On Financial Regulation: Jonathan Macey

Jonathan R. Macey is the Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale University, and Professor in the Yale School of Management. Professor Macey is the author of several books including the two-volume treatise, Macey on Corporation Laws, and co-author of two leading casebooks, Corporations: Including Partnerships and Limited Liability Companies and Banking Law and Regulation. Professor Macey earned his B.A., cum laude, from Harvard and his J.D. from Yale Law School. He received a Ph.D. honoris causa from the Stockholm School of Economics.

The Politic: What is your reaction to Bernanke’s second term confirmation? What do you hope to see from him in the coming years?

JM: I’m not surprised. I think he’ll be looking to combat inflation.

The Politic: Should the Fed retain all of its bank-supervision powers?

JM: I think we need regulatory reform. I think we need a better organized and less sort of balkanized regulatory system. Whether we split up powers or get some type of super-regulator, there needs to be some type of reform.

The Politic: You’ve advocated splitting up large banks to eliminate “too big to fail.” How would this work? Who would oversee it? What qualifies as “too big”?

JM: A lot of people, including Paul Volcker, are pushing this idea. I think it’s generally regarded as good public policy, but politically, the big banks have a strong political coalition, so it’s definitely an uphill battle and I’m not overly optimistic about it happening. I think the antitrust division of the Justice Department would be the most appropriate regulator agency to oversee the process. In terms of how to define “too big to fail”, the government takes the view that there are certain institutions, which they decline to really define, that should be split up. You have to essentially look at two criteria. Firstly, you have to look at leverage and how levered they are. Secondly, you look at how much they have in liabilities. If the liabilities side of the balance sheet gets too big, which I wound define as greater than 1% of total liabilities in the economy, then it should be broken up.

The Politic: What would the effects be on financial markets?

JM: Well, we had a situation, going back 20 or 30 years, under Glass-Steagall where no bank was really too big to fail and the financial system was very competitive. When Alan Greenspan began his term as Chairman of the Fed, there were no U.S. banks in the top 25 financial institutions in the world. So, while U.S. banks were small, they could still compete very well internationally.

The Politic: What other steps do you recommend taking to reduce moral hazard?

JM: I think that would really do it. The moral hazard results from the implicit guarantee of “too big to fail,” so if we get rid of that, we get rid of the moral hazard.

The Politic: You were appointed to the Bipartisan Policy Center’s newly created Rating Agency Task Force in August 2009. What role did credit rating agencies play in the current recession?

JM: They were definitely an enabler. Without their incredibly flawed ratings of residential mortgage backed securities, we wouldn’t have had this nightmare.

The Politic: What recommendations do you have for regulating credit rating agencies?

JM: I think that the objective is to separate credit rating agencies from regulatory regimes. I think that regulations that require that investors only purchase securities that have a high rating by an NRSRO – a Nationally Recognized Statistical Rating Organization – should be amended. I would like to see ratings moved backed into a market context rather than a regulatory context.

The Politic: Should central banks take steps such as raising interest rates to thwart perceived asset bubbles?

JM: I think that they should take steps to thwart perceived asset bubbles, but I don’t think that raising interest rates would be a very effective tool. I think when they see financial asset bubbles, they should increase the capital requirements of institutions that are investing, and things like that. If we make the assumption that regulators can identify asset bubbles, then they should do something about it. The problem is that they can not really identify asset bubbles. They don’t know the difference between an asset bubble and a very highly valued asset until the bubble pops, and by then it’s too late.

The Politic: How would you rate recent government attempts to regulate compensation? Is there a better solution?

JM: I would give them an F. The regulation of compensation has been very politically oriented and hasn’t done anything to address the fundamental problem of executive compensation. It’s been sort of “quick fixes” for institutions that received TARP funds. I don’t think there’s any lasting or structural change that’s coming out of it.

The Politic: What is the fundamental problem with executive compensation?

JM: I think the fundamental problem is the decision-making process with boards of directors, who are not really capable of independently judging the quality and performance of managers. They seem to have a systematic tendency to view all managers as being significantly above average, which I think is improbable. Until that gets fixed, the problem is not going to go away. I don’t think the government should be in the business of regulating compensation. I think it’s a corporate governance problem that markets will ultimately solve.

The Politic: Lastly, should Congress reenact Glass-Steagall type legislation?

JM: There is a common misperception that people have, which implies that we don’t have the Glass-Steagall Act, which is the popular name for a statute called the Banking Act of 1933, which consists of four statutory sections. The most important of those four, sections 16 and 21 are still in place. Right now, as we speak, the Glass-Steagall Act is enforced and commercial banks are not allowed to get involved in investment banking, and investment banks are not allowed to get involved in commercial banking. So, contrary to popular rumor, we actually have the Glass-Steagall Act in place. In the press, it’s often reported that it’s been repealed, which is not true. Two of the minor sections, sections 20 and 32, have been repealed. These related to common control of banks, investment banks, and other financial institutions by the same holding company and overlapping boards of directors, but the core sections, 16 and 21, are still there, so there’s no need to reenact it.

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    1. with the situation engerimg in the U.S. Take housing: Lindsey v. Normet (1972) says policy with regard to housing need only have a “rational relationship to a legitimate government purpose.” This has meant two things: 1. the political system has nearly absolute power over housing;2. the individual has virtually no rights with respect to housing. This is also true of other facts such as education and maintenance, and there was a spate of U.S. Supreme Court cases during the 1970s and 80s reaffirming minimum scrutiny for these facts (DeShaney, Dandridge and so on). Now this is changing. We are revisiting West Coast Hotel and the other “social rights” bugaboo, U.S. v. Carolene Products, and noting that in both cases the Court bases policy on “maintenance.” It is used explicitly in both cases, and is also used in Berman v. Parker (which seemed to grant carte blanche to eminent domain).What, in FACT, is maintenance? It turns out that what the Court is trying to say is that policy, to be Constitutional, must maintain important facts. The important facts test will be familiar to all familiar with Anglo-Saxon jurisprudence. An important fact is1. a fact of human experience2. which history demonstrates3. is unaffected an attempts to affect it.Meeting this test is how, in Barnette, exercises of religion were removed from the Constitution, and power over them was given to the individual.Now this “maintenance” doctrine is replacing the “scrutiny” doctrine, and public opinion has decided that housing is an important fact.IN FACT, the level of scrutiny for housing is being raised above Lindsey v. Normet minimum scrutiny. This is the awkward HAMP program in operation. Ineffective as it is, it raises all kinds of question about whether government ITSELF has subjected housing to the Barnette test, and concluded in its HAMP policy deliberations that housing is an important fact. You are going to see this with education, medical care, maintenance and liberty as well. In short, we have reached the end of the line with respect to government discretion regarding a number of facts. The vast increase of individually enforceable rights is going to have an enormous effect on what we perceive as the “economy.” In the U.S. this move is being driven by homeowners, who feel, rightly, imperiled. They are very conservative and both do and do not want more individually enforceable rights, but th

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