Oil Spill

The Importance of Blaming the Right People for the Wall Street and Gulf Disasters

This year’s notorious Supreme Court decision on campaign finance found that corporations have the full rights of individuals, at least in that area. The truth is, most of us do approach big companies as if they were people – and then, when those companies wreak havoc on the country, no one can be found to hold accountable. Congress can pass new regulations, but that’s little consolation to the victims. Anyway, both the Wall Street meltdown and the Gulf spill unfolded not only because regulation was lacking, but because enforcement was lax where regulations did exist. In both cases, we see signs of “regulatory capture,” with the SEC and the Minerals Management Service applying existing regulations in ways which, at a minimum, permitted the persistent risks that eventually led to disaster. In the quest for accountability, there also inevitably will be lawsuits. But that may not produce real accountability either. The companies may not survive to pay any judgments; and when they do, the costs fall to shareholders. The executives whose decisions brought on the crisis are left unaccountable – a moral hazard of the first degree – and the rest of us are left unsatisfied. 

Some of the public’s outrage about both crises probably stems from people’s assumption that large companies do operate like people, at least in respecting broad social norms. So, we expect our bank to be concerned about our personal finances, a view implicitly encouraged by the sketchy form of the neoclassical economics that dominates public discourse. In an abstract world of the perfectly efficient market, that market constrains banks to offer us goods and services that serve our interest; in the real world, our banker’s retail job is simply to sell us his bank’s products based on how profitable they are to that bank. And even when we recognize the difference, we assume our bank won’t abuse our trust, because the law will prevent it and, anyway, educated people just don’t act that way.

Similarly, whether or not Gulf residents expected oil companies to share their concerns about their regional environment – and many certainly did have those expectations – the market was supposed to ensure that the risk of incurring $20 billion or more in liability costs would prevent reckless operations of deep-water rigs. For how this works in the real world, think of Toyota: Like Toyota, BP adopted a calculus in which cost-saving measures outweighed those risks; and in deep-water drilling, that often involves less stringent safety systems and standards. So, even as BP was fined much more often than its rivals for deep-water rig safety violations, BP shareholders enjoyed years of higher returns.

If we can’t depend on regulation or potential liability to stop reckless corporate decisions, it’s time to focus less on the corporate “person” and more on the actual people who make those reckless decisions. The laws of corporations have long shielded a company’s decision makers from personal liability for corporate decisions, based once again on the idealized view that market competition will reliably drive executives to make decisions based on their shareholders’ best interest. But economists have long recognized – it’s called the “agent-principal problem” – that the interests of executive decision makers (the agents) can diverge sharply from those of the shareholders (the principals). And how those executives are rewarded for their decisions can make that divergence very wide and deep if, as with both Wall Street and BP, they can earn huge bonuses for steps that boost short-term earnings even when the decisions that generate those earnings eventually bring down the company. While Paul Volcker and a few others have called for a ban on such compensation schemes, Congress has bowed to Wall Street protests, in a form of “legislative capture” as dangerous as its regulatory counterpart.  

The result are nearly perfect conditions of moral hazard for America’s top executives, especially in critical areas like finance and energy, where their moral hazard can be most dangerous to the rest of us. Since moral hazard affects the top decision makers, perhaps more than their institutions more generally, the Wall Street and Gulf disasters suggest that it’s time to revise the limited personal liability provisions of the corporate form: The government should be able to sue executives personally for decisions that turn very bad for the rest of us – involving costs of, say, at least $25 billion – when those decisions entail risks that rise to a standard of negligence. This change could even be part of broader tort liability reform. But whether it is or not, it’s time to pierce the veil of the corporate “person” and get to the real people whose personal interests repeatedly lead them to embrace risks that end up harming tens of millions of others. 

Foreign Oil Company Dependency

It is ironic that the Obama Administration which came to Washington with perhaps the greatest dedication to environmental issues of any in modern history has had to deal with the worst oil spill in our history.  It is tragic that the Administation has yet to get its arms around the crisis.  If oil continues to gush into the Gulf of Mexico through August when it is said that a second well can be drilled, then the spill will not only be an unprecedented health and environmental disaster but may also hobble the Obama presidency and undermine America's global reputation for years.

The spill obviously grows worse day by day.  But it also has the unfortunate quality--like the Iranian hostage crisis for President Carter or the Iraq war in President Bush's second term--that each day without improvement adds to the sense of frustration.  The ability to handle a crisis is a sine qua non  of Presidential leadership.  However, the problem is not just one for President Obama, Democratic prospects in the fall or, for that matter, the oil industry.  Rather it impacts the reputation of the United States as a country that is competent in the use of technology, master of its destiny and able to exercise world leadership.

While this disaster appears to have no easy answer--no disaster ever does--it is imperative that the Administration upgrade the level of its response.  At first, it may have made sense to try to charge BP with solving a problem it created.  But we have long sense reached the stage where the cause of the crisis is less important than its resolution. 

In this regard, several changes in approach suggest themselves.

First, while BP created the spill, it makes the President and the US look weak to depend on BP to resolve it.  Depending on a foreign company to solve a technological and environmental problem is what a developing country does because it lacks knowhow and resources of its own.  America, in contrast, has knowhow.  Accordingly, one has to ask, where are the US oil companies in the response so far?  Understandably they want to stay out of it.  However, BP is not the only company in the world that drills in deep water.  Exxon Mobil, to pick one example, drills all over the world and has expertise the White House ought to be tapping.  Halliburton was actually a contractor to BP in building the rig that exploded.  The Administration should conscript the entire US oil industry--and the global oil industry for that matter--to help cap the well.  The US is bigger than BP and we cannot and should not be or appear dependent on one company that may be headed to bankruptcy to solve a problem threatening the fishing and tourism industry in multiple states.

Second, the Administration needs to mount a more muscular clean up effort that has passed the level where BP can conceivably handle it.  Again requests that BP change its use of dispersants and so forth--trying to limit this to a BP problem--makes the Administration and America look weak.  The Adminisration needs to harness the talents and energy of the entire US oil industry, regional maritime industry and armed forces and beef up efforts to organize volunteers, deploy ships and otherwise take measures to contain damage.  This is an international issue as well since the oil may touch Gulf and Caribbean countires and, at the international level, only the US government can coordinate action.

One other thing to grap about this crisis is that it is not about large or small government.  It is about a core function of government, disaster response that involves coordinating public and private efforts.  Failure of the government to succeed in this core role can only undermine trust in government to undertake more complex challenges like managing health care or regulating carbon. 

At the end of the day, the United States, still the greatest economic and naval power on earth, has a great deal more resources than one foreign oil company, BP to fight this diaster.  It is time to bring those resources to bear.   

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