(Originally published here.)
Ronald Coase, the Nobel-winning economist who died on Monday, spent much of the last few decades focused on something known as the “New Institutional Economics,” which examines the ways different legal rules and social mores affect living standards. The basic insight is that successful entrepreneurs have a much easier time growing productive businesses when they trust that the laws are fair and enforced impartially. On the other hand, countries with lots of corruption and little trust beyond blood relatives have much lower levels of productivity.
I’m reminded of this by a recent column in the Financial Times by Simon Rabinovitch on the Chinese government’s stern punishment of Everbright Securities. China’s legal system is far from ideal, but in this case it may have something to teach us about the restoring trust in the financial system. China held senior managers personally responsible for misconduct and imposed punishments on the company so punitive that it will literally be incapable of repeating its offenses ever again.
A few weeks ago, Everbright messed up an order for stocks on the Shanghai stock exchange, inadvertently sending the Shanghai Composite soaring. Once the error had been discovered internally, the company’s traders attempted to profit by betting that the index would return to its previous level, before formally announcing that it had made a mistake. That’s a form of insider trading and market manipulation.
Everbright’s regulator has now barred four senior executives from ever working in the securities industry again, banned the company from engaging in any future proprietary trades and imposed a fine equivalent to more than half of the company’s 2012 profits. (The company’s president also had the good graces to resign in shame.) Investors are suing Everbright’s management for compensation, since they are the ones who will be stuck paying for most of these penalties.
China’s conduct stands in striking contrast to the U.S. government’s treatment of large financial institutions accused of bribery, money-laundering, fraud and bid-rigging — among other crimes. For whatever reason, the Justice Department has been extremely reluctant to go after culpable individuals, preferring instead to extract relatively toothless settlements from shareholders. According to Attorney General Eric Holder, these firms are effectively “too big to jail.”
I can’t help but wonder if this lax attitude to law enforcement has contributed to the slowness of the recovery in the wake of the financial crisis. After all, investors are still pricing most of the big banks at discounts to their official book values, while financing conditions for small and medium-sized businesses remain relatively tight. And it’s hard to imagine the emergence of a robust private mortgage finance system when investors were badly burned by fraud that went unpunished by the government. (The new rules on securitization and risk retention, which arebasically meaningless, will also do little to inspire confidence and private investment.)
Wouldn’t it be something if the U.S. economy were held back by its unwillingness to embrace the Chinese approach to criminal justice?
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)