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Friday, June 17, 2011

British Banking Regulation in the E.U.

Before the financial crisis of 2008, the British government was light on banking regulation compared to other E.U. state governments. Oddly, some Europeans imagined an “Anglo-American” connection or likeness, as the American states had been on a deregulation kick since Carter’s airline and thrift deregulatory laws in the late 1970s. Reagan and the second Bush in particular extenuated the movement, which applied to the entire U.S. common market. After the crisis, however, even as Republicans in the U.S. House of Representatives, which is commensurate to the E.U. Parliament, were still voicing support for still more deregulation as though 2008 had not happened, the regulatory tussle in the E.U. reflected the greater involvement of the state governments (i.e., the stronger federalism than the lop-sided variety in the U.S.), with the British government in particular pushing for stronger banking regulation—if not at the E.U. level, then in the state of Britain. “British officials are waging an increasingly aggressive fight to impose banking regulations as they see fit, even if they go further than rules elsewhere in the European Union,” according to The Wall Street Journal. From this quote, we can unpack two distinct though interrelating strains: a desire for tougher banking regulation and an anti-federalism wherein the state governments of the E.U. can go beyond the federal government in terms of the regulation. Both of these points are significant.

The complete essay is at Essays on Two Federal Empires.

Long Term Capital Management

By 1997, “after three years of strong profits for LTCM, the opportunities were drying up. There was too much money chasing the same investments. . . . In early 1998, LTMC decided to give a large portion of its capital back to its original investors because profitable opportunities were so hard to find. At the end of 1997, LTCM had nearly $7.5 billion under management, compared to $1 billion when it started, and it now returned $2.7 billion of that to investors. The partners also figured that they could, if necessary, simply leverage their portfolio further to compensate for the loss of capital, which would compound their personal gains. Greed was at the heart of what turned out to be a disastrous decision. . . . Unable to reproduce the returns of the first three years, LTCM took increasingly more risk, abandoning its purer arbitrage for the kinds of ‘directional’ investments Soros made and LTCM had so long disdained—such as trying to forecast interest rate and currency movements. More and more of these trades were unhedged.” Furthermore, “LTCM’s risk models—VAR and related statistical tools . . . –were misleading.” For example, diversification was little protection if there was a run on the banks. When Russia defaulted on August 17, 1997, LTCM’s hedges against its Russian investments were worthless. Furthermore, because all fixed income assets fell sharply in value, “diversification, it turned out, did not matter. The finely calculated relationships on which LTCM was built and which the firm always believed would hold started to come apart. VAR could  not account for such an unlikely but sweeping event—an event in which everyone wanted out at the same time and almost all investments fell significantly in price. The use of VAR itself precipitated much of the selling. Commercial banks under the jurisdiction of the Basel Agreements, which . . . set capital requirements based on the level of VAR (the lower the VAR, the lower the capital required), were forced to sell assets to raise capital.” LTCM lost $1.9 billion that August. Eventually, fourteen banks, organized by the Fed, put together loans of more than $3.5 billion to purchase 90 percent of the firm.” LTCM “did manage to sell down assets in an orderly fashion and by early 2000 it was essentially out of business” (Madrick, pp. 277-81).

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Amtrak’s Conflict of Interest

On June 15, 2011, U.S. House Republicans called for the breakup of Amtrak’s de facto monopoly of intercity and interstate passenger-rail transport in the United States. Specifically, Republican lawmakers proposed that the lucrative northeast routes be opened to private providers. For example, Richard Branson’s Virgin Trains had been seeking to provide service between Boston and Washington. Of course, letting one of the providers build and own the tracks even as other providers use the tracks would put that owner-provider in a conflict of interest in charging the other providers for their use of the track, so it would be preferable to have the U.S. Government supply the tracks and charge all of the private providers of train service.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Banks on Reserve Requirements: An Institutional Conflict of Interest

As regulators were getting close to an international agreement on how much additional capital large banks that are deemed too big to fail should hold. In 2010, international policy makers met in Basil and agreed to 7 percent. The Dodd-Frank law passed in that same year in the U.S. meant that the Federal Reserve Bank would have to “impose tougher capital standards on ‘systemically important financial institutions’,” according to The Wall Street Journal.  Hence, American officials wanted “to coordinate with global regulators so that U.S. firms aren’t put at a disadvantage.” Not wanting to divert more capital to protect themselves from losses, banks were busy lobbying the regulators to reject the proposed 2.0 to 2.5 percentage points above the 7 percent set at Basil.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Monday, June 13, 2011

A Judicial Conflict of Interest: Walker on Prop. 8

 In 2010, Chief Federal District Judge Vaughn Walker issued a ruling that declared Proposition 8 (against gay marriage) an unconstitutional violation of gay Californians’ civil rights. After retiring in February of the next year, the judge revealed that he was in a 10-year-old relationship with a same-sex partner. The question is whether a reasonable belief that the judge would stand to benefit from the ruling means that there was a personal conflict of interest sufficient to have the judge’s ruling vacated. Amid the emotions swirling around issues such as gay marriage that involve the uneasy mix of personal matters and public scrutiny, an urgent need exists for ethicists and jurispruds to isolate the pernicious problems inherent in the conflict of interest phenomenon so we all can have faith that such issues are decided impartially in substance as well as appearance.

Andrew Pugno, one of the lawyers defending Proposition 8, has stated that the Judge Walker’s long-term relationship “creates this unavoidable impression that he was just not the impartial judge that the law requires.” That the judge withheld the information until well after his ruling suggests that even he may have thought the very existence of his relationship (even aside from any intention to wed) would be sufficient to trigger claims of a conflict of interest because he could stand to benefit personally from the ruling, according to the lawyer. Therefore, the conflict of interest lies not in the judge’s sexual orientation or in his particular state of mind, but, rather, in his being in a long-term relationship that could benefit from the option to marry. Obviating a personal conflict of interest based solely on one’s sexual orientation would be too general and it would constitute prejudice. Likewise, deciding another’s intentions is too subjective a basis for a judicial ruling on a conflict of interest.

A reasonable conclusion that a person stands in a particular position to gain a specific benefit can carry muster in a legal ruling dealing with a person’s conflict of interest. According to Pugno, it is “all about the fundamental principle that a judge really can’t sit to hear their own case when they have an interest in the outcome.”  

In deciding on whether Walker should have recused himself, Judge Ware conflates particular and general interests, arguing in effect that the former do not constitute a conflict of interest because the latter should not. "The presumption that Judge Walker, by virtue of being in a same-sex relationship, had a desire to be married that rendered him incapable of making an impartial decision, is as warrantless as the presumption that a female judge is incapable of being impartial in a case in which women seek legal relief," Ware wrote in his decision. Ware treats the specific connection of benefit between being in a 10 year same-sex relationship and having same-sex marriage legalized as equivalent to the general connection between a woman ruling on a case involving a woman.

Similarly, Ted Olson, whose wife died in 9-11, has argued that requiring judges to reveal elements of their personal lives sets a dangerous precedent. “What would a judge do who was Mormon knowing the Morman Church took such an active role” in campaigning for Proposition 8? What would a judge who had a nephew or niece or son or daughter who was gay or lesbian do? We have an unlimited number of permutations of what a judge might be asked to disclose.” In short, Olson sees a slippery slope toward a most undesirable outcome wherein recusals could be commonplace and at times for rather intimate reasons.

However, the slippery slope argument may be overdrawn, and it may be surmountable altogether, especially if one distinguishes between specific and general connections. Vikram Amar, a law instructor in California, argues that a recusal should be required because of “a specific and imminent benefit” rather than “some abstract and future benefit.”  According to Amar (and Ware), Judge Walker does not meet this test. I disagree.

That the judge was in a long-term relationship and was sufficiently old to retire means that the benefit would be both specific (i.e., him getting married) and imminent (i.e., given his age). For a couple discussing marriage, the discussion is not abstract. In fact, it can get down to whether a joint checking account would be opened and whether there would be a pre-nuptial agreement. Furthermore, couples who discuss marriage do not typically say, “maybe in ten or twenty years, we might get hitched.” The time frame is usually months or a few years, with a realistic expectation that a decision to marry would result in marriage.

One might counter that an intention must also exist—that it is not sufficient for a specific and imminent benefit to be possible.  For instance, in hearing the recusal case on June 13, 2011, Judge Ware asked the Prop. 8 lawyer, “I’m asking you to tell me what fact you would have the court rely on to suggest that Judge Walker wanted to change, not maintain, his relationship?” The mere fact that Judge Walker had been in a serious relationship “does not put him in the shoes of what the plaintiffs were doing, unless you cite to me some facts that he was desirous of the relief they were seeking,” Judge Ware said.

However, pegging desire is a tricky business, and far too subjective to serve as the linchpin of a judicial ruling; someone in a personal conflict of interest would only need to deny having been interested in one of the interests in conflict. When a conflict of interest is observed, the two interests involved are viewed as standing in themselves, rather than being conditional on being desired. That is, in recognizing a conflict of interest, the very existence of the interests is sufficient. Therefore, a recusal ruling should not stand on whether an intention or a desire was present. Given human nature, standing to gain is sufficient to make a conflict of interest situation sufficiently baleful that it should be eviscerated. Judge Walker stood to gain specifically and imminently even if he did not intend to marry. Therefore, we need not inquire as to his personal views or plans in order to conclude that his ruling ought to be vacated on account of his particular conflict of interest.

I would add, moreover, a criterion to Amar’s test for a personal conflict of interest in order to better counter the squalid slippery slope argument. Specifically, it is significant whether the benefit is to the person himself (or herself) or to a person or organization related to the person. To be sure, even having a relative or friend standing to benefit can be sufficient to give rise to a personal conflict of interest.

Indeed, on the very day of the recusal hearing on Judge Walker, the U.S. Supreme Court handed down a unanimous decision that state ethics rules that bar public officials from voting on matters because of a conflict of interest do not violate free-speech rights because voting is not the representative’s speech, but, rather, “a mechanical function of government.” In my view, treating voting (or  money) as speech evinces a category mistake, so Scalia’s opinion for the Court is “spot on” in this regard. For our purpose here, it is significant that the ruling approved the disputed Nevada law, which prohibits officials from “voting on an issue when their judgment could be affected by a relationship to someone in their household, a relative, business partner, or a person ‘substantially similar’ to those specified.” That is, a personal conflict of interest is assumed to extend to benefits to people bearing a significant relation to the person in the conflict.

The vagueness in the “substantially similar,” which was left to the state court to evaluate, may evince the possibility of a slippery slope in extending beyond benefit to the person himself. That is to say, extending the personal conflict of interest to include other people standing to benefit introduces a problem not present in a specific and imminent benefit to the person himself. Therefore, I contend that “benefit to the person” should be added to Amar’s criteria of specificity and temporality, with “benefit to others in a significant relation to said person” being added too, though secondarily and with receding importance as per the significance of the relation.

Even aside from the vague language, no clear boundary line exists between “significant” and “insignificant.” Nevada would have done better in using “significant relation to” and cited examples such as relative, friend, and business associate. Furthermore, a specific and imminent benefit to oneself can be localized, whereas one’s affinities to other people and organizations can be wide-open. Generally speaking, the bigger or broader the group/organization, the less an individual is apt to be invested in a benefit to it. For this reason, and because benefits to others are not as motivating as benefits to oneself (given the salience of self in self-interest, and self-interest in turn in human motivation), a distinction between “benefit to others” and “benefit to self” can and should be made in reference to personal conflicts of interest. To be sure, both are worthy of note in terms of personal conflicts of interest, but “benefit to self” ought not be held back due to problems associated with invoking “benefit to others.”

Therefore, in cases in which the person in a personal conflict of interest stands to benefit in a specific and imminent way, the slippery slope argument that can apply to “benefit to others” should not be invoked. In other words, “benefit to the person” should be added to Amar’s criteria, while “benefit to others” should be tailored so as to obviate any such slope and applied differentially depending on the degree of significance in the relation. Cases in which a spouse or close relative stands to benefit would come after “benefit to self” in importance, followed by cases involving friends and business associates. Similarly, a hierarchy can be established based on organizational affinities. For instance, a Republican would have more interest in a benefit to the Republican Party than to a more general organization such as the United Nations. My point is that discerning degrees of significance need not detract from the applicability of the “benefit to the person” criterion, or even from the secondary “benefit to others.”

Judge Walker himself stood to gain something specific and imminent that could reasonably be expected to benefit him even if he didn’t desire it at the time of the case on Proposition Eight. His standing to benefit is of more importance than had a significant relation to him, such as a gay son or daughter, stood to benefit. That is, he had a material vested interest in the ruling sufficient for him to have recused himself, given a judge’s deontological (duty-based) interest (i.e., responsibility) in being impartial—including having the appearance thereof. The latter is particularly important given the importance of legitimacy in judicial rulings (courts not having their own police force to enforce their rulings). Therefore, I contend that Vaughn Walker should have recused himself and that the Prop 8 advocates have a case in having his ruling vacated on the grounds of a conflict of interest particular to him.

Lest it be suggested that Walker should merely have made his conflict of interest known before the case, merely announcing a conflict of interest is not sufficient to nullify its force or appearance. Better than knowing that a judge has a personal conflict of interest, another can be assigned without such a conflict. As there are presumably other federal judges in California, the conflict of interest could have been easily obviated. That it was not tells me that we as a society discount the problems inherent in the conflict of interest phenomenon.

I suspect that we do not realize sufficiently the ethical problems that conflicts of interest can cause. Even if people do not always act unethically when in a personal conflict of interest, I contend that such conflicts are inherently unethical. Society seems not to agree. As a result, we do not do enough to avoid or otherwise deconstruct them. We believe that somehow such conflicts do not really matter, or that they lose their power if they are made transparent. In other words, we are a bit too naïve for our own good, and then we are surprised when someone in a conflict of interest acts unethically.


The Associated Press, “Gay Judge Targeted for Same-Sex Marriage Ruling,” msnbc.com, June 13, 2011.

The Associated Press, “Judicial Bias Is Alleged in a Ruling on Marriage,” The New York Times, June 14, 2011.

Joan Biskupic, "High Court Says Ethics Rules Don't Violate Speech," USA Today, June 14, 2011.

Lisa Leff, “Gay Judge’s Same-Sex Marriage Ruling Upheld,” Associated Press, June 14, 2011.

Corporate Ethics Codes: A Waste of Time?

Ethics codes are not enough; that is to say, making applications of ethical principles explicit is not sufficient, even where they are grilled into employees in recurrent training sessions. Indeed, individuals or a dominant coalition can use a code’s existence as window-dressing. For example, in his letter on July 1, 2000 announcing Enron’s new and improved 65 page Code of Ethics, Ken Lay writes, “Relations with the Company’s many publics . . . will be conducted in honesty, candor, and fairness.” If Ken Lay can trumpet a code of ethics, who’s to say who is out there now acting unethically in business under the cover of an effervescent code.

Fundamentally, ethical conduct is a matter of individual character, the more questionable sort being readily influenced by a sordid corporate culture. Therefore, looking out for character in hiring is paramount. Lest it be thought that candidates will ignore social desirability and readily give clues as to an unethical predilection in answer to facile “what would you do if” interview questions, common sense may dictate that references should be followed up and permitted to go on at length on the candidate’s character as per ethical conduct. In getting a sense of one’s ethical character, it is not enough to rely on stock questions.

Of course, if the managers with power, such as Ken Lay, are unashamedly unethical in their conduct, there would be stiff intangible penalties involved in acting ethical further down the line, even if unethical candidates have been screened out. Furthermore, if the CEO is also chairman of the board of directors, the board itself may be compromised in policing ethics in upper management.

However, if a company’s dominant coalition is serious about bringing its ethical code to life in the organization, compensation for ethical conduct must go beyond “rewards” or prizes. That is to say, compensation for such conduct must rival compensation for profitability. To say that ethics is important and then to relegate its bearers to receiving praise and recognition, plus perhaps a prize, is to introduce hypocrisy into the organization, from which point an unethical culture can easily take root.

In terms of whistleblowers, not tolerating retaliation is just a start. Compensation for the whistleblowers must be upped, for they risk much and thus show tremendous courage and fortitude—qualities that can come into play in taking a profitable strategy and running with it to fruition against seemingly daunting obstacles.

In short, stockholders, directors and upper echelon managers must put their money where their mouths are to be taken seriously as having a credible code of ethics that is alive in their organization and not merely window-dressing that can serve as a viable subterfuge for nefarious conduct.

Sunday, June 12, 2011

Stakeholder Management: Part IV (Property Rights)

Stakeholder theory can be interpreted as containing a series of prescriptive leaps in the direction of giving stakeholders a greater and greater share in the property rights of stockholders. The final leap issues in what can be called radical stakeholder theory, for it represents a fundamental challenge (or usurpation) of property rights. Perhaps the most astonishing thing about how stakeholder theory unfolds is its presumptuous claim that its prescriptiveness is merely description (i.e., pertaining to what is the case, rather than what is ideologically desired).

The full essay is at "The Stakeholder Subterfuge."