By DAVID SKEEL
We are losing sight of the basic principles that made us great in the 20th century.
No one doubts that the coming election will be the most important referendum on the size and nature of government in a generation. But another issue is nearly as important and has gotten far less attention: our crumbling commitment to the rule of law.
The notion that we are governed by rules that are transparent and enacted through the legislative process—not by the whims of our leaders—is at the heart of that commitment. If legislators exceed their authority under the Constitution, or if otherwise legitimate laws are misused, courts must step in to prevent or remedy the potential harm.
During the 2008 financial crisis, the government repeatedly violated these principles. When regulators bailed out Bear Stearns by engineering its sale to J.P. Morgan Chase, they flagrantly disregarded basic corporate law by “locking up” the transaction so that no other bidder could intervene.
When the government bailed out AIG six months later, the Federal Reserve funded the bailout by invoking extraordinary loan powers for what was clearly an acquisition rather than a loan. (The government acquired nearly 80% of AIG’s stock.)
Two months later, the Treasury Department used money from the $700-billion Troubled Asset Relief Program fund to bail out the car companies. This was dubious. Under the statute, the funds were to be used for financial institutions. But the real violation came a few months later, when the government used a sham bankruptcy sale to transfer Chrysler to Fiat while almost certainly stiffing Chrysler’s senior creditors.
According to two leading legal scholars, Eric Posner and Adrian Vermeule, rule-of-law violations are inevitable during a crisis. The executive branch takes all necessary steps, even if that means violating the law, until the crisis has passed. The argument is powerful, and its advocates are correct that presidents and other executive-branch officials often push the envelope during a crisis.
Yet pushing the envelope isn’t the same thing as flouting the law. Even in a crisis, jettisoning legal constraints can have enormously destructive consequences. Investors are likely to flee, for instance, precisely when continued confidence in the markets is essential.
Though one might excuse departures from the rule of law at the height of a crisis, one would expect to see a prompt reversion to rule-of-law principles immediately thereafter. The most famous 20th-century illustration was the Supreme Court’s invalidation, in the 1952 case Youngstown Sheet & Tube Co. v. Sawyer, of President Harry Truman’s attempt to take over the steel industry during the Korean War.
By far the most disturbing element of recent trends is that precisely the opposite seems to be taking place. The commitment of government officials to the rule of law has continued to crumble—even after the crisis has subsided.
Consider the litigation that led to the recent $25 billion National Mortgage Settlement, which was brought by the state attorneys general and quarterbacked by the Obama administration. The plaintiffs alleged that five of the nation’s largest banks used “robo-signers”—law firms that filed large numbers of foreclosure documents without bothering to check the details—and added unnecessary fees such as overpriced insurance during the real-estate bubble.
These actions deserved to be punished, but the settlement had almost nothing to do with the allegations. A large majority of the settlement will go to mortgage relief for homeowners who weren’t affected by the robo-practices, or to provide a bailout to the states. Both steps are illegitimate uses of the judicial process.
Or consider the Dodd-Frank Act’s new resolution rules. They require the Federal Deposit Insurance Corporation to liquidate the troubled financial institutions it takes over.
The liquidation requirement is a bad idea, but its purpose is clear. When California Democratic Sen. Barbara Boxer proposed the requirement, she insisted that the rules would only be used to shut down the institution. All “financial companies put into receivership . . . shall be liquidated,” she insisted in May 2010. “No company is going to be kept afloat.”
Yet as the FDIC has made plans for implementing the resolution rules, it has simply ignored the requirement, announcing that it will use the new rules to reorganize institutions and keep them going.
A sad irony of these developments is that rule-of-law values have been one of America’s greatest contributions to world-wide economic development in recent decades. When the economist Hernando de Soto tried in the 1990s to determine why economic growth is so limited in much of the world, he concluded that respect for basic property rights is essential.
America, where this commitment gradually emerged in the 19th century, was Exhibit A in Mr. de Soto’s story. In the years after the Berlin Wall fell in 1989, American markets served as a model of the importance of privatization and protection of property rights as the nations of Eastern Europe charted a new economic future. Now we increasingly are the ones that need to learn these lessons.
Rule-of-law matters cannot be separated entirely from questions about the size and role of government. The more government grows, the harder it is to preserve rule-of-law virtues like transparency and clear rules of the game. But the rule of law is nevertheless a distinct and extraordinarily important concern, and it deserves separate consideration as the presidential campaign begins in earnest.
Each candidate should be asked: Do you believe that the rule of law was abused during the recent crisis, and what would you do to protect it in the future?
Mr. Skeel, a professor at the University of Pennsylvania Law School, is author of “The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences” (Wiley, 2011).
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