Topic: Finance, Banking & Monetary Policy

Statutes of Limitations Apply Especially to Government Agencies

By
Ilya Shapiro

Statutes of limitations exist for good reason: Over time, evidence can be corrupted or disappear, memories fade, and companies dispose of records. Moreover, people want to get on with their lives and not have legal battles from their past come up unexpectedly. Plaintiffs thus have a responsibility to bring charges within a reasonable time of injury so that the justice system can operate efficiently and effectively – and that’s doubly so when the would-be plaintiff is the government, with all its tools for investigation and enforcement.

There’s a general federal statute of limitations, therefore, 28 U.S.C. § 2462, which protects liberty by prohibiting government actions “for the enforcement of any civil fine, penalty, or forfeiture … unless commenced within five years from the date when the claim first accrued.” In April 2008, however, the Securities & Exchange Commission sued the managers of Gabelli Funds LLC, a mutual fund, for civil penalties relating to conduct that ceased in August 2002, more than five years earlier. The SEC alleged that Gabelli Funds defrauded investors by failing to disclose that the fund was allowing a favored investor to engage in “market timing” – buying and selling mutual fund shares in a manner designed to exploit short-term price swings.

The U.S. Court of Appeals for the Second Circuit ruled that the SEC’s claim was nevertheless valid because courts should read into § 2462 an implicit “discovery rule” – a common exception to statutes of limitations that prevents fraud-based claims from accruing (“stops the clock” on the limitations period) until the plaintiff discovers, or with reasonable diligence should have discovered, the basis for the claim. Because of the allegedly fraudulent nature of the defendants’ actions, the court found that the government’s claim accrued not when their conduct ceased but a year later, when the violation was actually discovered.

The Supreme Court decided to review the case, and Cato filed an amicus brief supporting the defendants. We make three points:

First, Congress could not have intended a discovery rule to be implicit here because at the time the operative language in § 2462 was enacted, case law explicitly rejected a discovery rule – and since then Congress enacted numerous statutes with explicit discovery rules that would be superfluous if a discovery rule had already existed implicitly.

Second, reading a discovery rule into § 2462 violates the principle of separation of powers by judicially changing the statute’s meaning: When judges rewrite laws, those laws fail to meet the constitutional requirement of bicameralism and presentment (“how a bill becomes a law”).

Third, even if courts could alter rather than merely interpret the meaning of statutes, there’s no basis for creating a discovery rule for government enforcement actions. Government agencies with broad investigatory powers – indeed, whose purpose is to monitor regulatory compliance – don’t face the same difficulty as private plaintiffs in identifying causes of action which give rise to the discovery rule. Adding a discovery rule to § 2462 would create an indefinite threat of government lawsuits and invite agencies to review decades of past conduct of selectively disfavored companies and individuals – inevitably chilling innocent and valuable economic activity.

To preserve individual liberty in the face of an ever-burgeoning regulatory state and ensure constitutional separation of powers, we urge the Court to reverse the Second Circuit’s decision and hold that no discovery rule applies in Gabelli v. SEC.  The case will be argued at the Supreme Court on January 8.

Topics: 
Finance, Banking & Monetary Policy, Government and Politics, Law and Civil Liberties

Receivership Does NOT End GSEs

By
Mark A. Calabria

Since their failure in 2008, I’ve been advocating that Fannie Mae and Freddie Mac be placed in receivership, which is essentially an administrative bankruptcy.  In what is an otherwise wonderful read, James Hagerty repeats in his new book (see pages 182-3) the myth that placing Fannie and Freddie into receivership would end those companies.  As he writes:

Under receivership, the main providers of funding for home mortgages would be going out of business at a time when private money for mortgages had dried up.” He continues, “The Bush administration would have to explain how it was going to make sure mortgage lending would continue without Fannie and Freddie.

Few journalists have as deep an understanding of Fannie and Freddie as Hagerty.  But I worked on the receivership language (Section 1145) in the Housing and Economic Recovery Act of 2008 (HERA) while staff on Senate Banking Committee, and I think his read of its powers are incorrect.

First, under a receivership, the GSEs can continue to be run – that is, the regulator, FHFA, can still issue debt, buy mortgages and do everything else the GSEs currently do. Skeptical?  Well, here’s the law:

Section 1367(b)(B) Operate the regulated entity.–The Agency may, as conservator or receiver– “(i) take over the assets of and operate the regulated entity with all the powers of the shareholders, the directors, and the officers of the regulated entity and conduct all business of the regulated entity; “(ii) collect all obligations and money due the regulated entity; “(iii) perform all functions of the regulated entity in the name of the regulated entity which are consistent with the appointment as conservator or receiver; “(iv) preserve and conserve the assets and property of the regulated entity; and “(v) provide by contract for assistance in fulfilling any function, activity, action, or duty of the Agency as conservator or receiver.”

Also the law prohibits FHFA from ending the charters:

HERA 1145 (Section 1367(k) of 1992 Act) “Prohibition of Charter Revocation.–In no case may the receiver appointed pursuant to this section revoke, annul, or terminate the charter of an enterprise.”.

The law is quite clear.  FHFA would continue to run the GSEs, with the option of a good/bad bank model to resolve bad assets, and the only way FHFA can terminate the receivership is to sell the charters back into the marketplace (see Section 1367(i)(6)(C) “Termination of status as limited-life regulated entity”).

So let’s get the facts straight.  Receivership would not end the GSEs.  The fundamental difference between receivership and the current conservatorship is the ability to impose losses on creditors.  The sole reason that Paulson and crew chose conservatorship was to protect the debt-holders and stick the taxpayer with the tab.  There were options to do otherwise.  Which is of course the primary reason I am skeptical of Dodd-Frank:  we had the “tools” to protect the taxpayer from GSE losses, yet chose not to use them.  Why should we believe we’d use them for Citibank if we didn’t for Fannie Mae?

Topics: 
Finance, Banking & Monetary Policy

Occupy Pennsylvania Avenue: How the Government’s Unconstitutional Actions Hurt the 99%

By
Ilya Shapiro

That’s the title of a new paper that Carl DeNigris and I just published in the Drake Law Review.  Here’s the abstract:

Economic freedom is the best tool man has ever had in the perpetual struggle against poverty. It allows every individual to employ their faculties to a multitude of opportunities, and it has fueled the economic growth that has lifted millions out of poverty in the last century alone. Moreover, it provides a path for individuals and communities to free themselves from coercive government policies that serve political elites and discrete political classes at the expense of the politically weak. Because of their relative political weakness, the poor and lower middle class tend to suffer the most from these inescapable power disparities.

Yet economic freedom — and ultimately, economic growth — is not self-sustaining. This tool of prosperity requires sound principles that provide a framework for cooperation and voluntary exchanges in a free society. Principles equally applied to all and beyond the arbitrary discretion of government actors; principles that provide a degree of certainty and predictability in an otherwise uncertain world. That is, economic freedom requires the rule of law, not men.

In this article, we discuss the corrosive effects that unconstitutional actions have on the rule of law, economic growth and, in turn, on the ability of the poor to improve their economic misfortune. We focus on the institutional dangers and adverse incentives that unconstitutional policies tend to create. These dangers are not just abstract or theoretical; this article shows how specific unconstitutional actions adversely affect the lives of poor Americans. And while Part IV shows that even constitutional violations by local governments can have disastrous effects, our central theme is that the federal government’s disregard for the U.S. Constitution has led to policies that kill jobs, stymie economic growth, and ultimately exacerbate the problems of those living in poverty.

The case studies we use to illustrate our argument are Obamacare, bailouts/crony capitalism, the Sarbanes-Oxley/Dodd-Frank financial regulations, and housing policy.  It’s truly stunning to see how the policies that the government pursues – unconstitutional ones at that – hurt the very people they’re designed to help.  Read the whole thing.

Topics: 
Finance, Banking & Monetary Policy, Government and Politics, Health Care, Law and Civil Liberties, Regulatory Studies

Liability Is ‘Wrong’ Solution for Rating Agencies

By
Mark A. Calabria

Last week, while America was occupied with elections, an Australian court found Standard & Poor’s liable for “misleading” local council governments by awarding AAA rating to derivatives that later lost value (more detail on the case here). Not surprisingly, after the financial crisis, dozens of suits were filed in the United States, Europe, and elsewhere claiming investors were “misled” by the rating agencies. Most of these suits were quickly dismissed or withdrawn. The Australian case is one of the few to find liability.

First, as I documented in a recent Cato Policy Analysis, the regulatory structure for the rating agency is fatally flawed and was without a doubt a contributor to the financial crisis. That said, subjecting rating agencies to legal liability would make the situation worse, not better. From that analysis:

[A] risk from subjecting rating agencies to liability for either their statements or processes is that, in order to protect themselves, the agencies would adopt a “reasonable man” approach. For instance, if the agencies used government forecasts of house prices in their mortgage default models, then it is likely that any court would deem such assumptions “reasonable”; after all, these are the assumptions that regulators rely upon. If such assumptions are, however, grossly in error, as were the housing price forecasts used by various federal agencies, then the value of information created by the rating agencies would also be reduced, if not compromised. A reasonable-man approach would also encourage rating agencies to utilize “consensus forecasts” of key economic variables. Yet the consensus could be dangerously off. The economic forecasting profession does not exactly have a great record at predicting turning points, and it also missed the decline in house prices. A system of liability would likely destroy whatever additional information the rating agencies bring to the market, as the agencies would face tremendous pressure to simply mimic widely held beliefs, which themselves would already be priced into the market.

Another problem would be that rating agencies would most likely face litigation risk from those being downgraded, especially by governments. Witness the abuse Standard & Poor’s received from the SEC right after it downgraded the U.S. federal government. Do we truly believe that we would have more accurate ratings if a Greek court were able to decide if a downgrade of Greek government debt was accurate? I would also go as far to argue that ratings of sovereign debt should be considered politically protected speech (but then I’m also for protecting most, if not all, speech).

Topics: 
Finance, Banking & Monetary Policy

Zimbabwe’s Four-Year Anniversary—From Hyperinflation to Growth

By
Steve H. Hanke

In mid-November 2008, Zimbabwe recorded the world’s second-highest hyperinflation. Today, it can boast strong growth and single-digit inflation rates. In 2008, Zimbabwe’s annual real GDP growth rate was a miserable -17.6 percent and its annual inflation rate was 89.7 sextillion percent—that’s roughly 9 followed by 22 zeros.

So how did Zimbabwe go from economic ruin to an annual GDP growth rate of 9.32 percent in 2011, with estimates of relatively strong growth rates through 2013?  As I predicted in early 2008, the answer is simple: spontaneous dollarization brought an end to the horrors of hyperinflation.

In late 2008, the people of Zimbabwe spontaneously dollarized the economy. Thiers’ Law prevailed: good money drove out bad, and the government’s hands were tied. Indeed, the government was forced to officially dollarize in 2009. Since then, Zimbabwe has enjoyed positive GDP growth rates, a feat not accomplished since 2001 (see accompanying chart).

 

While these achievements are cause for celebration, there are still problems in paradise: Robert Mugabe continues to hold the reins of power; Zimbabwe’s “Ease of Doing Business” ranking is a dismal 172nd out of 185; and “change” is, in short, hard to come by. In addition, the government’s external debt is now close to $12.5 billion and lending rates between Zimbabwe’s embattled banks are as high as 25 percent. To top it off, the Zimbabwean government is attempting to force banks to buy its treasury bills at significantly discounted rates, after its debt auction flopped in early October. Talk about ruling with an iron fist.

If this isn’t bad enough, Zimbabwe’s official statistics have produced a very low signal-to-noise ratio—one that, quite frankly, leaves one listening to static. Both the quantity and quality of official data, ranging from migration statistics to trade figures, are in short supply, particularly data from the period of Zimbabwe’s 2007-08 hyperinflation.

None of this comes to a surprise to me. After all, as far as Zimbabwean officials are concerned, the country’s hyperinflation peaked in July 2008, with a monthly inflation rate of 2,600 percent. After this point, Zimbabwe stopped collecting and reporting data on price changes, throwing a shroud of secrecy over the country’s hyperinflation disaster. In reality, hyperinflation continued after July 2008, growing at an exponential rate until mid-November 2008.

Alex Kwok and I lifted the shroud on this hyperinflation in our 2009 Cato Journal article. We determined that Zimbabwe’s hyperinflation actually peaked in mid-November 2008, with a monthly rate over 30 million times higher than the final inflation rate reported by the government. In an attempt to correct the government’s lying statistics, I have contacted high officials in Zimbabwe via telephone and email. But, I have been stonewalled, given a bureaucratic runaround.

The last thing the Mugabe government seems to be interested in is an accurate account of the world’s second-highest hyperinflation. Lying statistics remain the order of the day.

Topics: 
Cato Publications, Finance, Banking & Monetary Policy, International Economics and Development

The ‘Lehman Trigger’ Myth Continues…

By
Mark A. Calabria

In yesterday’s defense of President Obama’s economic record, Alan Blinder starts, ”[A]fter the frightening financial panic and deep recession triggered by the collapse of Lehman Brothers in September 2008,” thereby repeating the myth that Lehman’s failure caused the recession.

Below is a chart of real (inflation-adjusted) personal consumption and civilian employment from January 2007 to December 2010.  Let’s recall that Lehman’s failure was in September 2008.  What should be immediately clear, even to such an accomplished economist as Blinder, is that both consumption and employment began their decline almost a full year before Lehman’s collapse.  So unless Lehman’s collapse caused some backward ripple in time, it’s hard to see how it triggered the recession.  In fact, about 75% of the decline in personal consumption preceded the Lehman collapse.  Also of interest is that the rate of decline in consumption actually slowed after the Lehman collapse.

Why is this important, other than my obsession with facts?  As long as we allow the narrative to run that Lehman’s collapse caused the crisis, then “solutions” like Dodd-Frank will continue to dominate the debate, rather than recognizing a housing bubble drove the crisis and that we should instead be focused on preventing the creation of housing bubbles.  And don’t get me wrong; Lehman got what they had coming. If anything, their well-deserved fate should have been shared by others.

Topics: 
Finance, Banking & Monetary Policy

Over Half of Foreclosures Now ‘Repeats’

By
Mark A. Calabria

A fundamental question with both the Bush and Obama approaches to the mortgage foreclosure crisis is to what extent are policies simply putting off the inevitable?  Are “permanent” solutions being offered, or are we just recycling the same borrowers through one foreclosure after another?  Recent data from Lender Processing Services (LPS) sheds some light on the question.

The most recent LPS data, covering to the end of August 2012, shows that for the first time, over half of foreclosures are for borrowers that were previously in foreclosure.  Now there are several ways to read the chart below.  On one hand, first-time-ever foreclosures are at their lowest levels since 2008, and in fact have been on a steady decline since the middle of 2009.  That is good news.  The pipeline of new foreclosures is decreasing, a reflection of both improving labor and housing markets (or at least not getting a lot worse).  The bad news is that foreclosures are increasing because of the same borrowers who have been delinquent for years.  I was recently told that the average time to foreclosure for Chicago, for instance, is over 1,000 days.  The LPS data also highlight that the largest increase in repeat foreclosures has been in states that use a judicial foreclosure process, providing further evidence that such a process generally does not change the final outcome, but simply delays it.

If there is one policy lesson we should take away from the foreclosure crisis, it is that delaying the inevitable makes the problem worse.  Had these borrowers finished the foreclosure process the first time around, housing prices would have adjusted quicker and the housing market would have been on the road to recovery quicker.  These families also would not have been stuck in “limbo” and would have been able to move on with their lives.  While some have argued that delaying these adjustments was appropriate, it is far from clear to me that longer periods operating under “false” prices will lead to better market outcomes.

Topics: 
Finance, Banking & Monetary Policy

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