A libertarian analysis of the corporate form, particularly the state grant of limited liability to shareholders, does not begin and end with the question of whether such a government intervention has any libertarian justification (it clearly does not), or even – as Stephan Kinsella continually suggests – with the narrow question of whether, in hie case of a particular “corporate tort,” it is fair to impose liability broadly on shareholders who had no personal role in a tort. Rather, as I have have long argued in my posts on limited liability, one must also examine the systemic consequences of the grant.
It is my own humble view that limited liability of shareholders, when combined with other corporate attributes like unlimited life and purposes and an ability to further ring-fence risky activities in separate subsidiary entities, has had profound and pervasive consequences: relative anonymity of ownership, remoteness of owners from communities in which the firms operate, an explosion of powerful firms and wealthy investors and their ability to influence judges, legislators, bureaucrats, the press and mass media, and a steady erosion of common law and growth in the centralized regulatory state – as citizens fight to limit the risks and costs that corporations impose on individuals and communities. The growth of corporations is accompanied by growing moral hazard, not simply because dividends paid to an anonymous and morally blind shareholder class cannot be clawed back when risks are materialized, but shareholders find it increasingly difficult to rein in a self-interested class of executives and employees.
The toxic combination of statism and limited-liability moral hazard -and the steady shifting of risks to society that both entail – can be clearly seen in both the BP Gulf oil disaster (see my BP posts) and in the financial crisis.
I recently ran across a post by an informed observer of the financial crisis that pointed to these problems; The Ten Trillion Dollar Black Swan in the January 26, 2009 online edition of American Thinker by Mike Razar, who describes himself as a “Phd in math from Harvard, a math professor, independent option floor trader, sr. vp swiss bank corp, 9 years on board of directors of the CBOE (options exchange), chairman of product development cmte., financial software development”; some excerpts follow (emphasis added):
As a poor taxpayer, I am at least entitled some entertainment for my money. Fire all the top executives and sue them for every penny they have on the grounds that they totally abandoned even a fig leaf of fiduciary responsibility to their share holders and bond holders. I bet we can get some lawyers to do that pro bono! But no, instead we have to vomit every time one of those self-serving empty suits who run the banking industry appears on TV telling us that we are too dumb to understand the intricacies of modern finance. Then he shakes his head solemnly, while proclaiming to us how unlucky they were.
It is unfair to blame every bank CEO. Just to name one, (I know there are others) Wells Fargo Bank share holders were sent a note of apology because earnings were off by 7% from the previous year because of bad mortgage loans. Gee whiz! They took what was believed to be a prudent risk and it didn’t work out. So the shareholders took a tiny hit, not in value, but in potential increased value. That is true capitalism. But small risk equates to small bonuses. How could you have expected the heads of Bear Stearns, Lehman Brothers, AIG, Morgan Stanley, Goldman Sachs, etc. to disappoint their employees with mere 6 or 7 figure bonuses?
And oh yeah. The aforementioned CEO of Wells Fargo was summoned to Washington by the Treasury Department’s secret police and water-boarded for 48 hours until he agreed to accept $25 billion or so, in order to save his badly managed competitors any embarrassment.
Am I being too harsh? After all we are repeatedly assured (as if we were the morons) that it was a perfect storm. No, worse than that. A black swan! Sure, hindsight is 20/20, but who could have anticipated it? Let’s see. You leverage your firm 30 or 40 to 1. That means (public school graduates) that you have a billion dollars of your own money. Then you use your “strong” balance sheet (no silly marking to market) to borrow another $39 billion. You loan out $35 billion of it and pay the other $4 billion to yourself or other co-conspirators. Your risk managers fire off e-mails telling you that if housing prices decline by as little as 5% to 10%, the entire firm is lost. What a bunch of academic worry-warts! Everyone knows that housing prices can never go down. Maybe one intrepid risk analyst (who earns less that 1% of your well deserved compensation) has the temerity to remind you that the latest reports show an excess supply of more than 2 million homes nationwide as compared to people who need a home to live in. After firing her, you console yourself with some caviar and truffles washed down with a $10,000 bottle of wine.
There was a time when the greed factor cited above was balanced by its equally famous sibling, the fear factor. Before 1970, investment banks and other NYSE members had to be individuals or general partnerships. When they converted to publicly traded corporations the risk was transferred to the shareholders but the rewards still went disproportionately to the senior managers. Why is that important? When that e-mail warning of the risk hit the CEO’s computer, he could ignore it, knowing that he had accumulated tens or even hundreds of million dollars in prior years. At worst, he could retire comfortably. Had he been the managing partner, the firm’s creditors could go after every penny he had to his name. Say goodbye to Mister [Fear] and hello to Mister [Greed]! …
This rant would be incomplete without a nice metaphor to take home. It was not a black swan that caused this crisis. It was a whole flying wedge of white swans flying over Wall Street marking the market in their own charming way.
One commenter left the following note:
the key point hear is the move from partnerships to public companies by the investment houses while still operating their compensation systems(at least on the bonus side) like they wre still partnerships. in this assymetrical, i win but cannot lose structure, traders used the firms(now shareholders) capital as their own personal gambling pot.this was an inevitable train wreck for us poor shareholders who did not get it .talk about the proverbial “other people’s money”!
Razar refers implicitly to successful lobbying by the investment banks to expand their permissible leverage, but fails to note that the moral hazard was further enabled by government bailouts. This combination of corporate risk shifting and rampant, government-fuelled moral hazard is also present in the case of the BP disaster.
Would we have healthier offshore oil and gas development and oversight if government did not license and pretend to regulate it, but rather those whose livelihoods are put at risk by spills? And if those engaged in it did not act through corporations, but partnerships with unlimited liability and without liability caps and royalty incentives set by government?
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