Regulating Against Bubbles: How Mortgage Regulation Can Keep Main Street And Wall Street Safe—From Themselves
As the Great Recession has painfully demonstrated, housing bubbles pose an enormous threat to economic stability. However, the principal mortgage market reforms in response to the latest boom and bust—the Dodd-Frank Act's provisions on mortgage lending and securitization—are not designed to protect the economy from a housing bubble. Instead, these reforms tinker with the incentives of securitizers and lenders to prevent their exploitation of naive investors and borrowers. In particular, these changes require securitizers to retain credit risk and lenders to assess borrowers' ability to repay.
This approach misses the mark. The sine qua non of a bubble is marketwide overoptimism about future house prices. Irrational exuberance in a bubble leads parties across the entire system of housing finance to make risky bets based on rosy beliefs. It is not just investors who underprice credit risk and borrowers who overextend. Securitizers and lenders are also eager to take on dangerous levels of risk and leverage. The Dodd-Frank Act's incentive-based reforms, by relying on rational behavior by supposedly sophisticated parties, will do little to protect the economy from a bubble. They might even increase systemic risk by concentrating mortgage risk in large financial institutions.
Because indirect incentive-based regulation is ineffective in a bubble, more direct mandates should be employed. We suggest a number of direct regulations to limit mortgage leverage, debt-to-income levels, and other contractual features that enable or induce borrowers to take out larger loans. We show how such limits can curb bubbles, lower defaults, and reduce household exposure to housing risk. While such limits would undoubtedly entail costs, such as restricting access to mortgage credit and homeownership, we suggest straightforward ways to mitigate many of these concerns. Our critique of incentive-based regulation also provides an important new perspective on current legislative efforts to reform the broader architecture of housing finance.
The Dodd-Frank Act's mistargeted approach reflects in part the growing literature in behavioral law and economics that shows how sophisticated firms take advantage of biased consumers. Indeed, much of the debate over the appropriate response to the Great Recession has been about how to keep Main Street safe from Wall Street. We advance this literature by showing that the mistakes of firms have important implications for the design of regulation. Our analysis calls for a fundamental paradigm shift. The central policy challenge is to keep Main Street and Wall Street safe from themselves.
Dangerous Liaisons: Criminalization Of “Relationship Hires” Under The Foreign Corrupt Practices Act
On August 17, 2013, the New York Times published a front page story on JPMorgan Chase & Co. that cast the firm at the center of an international bribery scandal and sparked a media firestorm. The article reported that the U.S. Securities and Exchange Commission (SEC) had opened a bribery investigation into the firm's hiring practices in China pursuant to the Foreign Corrupt Practices Act (FCPA), a statute that regulates bribery and public corruption in foreign countries. The story continued to garner national attention in the weeks following the article's release, especially after the Department of Justice (DOJ) joined the SEC's investigation. At the center of the controversy was the unusual nature of the investigation itself: unlike most FCPA bribery investigations, which target financial payments to foreign officials in exchange for business advantages, the central issue underpinning the JPMorgan investigation was the firm's apparent practice of hiring well-connected children of Chinese business and political leaders. More specifically, the government's investigation targeted the firm's “Sons and Daughters” program in China, a hiring program that allegedly favored children of Chinese owners of state-controlled enterprises in China. JPMorgan purportedly relied on this hiring process to gain a competitive advantage in China, where state-owned enterprises dominate the economy.
Although most media reports on the JPMorgan investigation characterize it as an unusual approach for the government, probes into corporate hiring practices are part of an increasingly apparent trend in FCPA enforcement. About eight months after the JPMorgan investigation began, DOJ and the SEC sent letters to at least five other financial institutions, requesting information on their hiring practices in Asia. Federal agencies have justified these types of “relationship hire” investigations as well within the scope of the FCPA. The FCPA prohibits the exchange of “anything of value” with foreign officials for any “improper advantage”—language that appears to encompass offers of employment to relatives of foreign officials. Critics of the FCPA's application to relationship hires have questioned the government's reading of the Act's language, characterizing it as an “aggressive” interpretation.
Despite the publicity surrounding the JPMorgan scandal, very little scholarship has examined relationship hires as an issue that defines and tests the limits of future FCPA enforcement. This Comment begins this discussion by analyzing both the rationale for the government's application of the FCPA to relationship hires and the implications of this type of FCPA enforcement.
Comptroller v. Wynne: Internal Consistency, a National Marketplace, and Limits on State Sovereignty to Tax
On November 12, 2014, the U.S. Supreme Court heard oral argument in Comptroller of the Treasury v. Wynne. The case, which has already been called the Court's most important state tax case in decades, asks how the dormant Commerce Clause restrains state taxation of individual income. Because Wynne lacks the usual indicia of “certworthiness,” the case raises the possibility that the Court will reshape the constitutional balance between the states' sovereign interest in collecting taxes and the national interest in maintaining an open economy.
The challenge for the Court, whose dormant Commerce Clause rulings have attracted intense criticism, is to delineate clear limits on state taxation that promote a national market economy without unduly restricting the states' taxing authority. In earlier writings, we developed a framework to resolve tax discrimination cases in a consistent and intuitive manner that provides states with broad flexibility while maintaining an open interstate market. In this Essay, we apply that framework to Wynne to demonstrate how Maryland's current system violates the dormant Commerce Clause. We also describe how our approach addresses Maryland's arguments and resolves many issues that seemed to trouble the Justices at oral argument.
The rest of this Essay proceeds as follows. After providing the factual and legal background of the case, we show that the contested Maryland income tax regime fails the Court's long-standing internal consistency test and so would be struck down were the Court to apply that test. We then respond to Maryland's three major arguments why the Court should not apply the internal consistency test. Drawing on our earlier work, we first show that Maryland's principal claim, that its tax law does not discourage cross-border commerce because residents are taxed at the same rate on in-state and out-of-state income, whereas non-residents are taxed at a lower rate on in-state income and not at all on out-of-state income, is not dispositive. Maryland's argument should not prevail because economic analysis shows that the comparison of tax rates that Maryland offers is too simplistic to reveal whether the Maryland tax system discourages cross-border commerce. Second, Maryland claims that any interference with the Wynnes' cross-border commerce stems from the interaction of different states' tax systems rather than Maryland's tax regime alone. This claim is wrong, and we show that Maryland's tax system would burden interstate commerce even if no other state imposed taxes. Third, we show that Maryland's claim that a decision for the taxpayer would allow residents with out-of-state income to free-ride on Maryland's public services is overstated because the internal consistency test provides states with wide flexibility to tax.
The arguments in Wynne largely followed the outline above, with an important exception. The taxpayer argued that the dormant Commerce Clause requires Maryland to eliminate double taxation of their interstate commerce for the simple reason that Maryland is their state of residence. But the Court's dormant Commerce Clause doctrine does not clearly support the interpretation that the state of residence must eliminate double taxation. Nor is such an interpretation needed for the Wynnes to win their case. Rather than requiring elimination of double taxation, the dormant Commerce Clause prohibits states from discriminating against interstate commerce. We show that Maryland discriminates against interstate taxation, and this discrimination would persist even if no other states imposed taxes. It is, therefore, independent of any double taxation that arises under the Maryland tax, and it is also independent of any action other states take. Double taxation is not the focus of the dormant Commerce Clause, and avoiding double taxation is not the same as not discouraging cross-border commerce. As we show, a state can discourage cross-border commerce even though there is no double taxation, and double taxation can occur without discouraging cross-border commerce.
There's A TV App For That: Putting The “Neutral” Back In Net Neutrality For The App-Based Television Future
In 2013, Netflix became the first non-TV network to win an Emmy. Did this event signal the beginning of the end for the traditional cable television experience and the classic television networks? In an age of consumer cord-cutting, where streaming video accounts for fifty percent of peak Internet traffic and viewers want to choose which show they watch instead of which channel, the future of television is likely to come in the form of apps. Instead of a cable box, TVs would be plugged directly into an Internet connection. Instead of tuning into live channels, a TV's main interface would be a wide selection of apps. Consumers could select the Netflix app and choose from its range of TV shows and movies, or select the NBC app to access any content from that network.
This exciting future comes at the height of the debate over “net neutrality.” The phrase “net neutrality” refers to the general principle of equal treatment for all Internet content, or, as one oft-cited definition phrases it: “all like Internet content must be treated alike and move at the same speed over the network.” However, a number of disparate ideas fall under the net neutrality umbrella, and these ideas have very different economic implications for consumers and providers. This Case Note argues that some of the principles of net neutrality should be enforced, while others are more likely to hinder innovation and economic growth. I begin by differentiating the separate concepts of net neutrality.
The debate over net neutrality has recently grown more fervent. In Verizon v. FCC, the D.C. Circuit cast the future of net neutrality into question by vacating the Federal Communication Commission's (FCC) 2010 Open Internet Order on the grounds that the FCC had treated ISPs like common carriers. The FCC responded by adopting the 2015 Open Internet Order, which reclassified ISPs as common carriers and imposed a strict form of net neutrality. However, this Case Note argues that this strict version of net neutrality could result in the exact opposite of the outcome that the FCC seeks. Instead, a more nuanced version of net neutrality could better accomplish the Commission's goals and provide better results for consumers.
King v. Burwell and the Validity of Federal Tax Subsidies Under the Affordable Care Act
Set for oral argument on March 4, 2015, King v. Burwell brings to the Supreme Court yet another challenge to the Affordable Care Act (ACA). The King plaintiffs cite 26 U.S.C. § 36B to attack the validity of certain federal health insurance subsidies provided by the Internal Revenue Service (IRS) through the ACA. Specifically, because § 36B authorizes subsidies for low-income taxpayers who purchase health insurance from an “Exchange established by the State,” the plaintiffs allege that such subsidies are not valid on exchanges operated by the federal government where the states refused to operate a state-sponsored exchange. Given that the federal government operates exchanges in thirty-four states, the Supreme Court's ruling will potentially affect nearly ten million taxpayers nationwide.
Professors Eric Segall and Jonathan Adler debate the merits of King v. Burwell, and each suggests how the Court should rule. Professor Segall argues that the Court should follow the IRS's interpretation of § 36B—namely, that federal tax subsidies are available in a state with a federally operated exchange, because the law allows the federal government to operate the “Exchange established by the State.” Professor Segall emphasizes that Chevron deference requires the Court to defer to the IRS interpretation. In response, Professor Adler contends that Chevron deference is unnecessary because the statutory language is clear: an “Exchange established by the State” cannot be an exchange established by the Department of Health and Human Services. Professor Adler argues that, given the unambiguous language in the statute, the Court need not defer to the IRS interpretation and should rule for the plaintiffs.