My dear friend and former AEI colleague Alex Pollock, a one-time banker and an occasional guest on this site, is a great and learned man. He lives by and teaches hard-acquired wisdoms. Like, “Debts that cannot be paid will not be paid.” Or, apropos financial busts: “It will always happen again.” As my ten-year-old inquired of Alex: “Why does a wise man like you work with my dad?”
Perhaps because we both belong to a lost age. Pollock’s laws don’t encompass the new first law of finance, famously articulated by former Morgan Stanley CEO John Mack: “Your No. 1 client is the government.” Client No. 9 is, or was, Eliot Spitzer. Clients 2-8 are also government agents, such as state Treasurers. Clients 10-100 are trial lawyers. Borrowers, depositors, and investors are not clients; they are cannon fodder.
J.P. Morgan Chase head Jamie Dimon (on all accounts, an exceptionally honest and competent man) learned Mack’s law of finance the hard way. He moped about Dodd-Frank, and so the powers-that-be went after him and his bank. They’re not remotely done.
This past Thursday, J.P. Morgan paid $920 million to settle investigations over its “London whale,” who managed to lose something like $6 billion in exotic trades. There’s no allegation that J.P. Morgan defrauded anyone in those transactions; nor any contestation of the fact that the bank lost a lot of its own money; nor any doubt that Mr. Dimon was livid, fired everyone in shouting distance of the fiasco, and tried to get to the bottom of it. The settlement is mostly over whether Mr. Dimon’s decision to withhold certain information from the bank’s audit committee and the authorities until he was sure he knew the whole story violated federal law. I’m no securities lawyer, but I know the answer: $920 million. The same day, J.P. Morgan also agreed to a $389 million settlement for alleged marketing abuses in its credit card agreements and debt collection. Bear in mind that the “settlements” settle practically nothing—not a pending SEC civil investigation in the London whale matter, and not pending or impending actions by the CFPB, a gaggle of state AGs, and class action lawyers in the marketing abuse matters. Mr. Dimon should consider the combined $1.3 billion an annual dividend. Remember: the government is your No. 1 client.
Inasmuch as this form of tax farming is becoming standard m.o. across the wide range of regulators (from financial agencies to HHS and the FDA), maybe we should ask where the money winds up, and with what effect.
Start with the $389 settlement: it consists of $309 million in customer “refunds” and $80 million in penalties, with most of it going to the Office of the Comptroller of the Currency (OCC). You have to be nervous about a form of law enforcement that amounts to a government-sponsored class action without the (Rule 23) protections defendants would get in a private lawsuit. Plus, the government need not show that any customer actually relied on or was harmed by the defendant’s conduct. “Restitution” in these kinds of cases is basically cash dropped from a helicopter. As it turns out, that’s the highest and best use.
Here’s where the $920 million went: OCC, $300 million; SEC, $200 million; the Fed, $200 million. (The remainder went to the British authorities.) That much money, in a single action, raises the alarming prospect of agencies that become self-funding and, moreover, profit centers for a cash-starved Congress—through their enforcement activities. Here’s the blazingly obvious problem: most of the laws on the books are stupid and, when fully enforced, would land half of us in jail and the rest of us in bankruptcy. A principal way to check that problem is the appropriations process, which limits the enforcers’ budgets (and may influence their enforcement choices, for good or ill). When the money starts flowing in the other direction, all bets are off: you’re living under a NAFI regime.
NAFI is a term of art: it means “Non-Appropriated Funds Agencies”—outfits that are part of the government but financed not through congressional appropriations but through their own operations and revolving funds. The U.S. Mint is a NAFI. So is the Federal Reserve: it finances its budget from its earnings and then kicks the rest over to the Treasury. The CFPB has strong NAFI features: it simply sends a demand letter to the Fed, telling it how much money it wants (up to a certain percentage of the Fed’s earnings—above that level, the CFPB may receive appropriations). As noted, the Fed’s earnings don’t initially go into the Treasury and therefore aren’t appropriated from it.
Agencies like the SEC (or the FCC and FDA) aren’t NAFI’s. (For years, the SEC has lobbied for NAFI status. That was the only stupid idea that didn’t make it into Dodd-Frank.) The fees, fines and other moneys they collect are deposited, pursuant to the ancient Miscellaneous Receipts Act, in the U.S. Treasury. The agencies remain subject to congressional appropriations. That arrangement curbs some bad incentives, including the risk that agencies might go into business for themselves. But it’s still a de facto NAFI regime: Congress will and does look kindly on agencies that produce profits for the Treasury or at least break even. That’s so especially under Congress’s funky accounting rules: in general, only appropriations net of an agency’s “income” count as “outlays.”
(Upon information and belief, this arrangement dates back to the Reagan administration, which wanted to “reduce the size of government,” budget- and perception-wise. Sure enough, it’s helped government grow.)
There’s no huge problem with NAFIs that provide goods and services, like the Mint or army PX stores. (There is a Marbury problem: NAFIs are agencies of the government but with few exceptions aren’t covered by the Tucker Act or any other statute that permits money claims against the U.S.—precisely because their money is not that of the U.S. Thus, you may have contractual or similar rights against a NAFI, but no remedy. Never mind, though.) There is a massive problem with (de jure or de facto) NAFIs that wield regulatory and enforcement powers: whaddya think their utility function will look like? Better yet, don’t think: watch what they’re doing.
I can think of only one argument for the arrangement: for the most part, the regulated entities and enforcement targets (from banks to pharmaceutical companies) are de facto utilities. They operate with huge embedded subsidies (think SIFIs) but no rate-of-return regulation. So maybe we should siphon off some of the excess profits at the back end and call it “law enforcement.”
No good? You be the judge: I’m trying to be fair-minded here.