Posted on March 19, 2012 by Simon Johnson
From the 1970s until recently, Congress allowed and encouraged a great deal of financial market deregulation – allowing big banks to become larger, to expand their scope, and to take on more risks. This legislative agenda was largely bipartisan, up to and including the effective repeal of the Glass-Steagall Act at the end of the 1990s. After due legislative consideration, the way was cleared for megabanks to combine commercial and investment banking on a complex global scale. The scene was set for the 2008 financial crisis – and the awful recession from which we are only now beginning to emerge.
With the so-called JOBS bill, on which the Senate is due to vote Tuesday, Congress is about to make the same kind of mistake again – this time abandoning much of the 1930s-era securities legislation that both served investors well and helped make the US one of the best places in the world to raise capital. We find ourselves again on a bipartisan route to disaster.
The idea behind the JOBS bill is that our existing securities laws – requiring a great deal of disclosure – are significantly holding back the economy.
The bill, HR3606, received bipartisan support in the House (only 23 Democrats voted against). The bill’s title is JumpStart Our Business Startup Act, a clever slogan – but also a complete misrepresentation.
The premise is that the economy and startups are being held back by regulation, a favorite theme of House Republicans for the past 3 ½ years – ignoring completely the banking crisis that caused the recession. Which regulations are supposedly to blame?
The bill’s proponents point out that Initial Public Offerings (IPOs) of stock are way down. That is true – but that is also exactly what you should expect when the economy teeters on the brink of an economic depression and then struggles to recover because households’ still have a great deal of debt. And the longer term trends over the past decade are global – and much more about the declining profitability of small business, rather than the specifics of regulation in the US (see this testimony by Jay Ritter).
Professor Ritter, a leading expert on IPOs, put it this way:
“I do not think that the bills being considered will result in a flood of companies going public. I do not think that these bills will result in noticeably higher economic growth and job creation.”
In fact, he also argued that the measures under consideration “might be to reduce capital formation.”
In other words, you will be ripped off more. Knowing this, any smart investor will want to be better compensated for investing in a particular firm – this raises, not lowers, the cost of capital. The effect on job creation is likely to be negative, not positive.
Sensible securities laws protect everyone – including entrepreneurs who can raise capital more cheaply. The only people who lose out are those who prefer to run scams of various kinds.
Investor protection is good for growth and essential for sustaining capital markets. Experiments involving doing without such protections – as in the Czech Republic in the early 1990s, for example, have not gone well. There might be a temporary frenzy, but the subsequent fall to earth will be painful – and again hard to recover from.
Perhaps the worst parts of the bill are those provisions that would allow “crowd-financing” exempt from the usual Securities and Exchange Commission disclosure requirements. A new venture could raise up to $1-2 million through internet solicitations, as long as no investor puts in more than $10,000 (section 301 of HR3606). The level of disclosure would be minimal and there would be no real penalties for outright lying. There would also be no effective oversight of such stock promotion – returning us precisely to the situation that prevailed in the 1920s.
This might well pump up the value of particular stocks – that was the experience of the 1920s, after all. But ephemeral stock market bubbles are not without real consequences. The crash of 1929 was made possible by the lack of constraints on what stock promoters could say and do. Combined with excessive leverage, this led directly to the Great Depression.
The Dumbest 'Bipartisan' Move Since Repealing Glass-Steagall
Posted: 03/22/2012 11:35 pm
Now we have the "JOBS" Act, which undoes Sarbanes-Oxley's key provisions. In a typically cynical move, the corrupt dealmakers of DC have appropriated two good ideas -- "crowdfunding" by individuals, as is done on Kickstarter, and the need to find investment capital for small and medium-sized businesses that are the engines of job growth.
But this bill will actually hurt both those efforts. Kickstarter finances creative projects, where it's fairly easy for investors to decide whether they feel a project has artistic merit. But this bill will unleash a torrent of unscrupulous scam artists onto the public, leaving them unable to decide which project has merit and which doesn't. Since these ventures won't be required to provide some basic financial data, many of them will bilk their investors -- drying up the pool of available capital for truly worthwhile startups.
Besides, why have we been pumping capital into the nation's banks through the Fed? Wasn't the purpose of all that support -- including TARP -- to prop them up so that they would lend to American businesses?
Worse, the bill is designed so that even billion-dollar corporations can be considered "startups," leaving the door open for a dozen Enrons of tomorrow to shaft the unwary.