Mr. Spitzer's lecture can be viewed online.
Drawing on his experience first as state attorney general and later as governor of New York, in his talk, Eliot Spitzer addressed a wide range of issues having to do with the relationship between the government and the marketplace. Spitzer concentrated his discussion on three main points, along with what he called "one footnote."
Spitzer's first point was that the government is uniquely suited to enforce rules related to integrity and transparency in the marketplace. The reason why this is so, Spitzer argued, is that in situations where market forces lead participants within a market to engage in problematic behavior, for any given participant to unilaterally forgo that problematic behavior would result in that participant's being at a competitive disadvantage. Thus, in order to eliminate that problematic behavior from the market, it is necessary for an outside agent, i.e. the government, to impose a market-wide role prohibiting that behavior. In motivating this analysis, Spitzer appealed to what he called the "analyst cases," which he pursued as attorney general. The analyst cases involved an investigation of an apparent conflict of interest on the part of investment analysts employed by Merril Lynch. The apparent conflict was that, while an analyst's principle task is to provide (unbiased) stock ratings to clients, these analysts were employees of Merril Lynch, a bank also involved in underwriting, i.e. raising capital. As such, Merril Lynch had a strong financial incentive to have their analysts provide favorable ratings of the stocks of underwriting clients, regardless of merit. After uncovering evidence strongly suggesting the ratings of Merril's analysts were being shaped by this apparent conflict of interest, Spitzer entered into discussions with Merril's lawyers, and was struck by what they had to say: Merril's lawyers acknowledged that theirs was a problematic business model, i.e. that it involved a genuine conflict of interest, but that it was a model that was adopted industry-wide, and, thus, for Merril to eliminate this conflict within their own operation would be to willfully put themselves at a competitive disadvantage. This line of reasoning would, of course, hold for Merril's competitors as well. As such, the only feasible way to bring to an end this problematic practice of having analysts and underwriters co-conspiring was to be to have an outside agent, i.e. the government, impose a rule prohibiting the practice market-wide.
It was at this point that Spitzer introduced his so-called "footnote," mentioning three specific areas in which we, he maintained, must rely on the government to impose rules on the marketplace. The first that Spitzer mentioned was anti-trust, i.e. monopoly prevention. Because all competitors within a given market are, Spitzer argued, monopolists at heart, competitors cannot be expected to prevent themselves from attaining a maximum market share. Rather, the government must take steps to prevent them from doing so. Second, Spitzer claimed that the government must be relied upon to regulate externalities. For example, insofar as individually rational decisions to take on risk can, collectively, result in the externality of systemic risk (see 2003-2008), it seems that the only way to prevent this externality is by external regulation. And likewise with externalities such as global warming, etc. Third, Spitzer maintained that we must depend upon the government to regulate the market in such a way that it creates and preserves what he called "core values." For instance, it would be a mistake, Spitzer argued, to assume that market forces will always work to advance values such as a living wage for all workers, non-discrimination, etc. Rather, insofar as we have an interest in seeing those values created and preserved within the marketplace, we must rely upon external governmental regulation to ensure that this occurs.
Moving on to his second point, Spitzer posed the question of how we, i.e. the U.S. government, have dealt with the current financial crisis. The answer, Spitzer argued, is not well. While the government was correct, Spitzer maintained, to inject large amounts of capital into the financial system to restore solvency and liquidity, that was the "easy part" of dealing with the crisis. The hard part, Spitzer argued, was to use the leverage of the crisis to 1) extract monetary concession from the key players to help finance the bailout, 2) push through regulatory reforms that would prevent a future crisis, and 3) push through policies that would minimize unemployment resulting from the crisis. And on these three counts, Spitzer maintained, the government did quite poorly. On the first count, as was shortly confirmed by special inspector Neil Barofsky, Spitzer suggested that government agents extracted approximately no financial concessions from the main players when orchestrating the AIG bailout, opting instead to make all involved bondholders whole (thus, as Spitzer put it, "socializing" their losses). On the second, Spitzer observed that there has been no serious discussion within the administration about preventing the need for future bailouts by passing regulation outlawing the existence of so-called "too big to fail" firms (a position advanced recently by, among others, former Fed chairman Paul Volker and Governor of the Board of the Bank of England Mervyn King). On the third, Spitzer observed that there were effectively no conditions put on firms receiving bailout funds that they take steps to stem job losses (e.g. there were no mandates that these firms resume lending to businesses). Moreover, Spitzer argued that federal stimulus efforts at minimizing job loss have fallen far short of what is necessary (Spitzer advocated federal spending on, among other things, high-tech infrastructure projects, e.g. high-speed rail, electric cars).
Finally, turning to his third point, Spitzer put forward that there needs to be a greater emphasis on the health of corporate governance and that further steps need to be taken to ensure that shareholders' interests are being appropriately advanced by corporate executives, i.e. that executives are adhering to their fiduciary duties. As one example of a possible breakdown on this front, Spitzer cited the massive increase in the ration of CEO to worker pay within U.S. corporations between the 1980s and the early 2000s. In the ‘80s, the ratio of CEO to worker pay was approximately 40:1. By contrast, by the early ‘00s, CEO pay had exploded to the point where the ratio was approximately 550:1. Under the assumption that CEOs had not become 10x more valuable relative to workers over that period, Spitzer argued that this was strong evidence that corporate executives were taking steps to advance their own interests rather than those of their shareholders. The source of this and similar problems, Spitzer argued, is that corporate boards have become largely silent, ceding nearly sole decision making power to executives, and that, relatedly, shareholders have had very little say in the selection of corporate board members. As a solution, Spitzer advocated the adoption of policies that would encourage greater shareholder activism and, in turn, greater activism from boards. CEOs, Spitzer argued, "need to have their wings clipped."
At the dinner that followed the talk, probably the most interesting discussion centered on the notion of fiduciary duty mentioned above. In the talk, Spitzer seemed to assume that better adherence to fiduciary duties on the part of executives was something that would be beneficial the population as a whole. However, as a number of guests pointed out, insofar as fiduciary duty is defined narrowly as the pursuit of the interests of shareholders through the maximization of stock price, it is less than clear that more faithful adherence to this duty would benefit society as a whole. Spitzer conceded this point, and suggested that the notion of fiduciary duty might have to be broadened to take into account not only these narrow shareholder interests, but also the interests of society as a whole (e.g. job creation).
Ryan Doerfler, Graduate Fellow in Ethics 2009-10
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