for a history of how this sort of thing ends. See especially Chapter III, “In Goldman, Sachs We Trust.”
Another mistake? No more, please. We already have made a serious mistake down the path to economic self-destruction in real markets, but unfortunately, nobody has recognized it yet. What that mistake? Please see: “To have Prosperity or to have Decline, it depends on Your Choice” http://goo.gl/AeP9O .
JUst another reason why the small investors strike will continue, (it is noted that there are vast amounts of money not yet invested) Brokers will have to work harder to sell sell sell their clients on the toxic junk they are peddleing to clients. More reason to stick with Boogle’s concept of index funds where a lot of these small companies won’t appear. As with many things wall street apparently only wants the gamblers involved, and crowdsourced stocks are gambling, perhaps they should be regulated by a gaming commission, at least there you know that the odds are you will loose.
I am sick and tired of people who don’t know rats about stuff but they write and pretend that they do. Only people involved in running small business please comment. If you don’t run a small business and especially if you have never ran one, just wash your feet and keep your s tupid mouth shut!
Simon, if you want to stir up grassroots resistance to legislation, you need to write about it more than a day or two before Congress is scheduled to vote on it!
I liked the part about the internet offering of between $ 1-2 million USD with the $10K limit.
Talk about financial “mayhem”…..:)
Anonymous, I am retired now, but I did start and run a small business with sufficient success to allow me to retire at 55. Most of the comments by other people make sense to me. However, your experience undoubtedly differs from mine and may give you more insight.
@anonymous – there are different kinds of small businesses. Some service large corporations, some service their local consumer community, some go *global* with what they have to sell/trade. But they all have one thing in common – credit made available to them is at a higher rate (8%) and there is no way that a small business can lift itself up from being killed overnight (corps do that to their suppliers on a regular basis) to re-inventing themselves with an 8% sword over their heads…
Hmmm – don’t t say anything about this bill unless you have run or are planning to run a small business. Maybe we should apply that more broadly: for example, don’t legislate or pontificate about women’s access to contraception, etc unless you are (or are planning to become) a women. Actually not a bad idea – it would certainly shut a lot of people up.
More seriously, that the same line of “reasoning” (using the term very loosely) that some who supported the VN War used to apply: you can’t oppose it unless you’ve gone over there and fought it.
This is a bad bill and the administration is too hung up on high tech solutions in search of a problem to recognize it – and many others in Congress are just plain ignorant.
The Ponzi Scheme Act of 2012 – yep.
Does the phrase “blue sky” ring a bell?
Simon Johnson writes “the way was cleared for megabanks to combine commercial and investment banking on a complex global scale. The scene was set for the 2008 financial crisis”
Pure agenda driven half truths! For the umpteenth time, this crisis was caused almost entirely because bank regulators, Simon Johnson´s colleagues, authorized the banks in Europe and led the banks in the USA also to believe they would soon be able to do so, to invest in triple-A rated securities or lend to infallible sovereigns holding only 1.6 percent in equity… which allows for a mind-boggling leverage of bank equity 62.5 times to one. Had the banks needed to hold the same amount of capital they needed to hold when lending to small businesses or entrepreneurs, namely around 8 percent, for a leverage of 12.5 to one, then the demand for triple-A rated securities and sovereign debt would have been but a small fraction of what it ended up being.
Over a trillion dollars from Europe were invested in triple-A rated securities backed with lousily awarded mortgages to the subprime sector in the USA… what has that to do with combining commercial and investment banks… banks could, for instance, lend to municipalities (like that in Norway) so that these could acquire the securities and since these loans were guaranteed with the same triple-A rated securities, the banks needed to hold only 1.6 percent in capital.
And what is the easiest way for a bank to grow too big to fail? Answer, the minimum capital requirements
And had congress anything to do with these capital requirements? Of course not!
Sorry, but this sounds like the original off-Wall Street (like off-Broadway) (freak) show. If I understand correctly, basically any, that is ANY snake oil salesmen with any nice sounding contrivance, can publish an offer for investors on the internet, regardless of how bogus or contrived it is. Wow, this is a new low for the Plutocracy. It would seem that all of the scams which the Goldmans (et al) have put on the shelves to ripen (like so many carcasses), can now be hawked to anyone who is willing to take flyer. Think all of the gambling junkies who will think that somehow this is a brand new day, a sort of get-rich-quick free-for-all for those with a few hundreds or thousands set aside (like the Madoff wanabees who still believe that sure things can be found “off-Wallstreet” which just haven’t been allowed during the regulatory morass (as proclaimed by the GOP and now being cited by the Obama-Reid connection) which is being restored and which will unreasonably constrain true economic activity. Simple oil speculation and uberzealous stock, bond and commodity speculation now building an ever growing new massive bubble is simply not enough.
Well, I suppose the world has to end somehow. Why not this? It seems so fitting!! Plutocrats of the world unite, now is the chance to truly bury the 99%!!!
In July of 2009 James Kwak said: “Really what we want is a reliable indicator of irrational exuberance that will be the same in every bubble; but how you would find such a thing, and how would we be sure that it would work in the next bubble, is beyond me.”
The word ‘bubble’ is a synonym for ‘Ponzi Scheme’. Both are detected almost immediately by using a proper double-entry book-of-accounts. The proper book of accounts in seven centuries old. Clearly it is not being used by today’s accountants, auditors, and economists.
That said, since the proliferation of microprocessor driven computers, where millions of users could buy and use identical software programs, venture capital was quick to assemble mercenary programmers to write code that legislated banking and commerce rules in the software itself. Simultaneous with biased and bad microprocessor software, a proper double-entry book-of-accounts was never programmed into those same microprocessor driven computers. Quick Books, at its best, is simply a checkbook organizer. It is not the proper Book of Accounts that will detect a Ponzi Scheme.
When Ponzi took payment for a promise to pay a 50% gain on a 90 day investment of money, a proper book-of-accounts would immediately reveal the impropriety of the deal. The answer to the foolishness that is going on today is to go back to the basics and get a bookkeeping framework in place that does the job that a proper bookkeeping had been doing for seven centuries. If persons of Simon’s and James’ caliber remain unaware of these facts, what in heaven’s name are we the readers of this blog hoping to have happen?
Bayard Waterbury “Plutocrats of the world unite, now is the chance to truly bury the 99%!!!”
It might be important not to forget in this context that the Plutocrats you refer to actually buried only some investors and that it was the Fed and other similar who, with their QE, rescued many of those investors and buried the 99% in taxes to be paid.
@Dan Palanza… The trillions of losses in triple-A rated securities or loans to fallible infallible sovereigns, have nothing to do with a Ponzi scheme… and all to do with some loony bank regulators. And you can account for it how you like, but a bad investment or a bad loan is a bad investment or a bad loan.
This is a great idea. Forget all those industrial jobs lost to China, we obviously should be worrying about all the scammer jobs lost to Nigeria. This legislation will do a fantastic job of repatriating them…
Per is correct here Dan, take for instance the most recent Apple bubble. Africa is exploding with cell phones, since there is no infrastructure in Africa, there is no way to charge the batteries. And this is not to mention that the average African, has little or no money to eat, but now has a bill in the form of a phone, and an even heftier one to charge the phone. Ironicly, the only place on Earth that has solar panels that pay for themselves is Africa. Another bubble inside a bubble that has burst, but has been contained until you the consumer do the math to relize that it does not pay. It doesn’t take a rocket scientist to figure out that this is just another unsustainable credit situation to add to many current global ones, external debt to the bric countries being the kicker.
Per: a Wall Street Broker buys a relatively worthless mortgage from a local bank and packages it into a AAA bond scheme, takes his commission, and you say that those transactions are not in a class with a Ponzi Scheme? Do you really believe that the parties to the mortgage bond scheme, every step of the way, did not know they were running a Ponzi Scheme?
A proper double-entry book-of-accounts would point the finger directly to each person responsible for this Ponzi-chain of events. Exposing that is the accountant’s job description. Forty years ago, even the lowly bookkeeper would have been held liable for knowingly entering the data of such shoddy accounting practices.
M. Price: So that’s a bubble, which is okay in your book?
Dan Palanza…. I did not say that they were not in a class with a Ponzi Scheme… what I said was that they were not a Ponzi Scheme… the profits were pocketed and not used to provide others enticing returns.
Crowd financing=boiler room
@Simon Johnson writes “The premise is that the economy and startups are being held back by regulation, a favorite theme of House Republicans for the past 3 ½ years – ignoring completely the banking crisis that caused the recession. Which regulations are supposedly to blame?”
I have not the faintest ideas what regulations that are holding back the economy and startups others could be referring to…. but I sure know that when small businesses and entrepreneurs, who because they are perceived risky are already discriminated against by the banks and markets by means of higher interest rates and lower loans, also have to suffer a second whammy of discrimination by the bank regulator, by means of originating higher capital requirements for the banks when they are lent to, that is most definitely holding back the economy and backups.
What a sad bunch of progressives who see nothing strange in discriminating against those perceived as risky!
What a sad bunch of free-marketers who see nothing strange in the regulators distorting the markets this way!
Thank you Per; to a bookkeeper the line is so slim we do not see it :) What we surely agree on is that it is all a sad state of affairs.
http://www.huffingtonpost.com/2012/03/19/renting-foreclosure_n_1362356.html?ref=business
How can you not pop a blood vessel in rage?
With all do respect, your article is a colossal mistake of historic proportions. First of all, the dearth of IPOs began in 1998 as a result of Reg ATS (long before Enron, Worldcom, Sarbanes Oxley and the 2008 crisis). See http://www.thesoholoft.com/wp-content/uploads/2012/03/Capital-Markets-Advisory-Partners-3-14-2012.pdf Second of all, neither stock promoters, fraud nor under regulation caused the ’29 crash which led ultimately to the depression. The crash of ’29 was a direct result of the misuse of credit. When 80% of household appliances are bought on installment and stocks in the companies that made those products are purchased on 10% margin, you are inevitably left with a credit fueled bubble waiting to burst. Debt is the culprit not fraud. People need to wake up and recognize the true culprit of our financial meltdowns (excessive debt not under-regulation) so that we can productively resolve them. We consistently ignore the true problem and foolishly hope that increased regulation will save us. For once in our history we need to solve a problem with a solution and not create additional problems. A complete overhaul of our capital markets is necessary. Instead of capital flowing from big investment bank to big favored institutional client to large cap company, we need a capital markets system that enables capital to effectively reach the entrepreneurs, the innovators – America’s job creators. Crowdfunding allows for just that. This bill is a good start. Times are changing. Technology is advancing. It is inevitable that our capital markets will be evolving. That is called progress.
There are numerous parts of this article that I take great exception to. It is devoid of fact, and makes numerous unsubstantiated points. I will focus on one — the idea that the portion of the bill supporting Crowd Source Funding is somehow a Wall Street driven effort at deregulation. Nothing could be further from the truth. In fact the only organization on the record against the bill are the securities industry special interests. Based on reading the article one could read that they were supporting it — they are not.
Why? Because in the name of regulation, the SEC has concentrated the power of the financial markets in the hands of the few. They have created barriers for businesses trying to raise the capital they need to grow. They have created barriers to the majority of Americans that make more than 50,000 a year but don’t have a spare million dollars in the bank that allows them to become “accredited investors”
The current Angel and Venture Capital markets simply do not work. Driven by greed to maximized returns of 40%+ they simply do not fund the majority of business that are looking for capital to add employees, a second shift, or a new product line. Supposedly these business can go to banks, but banks long since replaced the business of lending money with the business of charging fees for accessing your money. My small business clients have had their lines of credits reduced and eliminated as banks shore up their balance sheet to offset losses in mortgage back securities (where the securities industry made huge fees “protecting” investors) When the try to get loans they have to turn over their homes (assuming they aren’t one of the 40%+ Americans who are upside down on their house) and retirements just so they can “guarantee the loan.”
A deeper analysis of the funding market sees other trends. Women-owned, minority-owned, ventern-owned businesses serving the urban core, or opening in rural America are not funded by Angels and Venture Capital. In fact if you don’t have a CEO or CFO with a MBA from Harvard, Yale, or Stanford you are putting your company at risk for being evaluated as not “having the right team.”
Another view is to realize that fortunes are made by investing in early stage companies. Current securities law restricts this opportunity to the wealthy. Yes, with rare exception (Blue Sky friends/family) the investors in a privately held company need to be people who are already wealthy. Sure, there are State sponsored Lotterys that sell the promise of wealth to those that skipped math class, but the real opportunities to make enough to pass a legacy on to the next generation is restricted to those who got the ticket from the one before them.
The bottom line is that the current captial markets that fund business in America are broken and not changing them would be a colossal mistake.
So what is the solution? Allow the business to go directly to their customers, vendors, clients, suppliers, and members of the community that know them. Allow them to go to the “crowd” and “source” the “raise” that they need. It might not give the angel investor the 45% return, but the members of my community can all put $100 on the table to ensure that Sonny’s Ice Cream can get another freezer to expand their production line.
This isn’t as much about deregulation, as opening a new market. One that will force the other players in the market to come back to earth and become engaged in the real work of growing businesses, putting people to work, and nurturing the entrepreneurial culture in America. Will some business fail? Of course. Will some investors make mistakes and lose money? Of course (think of all the people who will invest in restaurants for example). But that is okay, it wont be their life savings. And it isn’t like the current professionals have done a great job of protecting life savings so far.
The “sky is falling rhetoric” ignores that in this new market place new businesses will emerge. I have recently raised a significant amount of money to launch a new company to provide services to businesses and investors in this very space. We raised it all from small business owners that have been clients of my consulting firm over the years. People who have first hand experience with how broken the current system is.
CommunityLeader was founded on March 1 to connect companies and investors in the community. In the emerging crowd-source funding market, CommunityLeader’s disciplined community-sourced funding platform provides security, compliance and success to business while ensuring transparency, accountability and compliance for investors.
CommunityLeader’s CampaignLeader application provides business the legal, accounting, marketing, operational, and resource support to run an successful crowd-sourced capital campaign. CommunityLeader’s CommunityInvestor application provides investors with the legal, accounting, reporting, and oversight resources to feel comfortable participating in successful crowd-source capital campaigns.
Yes, the securities professional on Wall Street wont like it and claim it is all a colossal mistake — but that is because they will no longer get paid simply for moving money around and not truly helping companies and business grow. They already made their colossal mistake — Crowd Source Funding is part of the appropriate, responsible fix.
Gut parts of the Sarbanes Oxley Act? Good. Depending on which parts. And I note the link you provide does not specify which parts. For the most part the SOX Act was exactly that kind of law “crafted hastily and pushed through in a great rush…” that you complain about in the JOBS Bill.
Sox’s concrete effects are for the most part cosmetic and procedural; if you believe policies and procedures, CFO signoff, separation of audit and consulting etc have made a single piece of difference to the reliability of financial reporting, you clearly aren’t in the real world of finance.
I don’t believe gutting SOX will necessarily be a positive for investors or for capital raisers; just that getting rid of laws that serve no real purpose is always a positive.
joseph@sgione “My small business clients have had their lines of credits reduced and eliminated as banks shore up their balance sheet to offset losses in mortgage back securities”
And it is not only to offset losses. Still today a bank has to have several times more capital/equity when lending to your small business clients than when investing in triple-A rated securities, and this even though your small business clients have never ever caused a bank crisis as these have always been caused by excessive exposures to what was perceived as absolutely not-risky.
Great post, Joseph! Eventually, you’ll find that a whole new sovereign-country currency is needed for SUSTAINABLE life-maintenance since the *toxic asset* derivatives – or “mortgage backed securities” in this latest Savings and Loan theft – were recently thrown by accountants into *commercial bank* accounts, not *investment bank* accounts. The real fallout from Glass Steagall is that the extraction of wealth from sustainable commerce will never end – their extraction formula ends with “to infinity and beyond” – I kid you not. Nothing will be un-broken until the extraction formula in their monkey brain-matrix is DELETED along with the people who launched it.
Yes that just happend…..after the crisis, that know one got in trouble for.
I think it’s safe to say: The population is just a resource used to fule the .01%.
To be happy for this would be the same as getting excited somone got popped in the streets and now we can loot his pockets…..Greed and power it’s a hell of a drug.
I
This is the best court support for your article http://livinglies.wordpress.com/2012/03/21/the-emperors-new-clothes-revisited/#comment-139122
I think to the contrary, we must remember that 45 to 80% of new jobs are created by new small business. New small business venture capital has been crowded out of the market place, and the few new jobs being created are lower paying. Furthermore, the percentage of people participating in the workforce is still down, and this severly distorts the unemployment figures.
Small businesses and entrepreneurs have also been locked out from access to bank credit by regulators who consider them more risky even though small businesses and entrepreneurs have never ever caused a systemic bank crisis… http://bit.ly/dFRiMs
Your analysis is terrible. It cost us $4.8 million to do our $6.5 million IPO in 2008 for Bioheart, Inc. BHRT.ob due to excessive regulation. The lawyers, accountants, bureaucrats, financial printers and insurance companies that took this amount in the name of protecting investors were doing just the opposite. We produce products for treating heart failure and needed those funds to complete the clinical trials. The investors thought their money was going to that purpose not to regulators and lawyers. The JOBS ACT is a great bill and passed with unprecedented bi-partisan support after years of analysis for good reason. We first proposed these financial reform measures in 2008.
Howard Leonhardt… Thanks for reminding the busybodies that there is always another side of the coin… For instance, without any bank regulations, we sure would have had other bank crises… but never ever a bank crisis so systemically large as this one… because, no doubt whatsoever, it was the bank regulators who with their silly capital requirements based on perceived risk, leveraged perceived risks and the banks´ balance sheets way up into the stratosphere!