Speech by SEC Chairman:
'The Role of Government in Markets'
Keynote Address and Robert R. Glauber Lecture at the John F. Kennedy School of Government
Chairman Christopher Cox
U.S. Securities and Exchange Commission
October 24, 2007
Thank you, Bob [Glauber], for that kind introduction, and thanks especially for extending to me the honor of delivering the first Robert R. Glauber Lecture. It’s particularly nice to combine a visit to my alma mater with the opportunity to pay tribute to someone who has contributed so much to the world’s capital markets. Bob Glauber’s entire career has been devoted to improving capital formation and the health of our securities markets. I want to take this special occasion to thank you, Bob, in behalf of investors everywhere.
Professor Glauber, of course, served as the CEO of the NASD for five years, and in that capacity was a frontline regulator for broker-dealers in America. He also served as Under Secretary of the Treasury in the first Bush administration. And before that, on October 30, 1987, he was drafted from his Department Chairmanship at Harvard Business School to serve as the Executive Director of the Presidential Task Force on Market Mechanisms — better known as the Brady Commission, which was eponymously named for its Chairman, Secretary of Treasury Nick Brady, who is with us here this evening. That Commission, which as Bob has told you I was involved with as a member of the President’s White House staff, provided the definitive autopsy on what happened to the markets 20 years ago this month. So, happy 20th anniversary to both of you, Bob and Nick.
Having served with distinction for so many years at the Business School, Professor Glauber is back at Harvard, but now at the School of Government. That makes him the personification of the two disciplines that are the focus of the Mossavar-Rahmani Center, which is also celebrating an anniversary this evening. Congratulations on a quarter century of exploration of the intersecting roles and responsibilities of business and government.
These are the very two topics that are synthesized in my brief remarks tonight, “The Role of Government in Markets.” At Bob’s invitation, I’ve prepared a few thoughts on this subject from my perspective at the Securities and Exchange Commission.
When the SEC was created, its purpose was to serve as an independent regulator of the unbridled profit-seeking activity of self-interested individuals and firms in the securities markets. It was not, however, to supplant the market or directly participate in it. Government ownership of the economy was an issue in other countries at that time, but not in America. In Germany during the 1930s, the independence of the private sector was a pre-World War I memory. In the Soviet Union, where the Bolshevik Revolution was not yet a generation old, government virtually occupied the field. And in Italy, where Benito Mussolini’s Fascist party promoted an economic approach called syndicalism, nominally private property was devoted to state purposes. Even in France at that time, the corporatist spirit was in the ascendancy, and the government controlled many industries.
But for all of the time since America’s founding, our country had far less government involvement in the economy than Europe. This was true mostly because we had far less government, period. Federal revenues totaled less than 5% of GDP in the early 1930s. Today, more than 70% of the U.S. economy remains in private hands, with the balance accounted for by federal, state, and all other government.
It is true that during the 1930s, America first experimented seriously with government-owned industry. Since our earliest days, of course, government had carried the mail, but under FDR the United States embarked upon experiments in other federally-owned enterprises, such as energy production. The repeal of Prohibition in 1933 put many states into the retail liquor business, and many were already involved in the ownership of public utilities. But these were exceptions, and the essential approach of the Roosevelt administration was to regulate business, not own it. So, for example, the government did not attempt to acquire ownership of farms (putting aside the question whether that would have been constitutionally permitted), but rather chose to closely regulate production. From minimum wage laws to the abolition of child labor to a National Planning Board that provided production recommendations across many industries, the New Deal aimed to forge all elements of society into a cooperative unit. This was America’s response to the more radical integration of business and government that was underway abroad.
In the case of the securities markets, which also came under regulation for the first time in the 1930s, there was never an impulse for the federal government to own the exchanges, the investment banks, or the broker-dealers. The creation of the Securities and Exchange Commission in 1934 marked a deliberate effort to clearly define and separate the role of the national government, on the one hand, and the capital markets, on the other. Henceforth, fraud and unfair dealing in the stock and bond markets would be subjected to external discipline by the federal government. Minimum standards would be enforced, such as requiring that every investor be told the essential details about the security in which he was investing. Registration of securities, and licensing of broker-dealers, would be required. It was, in short, arms-length regulation of an unabashedly private market, rather than nationalization.
Over the years, as the role of the SEC and its relationship to the markets has been refined through experience, the agency has acquired three explicit goals: protecting investors; maintaining fair and orderly markets; and promoting capital formation. These three complementary missions are logically consistent with the original premise of the securities laws, which was that government is an auxiliary to the market, not a substitute for it or a participant in it. Virtually every aspect of the 1933 and 1934 Acts, and the regulations implementing them, follows from the notion that markets should be efficient, competitive, transparent, and free of fraud.
The normative judgment implicit in this legislative and regulatory scheme is that markets are good. So long as they are in fact operating efficiently, competitively, openly, and honestly, they are good for consumers, investors, producers, and our entire economy.
We do not spend much time justifying this premise. But because the idea of the market is so fundamental to everything that the SEC does, it is now incumbent upon us to remind ourselves exactly why it is we value markets so highly, because the very concept of what constitutes a market is now being reinvented.
Two relatively recent developments in our capital markets, in particular, are challenging our basic approach to regulation. First, the number of government-owned or controlled corporations in our public markets, as well as their size, is growing. Second, the number and size of government-owned commercial investment funds is on the rise.
The phenomenon of the state-owned, but publicly traded, company is being driven by the semi-privatization of government enterprises in areas such as banking, oil and gas, infrastructure, transportation, and real estate, among others. The result of several large public offerings of government-owned enterprises outside the United States in recent years is that, post-offering, private investors have purchased a significant amount of stock, but even collectively they still represent a minority. The government, in turn, still owns a majority of the company and controls all of the decision-making — just as it did before the public offering.
Government ownership of large investment funds, or so-called sovereign wealth funds, is not new, but it is a markedly growing trend that raises many of the same issues of government ownership, and others as well. In operation, sovereign wealth funds are simply the investment arms of governments. But while they have existed in one form or another for many years, today they are making an increasingly obvious footprint in the global financial marketplace, growing in size relative to private assets. Today, the world’s sovereign wealth funds are significantly larger than all of the world’s hedge funds combined. According to some estimates, they could grow as large as $12 trillion over the next eight years.
Both of these developments — the growing prominence of state-owned but publicly-traded companies, and the rise of sovereign wealth funds — challenge our regulatory model in a number of ways. First, by breaking down the arm’s length relationship between government, as the regulator, and business, as the regulated, they call into question the adequacy of our enforcement and regulatory regime. When the government becomes both referee and player, the game changes rather dramatically for every other participant. Rules that might be rigorously applied to private sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules. One need look no further than the environmental degradation within the Soviet Union and the Warsaw Pact countries under Communism to observe this principle in action. When the regulator and the regulated are one and the same, deference to the government-owned industry can all too easily trump vigorous and neutral enforcement.
This poses potential problems. One of our most basic missions is preventing fraud and unfair dealing. Will a U.S. government agency be capable of doing this, if a sovereign foreign government is commercially interested in an entity we have under investigation? Let me offer an example. Today, Internet fraud is on the rise, and the only way that our government or any other can protect its citizens is to cooperate with other nations. The perpetrators of fraud on the Internet aren’t restrained by national boundaries. In just the last few years, as Chairman I have forged new arrangements with our regulatory counterparts overseas precisely so that we can share the information necessary to crack down on cross-border fraud. Will the high level of cooperation that we know from experience is required in international cases be forthcoming if the foreign government or an entity it controls is itself under suspicion?
A corollary of the inherent conflict of interest that arises when government is both the regulator and the regulated is that the opportunity for political corruption increases. Graft, bribery, and other forms of financial corruption by governments and political figures is an unfortunate fact of life throughout the world — as the Commission’s enforcement responsibilities under the Foreign Corrupt Practices Act remind us on a daily basis. When individuals with government power also possess enormous commercial power and exercise control over large amounts of investable assets, the risk of misuse of those assets, and of their conversion for personal gain, rises markedly.
Here’s another example. One of the most important byproducts of what the SEC does is the maintenance of investor confidence. If ordinary investors — an estimated 100 million retail customers who own more than $10 trillion in equities and stock funds in U.S. markets — come to believe that they are at an information disadvantage, confidence in our capital markets could collapse, and along with it, the market itself. That’s why so much of our effort is focused on full and fair disclosure to all market participants, and the prevention of fraud and unfair dealing such as insider trading. With the powers of government at our disposal, we can make life difficult for inside traders. But if the powers of government are no longer used solely to police the securities markets at arm’s length, but rather are used to ensure the success of the government’s commercial or investment activities, not only retail customers but every private institutional investor could be put at a serious disadvantage.
That disadvantage could include significant disparities in the information that is available to government as compared to private marketplace actors. For instance, unlike private investors and businesses, the world’s governments have at their disposal the vast amounts of covert information collection that are available through their national intelligence services. Think Bill Belichick on a global scale — but with far greater consequence. Current legal restrictions in some countries on the domestic collection and use of such information might serve to protect the civil liberties of that nation’s citizens. But there are normally no concomitant protections for foreign nationals, or for intelligence collection activities conducted in other countries. Unchecked, this would be the ultimate insider trading tool.
Government ownership potentially threatens transparency, as well. In many industrial countries today, the ability of journalists and citizens to inquire into government affairs, or to criticize the conduct of government, is severely limited. In some countries, criticism of government policies lands you in jail, or worse. Is it reasonable to expect that these same governments will be magically forthcoming with investors?
The fact that minority shareholders in state-owned companies will be dependent on the full disclosure of governments that are not subject to independent regulation raises significant questions for regulators such as the SEC, whose mission includes investor protection. And when it comes to transparency, the track record to date of most sovereign wealth funds does not inspire confidence.
Even the economic rationale for our legislative and regulatory deference to markets is called into question when the major marketplace participants are not profit-maximizing individuals, but governments with national interests. A nation’s interests — and the interests of its government, to the extent they are the same — are certainly legitimate. But by definition, a nation’s interests extend beyond simply seeking return on investment through economic gains and the avoidance of economic loss. Investors and regulators alike have to ask themselves whether government-controlled companies and investment funds will always direct their affairs in furtherance of investment returns, or rather will use business resources in the pursuit of other government interests. And if the latter is the case, what will be the effect on the pricing of assets and the allocation of resources in the domestic economies of other nations? Ultimately, that is a judgment that economists will have to make. But if the trend toward government owned or controlled enterprise and investment accelerates, as has been forecast, the answer to that question will continue to grow in importance.
In these and many other ways, government ownership of companies and investment funds poses a fundamental challenge to the market premise upon which the SEC operates. So perhaps we should ask ourselves: is our premise a sound one? Why do we in the United States prefer markets and private ownership to direct government ownership in the economy?
Our emphasis on private ownership is directly tied to America’s dedication to individual freedom. It’s in our DNA. It’s in large part why the United States came to be at all. Our Declaration of Independence is a recitation of the abuses of excessive government power. Our Constitution is a brilliantly crafted system of checks and balances to prevent that abuse by limiting government’s authority over individuals — including in the economic realm, where we’re guaranteed our constitutional rights to liberty and property, to freedom from expropriation, and to freedom of contract.
But beyond that, beyond ideals of freedom, the national preference for private ownership is also based on the most basic practicality: it works. America’s rise from New World outpost to global superpower was fueled by the dramatic growth of our free enterprise economy into the world’s largest. Free enterprise has produced spectacular results. Compared to other national economies with substantial government ownership and central planning, America’s economy has been more creative, resilient, and dynamic. We’ve found that decentralized decision-making, in which millions of independent economic actors make judgments using their own money, results in the wisest allocation of scarce resources across our complex society. And we’ve found the market to be more reliable in heeding price signals and meting out discipline to failing enterprises than government could ever be.
The rise of sovereign wealth funds and state-owned public corporations challenges us to ask whether these many benefits of markets and private ownership will be threatened if government ownership in the economy, manifested in these or other new ways, becomes more significant — or whether alternatively, the world will be better off. It’s a question that at least for now is unanswerable empirically, because we are just now beginning to see the manifestations of what some analysts are predicting will be a significant trend.
But ask these questions we must, because the evidence is all around us that some and possibly many nations will indeed head in these directions. If the dramatic growth in government-owned commercial investment comes to pass as some have forecast, what does this portend for global capital markets? What effect will these new government participants in our markets have on our markets? At the SEC, our concern is that these activities not harm the investors we work to protect every day, that they promote and not inhibit capital formation, and that they not compromise the maintenance of fair and orderly markets.
One possibility is that as a result of these developments, our markets will be less transparent, less yielding to outside law enforcement, and less able to serve their role of wisely allocating scarce resources. If government-owned investments lack transparency, they could contribute to market volatility stemming from uncertainty about the allocation of their assets. The rise of sovereign wealth funds and state-owned public companies could even provoke a new round of protectionism, in which various national governments erect barriers to foreign investment in what they consider to be strategic sectors of their economies — and in which the lines between restrictions on foreign government ownership and foreign private ownership are dangerously blurred.
Alternatively, these developments could be viewed as a stabilizing and modernizing influence in global finance. The rise of sovereign wealth funds might be seen as a better way for a nation’s monetary authority to stand ready to meet its balance of payments needs, through better diversification into a broader range of asset classes and the attainment of higher returns. And the accelerating trend toward privatization of state-owned enterprises, even if the privatization extends to only a minority interest and does not yet eliminate government control, could be interpreted as a positive step along the path to eventual full conversion from government to market ownership. Moreover, sovereign wealth funds could be welcomed as a new source of liquidity for our capital markets, while the fact that U.S. investors can now own minority stakes in state-controlled corporations might be considered simply a new range of investment choices.
Which of these views is the more accurate is not self-evident. It is not simply a question of whether one prefers government or private ownership, since these latest forms of government activity are, strictly speaking, neither one nor the other. They represent any number of variants in the level of government involvement. The more precise question is, as the distinction between government and private activity in our capital markets is blurred, at what point does the private market stop being a private market, and morph into something else? And how can we even begin to answer that question on a global basis when each nation's definitions of the market vary? Whose definitions do we use?
Even in America, where over 70% of the economy is in private hands, there have been sporadic efforts to change Uncle Sam’s role from market referee to market player. During the 1970s, for example, the California-based Campaign for Economic Democracy proposed that the U.S. government should own at least one significant competitor in each major industry. From their perspective as individuals who viewed the market with suspicion — and government participation in the economy with approval — this would serve to keep the competition honest. In more recent years, it has routinely been proposed that the $2.2 trillion Social Security Trust Fund be directly invested in the capital markets by the federal government. This would be investment controlled by the government, not the account holders — in effect creating our own sovereign wealth fund, with a portfolio larger than the combined economies of Russia, India, Canada, and Mexico.
These examples serve to illustrate that the question of state ownership in the economy continues to present itself in a variety of ways, not just in other countries but in our own as well. And they help us to appreciate that the fundamental question presented by state-owned public companies and sovereign wealth funds does not so much concern the advisability of foreign ownership, but rather of government ownership. Precisely because the rise of sovereign wealth funds and publicly traded state owned corporations portends a greater degree of state ownership in the economy, their new prominence raises many of the same questions that any program of state ownership entails.
There is one respect, however, in which it does matter if investments are made by a foreign government rather than one's own government. A reason often advanced in support of state ownership is that it is the responsibility of one's own government to promote the good of the citizenry and put the nation's concerns first. Another reason is that a nation's citizens can influence their own governments, often through democratic means. But if the government in question is a foreign government, neither of these reasons exists. The national interests that the foreign government will presumably advance will be its own. Likewise, the citizens of other nations will have no direct way to influence a foreign government through the democratic process.
From the SEC’s standpoint, these differences have practical consequences. For example, the Commission has the power to pursue sovereign wealth funds for violating U.S. securities laws. Neither international law nor the Foreign Sovereign Immunities Act renders these funds immune from the jurisdiction of U. S. courts in connection with their commercial activity conducted in the United States. But a discussion between the SEC and a foreign government might be quite different if, instead of seeking cooperation in an enforcement matter in which we were mutually interested, the SEC were pressing claims of insider trading against that very government. When a foreign private issuer is suspected of violating U.S. securities laws, our experience working with our overseas regulatory counterparts indicates that we could almost always expect the full support of the foreign government in investigating the matter. But if the same government from whom we sought assistance were also the controlling person behind the entity under investigation, a considerable conflict of interest would arise.
Even in the United States, where we have neither federally-owned corporations trading in our public markets, nor U.S.-sponsored sovereign wealth funds — and where the presumption must be that the national government has the best interests of U.S. citizens at heart — our government is sometimes criticized for being insufficiently aggressive when it comes to securities law enforcement. The cause most often cited is that business carries too much influence with government representatives and officials. Straying from the model of arm’s length regulation toward one of government-on-government regulation would likely further fuel such suspicions and undermine investor confidence.
To begin to enumerate these many questions provoked by the rise of sovereign wealth funds and state-owned public-traded companies, of course, is not to answer them. But systematizing our thoughts about the possible good and ill effects of increased direct participation in the world’s capital markets by governments can help in the process of structuring norms and practices to maximize the potential benefits and minimize the risks. This important analysis is well underway in a number of venues, including the President’s Working Group on Capital Markets, of which the SEC is a member, as well as in the G-7, the World Bank, and the IMF. The outcome of these analyses may well be more generalized agreement about the kinds of strong fiduciary controls, disclosure requirements, professional and independent management, and checks and balances to prevent corruption that will help protect both investors and markets.
Meanwhile, as securities regulators, the SEC will continue to treat both state-owned companies in our public markets and sovereign wealth funds as we would any similarly situated private entity. We will continue to pursue a cooperative and collaborative dialogue with our regulatory counterparts in other nations, and to engage them regarding the best way to apply our regulatory approaches in light of the growing presence of government-owned businesses and investment funds in our markets. And we will continue to vigorously pursue tough, independent regulation, which is the bedrock of investor protection, and the sine qua non of efficient capital markets — because in the end, our entire free enterprise system depends upon the rule of law that the SEC upholds.
When ultimately policy makers in this country and across the globe refine our approaches to the growing presence of government in markets, the decisions we make will likely depend upon where we think these trends are heading. Do sovereign wealth funds and publicly traded government-owned corporations portend more market discipline of government fiscal management, or instead a detour away from free markets and toward government displacement of the private economy? Much will depend, therefore, on our judgment about what the future holds. No government policymakers can see the future, of course, but appreciating where we have come from — what we lived through, and where we are headed — offers the best hope of wise choices.
This is not only my alma mater, and yours, but also John F. Kennedy’s, after whom the School of Government is named. For President Kennedy’s Inaugural, Robert Frost wrote a poem entitled Dedication, in which he paid tribute to the wisdom of our founders — Washington, Adams, Jefferson, and Madison — and he attributed their successful leadership to their vision of what the future held for America. He wrote:
So much they saw as consecrated seers
They must have seen ahead what not appears
Without question, a firm grasp of history’s trends is important for national leaders. But in spite of their uncommon foresight, neither our Founders nor even Robert Frost, who lived so much more recently, could ever have imagined the complex world of electronic global finance that has developed in the 21st century and that today is integrating the economies of every nation on earth. So these choices are ours alone to make. But even though we can’t divine the answers to such questions by consulting the wisdom of our Founders, we can lean heavily upon the principles they cherished.
Like Washington, Frost was relentlessly on guard against political ideology, which he regarded as a corruption of philosophy. He warned against the self-delusion that individuals in government possess enough knowledge to regulate human action down to its raw details. In a 1925 letter to his friend Louis Untermeyer, a Marxist, the great poet wrote: “I might sustain the theme indefinitely that [neither] you nor I nor [anybody] knows as much as he doesn’t know.” Frost put his finger on why America has embraced markets: it is because in doing so, we give substance to our support for individual freedom, our suspicion of government excess and abuse of power, and our skepticism that the few can make wiser choices than the many. And by our commitment to arm’s length regulation of those markets, we have simultaneously acknowledged the need for the policeman and the referee — in other words, for the rule of law, and the role of the SEC.
Our nation’s support for markets, and our commitment to independent regulation, represent a fragile balance — yet one of such enormous strength, it has supported the hopes, dreams, and wealth creation of the world’s most powerful and prosperous nation.
Today, as this approach is under stress because other national governments seek to play a much more active role than just regulator in the world’s capital markets, we’ve got to return once again to first principles and reexamine both our premises and our conclusions. Perhaps with the wisdom of our Founders, the humility counseled by Robert Frost, and the help of all of the bright students and faculty at Harvard University, we can fully appreciate the gravity of these problems. We certainly will need all of the help and analysis we can get — and so, on behalf of all of the professional men and women of the SEC, please know that we are proud to be your partners.