Here We Go Again!
More destructive financial deregulation sold to the public as the ‘JOBS’ bill
by Hank Van den Berg
UNL Professor of Economics
The “Jumpstart Our Business Startups Act” (which cutely abbreviates into the “JOBS Act”) was signed into law by President Obama on April 5. The signing ceremony featured the usual cast of smiling politicians, with the President handing out the pens he used to sign the bill to the various congressional leaders standing around him. The bill passed with huge majorities of Republicans and Democrats in both houses.
But before you celebrate this rare moment of bipartisanship, you should note that this bill does not directly create jobs. Rather, the bill deregulates “Initial Public Offerings” (IPOs) of stock on the alleged premise that job creation is restricted by ‘excessive regulation’ of IPOs, which prevents new companies from starting up and generating new jobs. Any direct job-creation measures had long been eliminated in earlier political wrangling, and only the deregulation provisions of the bill remained.
The JOBS Act reduces most reporting requirements for small- and medium-sized companies when they issue new stock. On the one hand, the act lets more companies issue new stock without facing the usual Securities and Exchange Commission (SEC) requirements for full disclosure and periodic reports. Even some of the reporting requirements instituted just a few years ago after the ENRON and WorldCom frauds are waived for qualifying upstart companies. Before, exemptions from SEC regulation were only granted for companies with less than 500 shareholders; the JOBS Act increases that limit to 2,000 shareholders. Of course, these limits are nearly meaningless in practice, because a stockbroker who represents a large number of buyers can register as a single purchaser who counts as just one shareholder under this regulation.
The act also raises the total amount of stock that companies can exempt from SEC reporting requirements from its current $5 million to $50 million. The White House and the legislators touted the act’s legalization of “crowd funding” (which refers to active internet advertising and sales of stocks directly to the general public). The bill also permits other forms of ‘general solicitations’—such as phone solicitations through call centers—that are now prohibited for first-time stock issuers. Because of the lack of information available to the public, such new small company stock offerings without SEC oversight have, for the past 70 years, been limited to sales by certain brokerages to select customers.
But what does this JOBS bill really mean for the economy and the 99 percent that are not protected by their obscene wealth?
First of all, we should point out that ‘excessive regulation’ is not the cause of the sharp decline in stock offerings in the last several years. Unlike what sponsors of the JOBS Act kept suggesting, regulations in the securities industry have not been increased substantially in the past few years. The obvious cause of the decline in stock offerings is the Great Recession. Why invest in new firms when economic conditions are bad?
It is also not at all certain that the JOBS Act will really make more money available to small companies (assuming companies issuing $50 million in new stock are ‘small’). In fact, total flows of funds to IPOs for companies exempted from regulatory requirements are likely to decline. The politicians do not tell us that reporting requirements and regulations for transparency have long been recognized as desirable mechanisms necessary for attracting investors in new stock because they reduce the chances of fraud and enable potential purchasers to better judge the value of the stock. Every IPO by a new company faces the common problem of ‘asymmetric information,’ where the issuing company knows much more about the future of the company than the buyer of the stock. Without the reporting requirements, potential buyers are unlikely to commit their money. A very recent “National Bureau of Economic Research” study by Glaeser, Johnson and Schlieffer (three highly noted financial economists) compares financial flows to newly opened regulated and unregulated financial markets for IPOs, and it indeed finds that the more regulated markets saw steady growth in IPOs while the unregulated markets did not get off the ground. You could say that reporting requirements and other regulations to enforce honesty and transparency help honest businesses and deter dishonest companies from gaining access to investors’ funds.
Because the JOBS Act will undoubtedly allow some dishonest companies to sell stock while reducing the overall flow of funds to businesses, there will not be any jobs created. As MIT’s Simon Johnson recently argued in a widely distributed op-ed, the best we can hope for is that honest companies continue to provide full disclosure and transparency in order to attract funds for expansion—in which case the JOBS bill simply does nothing. Experience suggests, however, that there will be more fraud, and unsuspecting or greedy clients will get bilked of money that would otherwise have flowed to honest companies. We might better refer to this legislation as the ‘UNJOBS’ Act.
The University of Missouri—Kansas City’s William Black, a noted researcher of financial fraud, calls the JOBS Act a “form of insanity” because it will create a lot of new financial assets that no one understands or can put a true value on. It was precisely those types of complex assets that sank the global financial markets in 2007 and 2008.
To illustrate Black’s point, I will finish with some speculation on why the heavy hitters in the financial industry wrote this Act for their representatives, senators and President to enact into law, despite the clear dangers for the economy.
Note that, after deregulating much of the financial industry between the 1970s and the early 21st century, the only part of the financial industry that still faced some substantial remnants of the regulatory structure set up in the 1930s were the stock and bond markets. The Securities and Exchange Commission is still operating. But now the JOBS Act pushes it out of the picture for certain IPOs. And, it does not take much imagination to expect that next year the somewhat larger companies who want to issue, say, $100 or $200 million in new stock begin to mount a lobbying campaign to be awarded the same freedom from disclosure and reporting requirements that ‘small’ companies gained with the JOBS bill this year. If unemployment is still high next year, which is a certainty given that the JOBS Act is the only thing our government is able to come up with, the larger companies should have little trouble getting their bill. Then, the following year, the limits could be raised some more. Pretty soon, we begin to approach complete deregulation of new IPOs and reporting in the stock markets.
I can see why there is support for the JOBS bill in the financial industry. With more poorly understood assets being issued, those same ‘smart guys’ at Goldman Sachs and other investment banks whose bundling of over-valued mortgages prompted the ‘housing bubble’ that led to the Wall Street meltdown in 2008 must be drooling in anticipation. In the years ahead, I envision that this same crew will be marketing large bundles of these newly issued stocks in what, in the world of finance, are called “collateralized debt obligations” (CDOs). Of course, no one would really know the true value of the stocks in the various components of the CDOs (except for their creators like Goldman Sachs). But as happened in the run-up to the meltdown of 2008, the closely allied ratings agencies like Moody’s and S&P will, for a handsome fee, issue their quote/unquote ‘objective’ opinions. More than a few ‘AAA’ ratings will be handed out, on the assumption (programmed into the models) that bundles of diverse assets always reduce risk below that of any individual asset. Invariably, some renegade economists (yours truly among them) will warn that deregulation tends to drive honest businesses out of the IPO market, so that the overall investment bundle would be subject to higher default rates than the models suggest, but those ‘fringe’ pessimists will be categorically ignored. Goldman Sachs et al, on the other hand, understand this increased risk very well, and will in turn bet on the eventual failure of the new businesses by purchasing credit default swaps after they ‘aggressively’ sell the junk investments to their customers. The investment banks would then be able to top off the earnings from
1) underwriting the IPOs,
2) creating and selling the CDOs, and
3) marketing the swaps by also collecting their full value of the failed CDOs from the insurers.
What a deal!
This is sure worth a few campaign contributions to those smiling Democrats and Republicans standing around the smiling President at the JOBS Act signing ceremony on April 5.
The rest of us can celebrate knowing that our corrupt political leaders have just created another potential source of financial instability for the benefit of their financial masters. You should, in fact, be just as happy as when similar bipartisan groups of legislators stood around Ronald Reagan in 1982 during the signing of the bill that let S&Ls venture into commercial banking and generate the $200 billion in S&L fraud and losses. Or when Bill Clinton signed the bill that abolished the restrictions that would have prevented the mortgage derivatives from pushing the entire world economy into the recent Great Recession.
A toast to insanity, anyone?