Truth on the Market

Wednesday, December 16 I will be testifying at 10am before Congressman Kucinich’s Domestic Policy Subcommittee of the House Committee on Oversight and Government Reform.  The topic will be The Government as Dominant Shareholder: How Should Taxpayers’ Ownership Rights be Exercised?  Also on the list to testify are Ralph Nader and a few experts from the GAO.  On Thursday, the second part of the hearing will feature Herb Allison, the TARP czar.  TOTM readers who would like to watch the hearing live can check out this link.  The text of my testimony is below, and I will be sure to share the post-game with TOTM tomorrow.  Wish me luck.

Chairman Kucinich, Ranking Member Jordan, and distinguished members of the Committee, it is a privilege to testify in this forum today. My name is J.W. Verret.  I am an Assistant Professor of Law at George Mason Law School, a Senior Scholar at the Mercatus Center at George Mason University and a member of the Mercatus Center Financial Markets Working Group.

The past year has seen some unprecedented events in the history of American business.  Through the bailout our government has become a controlling shareholder in many bedrocks of the business community.  Some political leaders have argued that since the government owns these companies, it should seek to control their day to day business decisions.  The reason I have joined you today is to explain why this view is not only misguided, but downright dangerous to the taxpayer’s investment as well as the pension funds and retirement funds of ordinary americans.

Government ownership in private companies perverts the accountability of both government and business.  To understand why, one must appreciate that government leaders and business leaders are held accountable by entirely different means.  Government’s are accountable to voters based on their ability to get re-elected by voters.  Business leaders are held accountable by their ability to maximize profits for their shareholders.  And the overwhelming majority of those profits for shareholders go to main street investors.  Teachers, firefighters, policeman, and other working Americas depend upon this mechanism to fund their retirements.

Maintaining a buffer between short-term political interests and long-term financial soundness is critical.  The economic evidence from around the globe is overwhelmingly clear that political ownership of private banks and financial companies results in lower GDP growth, increased need for government bailout, and politicized lending practices.  I am concerned that we may see politics driving business decisions, such as TARP banks encouraged to subsidize lending in battleground states.

The Treasury Department owns one-third of Citigroup.  This fact has given the government enormous power over Citigroups’s operations.  Consider the case of Andrew Hall, a commodities trader at Citigroup, who generated an average of $250 million per year over the last 5 years for Citigroup and its investors.  He was paid a percentage of what he earned for the bank.  His annual salary was high, but was an entirely performance-based pay package.

The pay czar decided that his salary was just too large to justify to populist pressures, and so Citigroup was forced to sell off his Division at a discount.  Losing Andrew Hall will cost Citigroup hundreds of millions of dollars per year.  And that cost will fall on Citi’s investors.  But the decision was politically advantageous to the executive branch in the short term, and so it was inevitable because of the government’s share ownership.

The case of General Motors is even worse.  GM has been pressured by political leaders, responding to alliances with failed automobile dealerships, to keep those failed dealerships open.  Political leaders have exerted pressure to force GM to overpay on its shipping contracts so that truckers using politically favored unions, like the Teamsters, win the bids.  Make no mistake, the cost of this crony capitalism is borne by by the American taxpayer.  Government shareholders don’t have to play by the same legal rules as the rest of us, a fact which will strain the governance mechanisms of the capital markets at a time when they are already in crisis.

Bi-partisan legislation pending in the House and Senate stand to address these drawbacks and create a buffer between the taxpayer’s investment and the politicians who would use that investment to pander to special interests.  The “TARP Recipient Ownership Trust Act of 2009,” introduced in the House by Congressman Bachus and in the Senate by Senators Corker and Warner, would require the Secretary of the Treasury to place ownership of TARP investments in trust to be held on behalf of the American people.  The Act would task those trustees with a fiduciary duty to maximize the value of that investment.  It would also include a sunset provision that the Treasury must sell its investment in these companies by December 24, 2011.  I commend this Act to the Committee’s attention.

The prospect of the government actively voting their shares in TARP recipients holds grave risks.  Political leaders have stuffed the federal budget with pork barrel projects at great cost to the American taxpayer.  We must not permit them to do the same to the budgets of privately held companies.  If we do, the taxpayer will be left holding the tab.