Corporations are not People (They’re “Persons.”)

Contrary to what some people are arguing, no one is seriously positing that corporations are, in fact, people. What is undoubtedly true, however, is that corporations are persons.

See, the law has to deal with more diverse economic units than just individuals. So when legislators craft a law imposing something even as mundane as, say, the requirement to take out workers compensation insurance to protect laborers, they have to craft it to apply to more than just individuals. It is, in every jurisdiction I know of, illegal for corporations and individuals alike to employ a laborer to work on a roof without having first taken out workers compensation.

How do they do it? By defining the term “person” under the law, to include not just individuals, but also corporations, trusts and estates (and labor unions, for that matter).

There are a lot of reasons for this: Any of the above entities – a corporation, a trust or an estate – can and frequently do enter into contracts. A corporation, trust or estate may, through a direction of their trustees or executors, enter into a contract for services from an individual, such as an attorney, for example. We regard corporations as “persons” for a very good reason – to include them in the long tradition of contract law, to make agreements they enter into enforceable. Otherwise, an attorney (or financial planner, for that matter!) could put in hundreds of hours of time into the account – only to find out that the executor, trustee or officer of the corporation who physically signed the contract got fired, quit or died.

The doctrine of corporate personhood allows the individual or other person who rendered goods or services to enforce the terms of the contract, regardless of personnel changes at the corporation, and regardless of whether ownership of the corporation changed hands in the meantime. The new stockholder has responsibility for all the inherited obligations and debts of the corporation. You can enter into a contract with a corporation secure in the knowledge that the contract is legally enforceable, precisely because we consider the corporation a separate legal entity from the people running it.

This is part and parcel with the doctrine of limited liability. Few people can take personal responsibility for the obligations a large corporation must enter into routinely. If a middle manager at Boeing thought that having signed a contract for delivery of a 747 jumbo jet to an airliner in three years’ time thought the courts would hold him personally responsible for a $100 million dollar airplane on his salary of $150,000 per year – and threaten to strip him of everything he owned and his children’s college if there were a snafu with the delivery beyond his control, he would find another job. And if the contract were not enforceable after he quit, no one would enter into a forward contract for a large capital investment anyway. The result: Boeing doesn’t function, planes don’t get bought or sold, and nobody travels.

The doctrine of limited liability, of course, extends specifically to shareholders: Stockholders in C publicly traded corporations stand to lose their entire investment in every stock they own – but unless they buy on margin, they can’t be sued for more than that. If people who owned a single stock in Boeing could realistically get pursued and held jointly and severally liable for a judgment after a company declares bankruptcy, it would be exceedingly difficult to raise money for the next corporation. The result: Again, planes don’t get built, jobs don’t get created, and nobody flies.

You cannot have limited liability without considering corporations to be a separate legal entity. That doesn’t mean that corporations are people, though some, like Bill Press, are working hard to obfuscate the definition. It means that corporations have obligations under the law, and with those obligations come rights, as well.

Citizens United

In a landmark Supreme Court Case from a few years back, called Citizens United, the Supreme Court held 5-4 that laws abridging the freedom of speech were unconstitutional, even when applied to U.S. corporations (Citizens United had just made a move critical of the Clinton response to the gathering Al Qaeda threat, and prominent Democrats were moving to suppress it.)

This would seem to be a 7-0 decision, simply on the basis of a plain reading of the first amendment’s text:

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

There is no provision, allowance or carveout for exempting legal entities other than individuals from the protections of the 1^st amendment.  Indeed, even a moment’s thought renders the notion absurd:

If we grant government the authority to suppress the freedom of the press on the grounds that corporations such as Citizens United are not entitled to 1^st amendment protection of freedom of expression, then we would have to apply that law evenly to include The New York Times Corporation, The Washington Post Corporation, ABC, NBC, CBS, the Tribune Corporation, Gannett, FOX, Time Warner, which owns CNN, and thousands of others, including your hometown newspaper.

All of these organizations that we rely on to hold government accountable could exist only at the mercy of the government, which could shut them down as soon as they viewed coverage to be unfavorable.

We would also have to extend the ruling to labor unions, which are themselves 501(c)(3) corporations, as are churches and synagogues. (Contrary to popular belief, they are not prohibited from making political statements or participating in campaigns. They only risk losing tax exempt status because of it. They risk no other sanction, absent any fraud, other than being treated like everyone else under the tax code.)

Advocates of a restrictive policy, abridging 1rst amendment protections for non-individuals, must address the troublesome question: If I have a 1^st amendment right as an individual to express myself via advertising, why is it that I lose those protections if I band together with other likeminded individuals in an association?

Yes, Mitt Romney is on record saying “corporations are people.” And democrats and republicans like Ron Paul pounced on him, alike, making the obvious points – that are only obvious if you don’t think about them too hard.

But in a legal context, Romney was referring to the fact that corporations are, in fact, associations of individuals with a common purpose – and that any taxes collected from corporations ultimately come from the pockets of individuals, for they can only be paid by reducing shareholder dividends or (as is common with gasoline), by raising the price the individual pays for goods and services to account for the higher tax.

There may be a legitimate state interest in placing some restrictions on corporations spending money on political advertising – though the constitution should properly place a very heavy burden on those seeking to abridge the first amendment to do so. But the effort to go beyond that, by mounting a withering attack on the doctrine of corporate personhood in its entirety, are throwing the baby out with the bathwater.

Four Big Banks Fail Fed “Stress Test” – What It Means

Specifically, they looked at the capital structures of 19 major U.S. banks, and tried to predict what would happen to them if the economy went through a rough patch.

The scenario: A theoretical 50 percent drop in stock prices, housing prices falling another 21 percent, a 13 percent unemployment rate, and a sharp recession in Europe.

The result: 15 banks survived the notional crisis – with the Fed dictating “survival” as success in maintaining tier-one capital ratios of at least 5 percent.

The failures included a few giants, though – most notably Citigroup, though it only failed by a very slim margin, falling to 4.9 percent tier one capital in the scenario.

The dog of the bunch was Ally, formerly the financial wing of General Motors. It would collapse to 2.5 percent tier one capital – just half of the Fed’s requirement. Guess who owns it? You do! This company came under the control of the U.S. Treasury Department after the auto bailout of 2010. Yay, team.

Other banks in the doghouse include MetLife (actually a bank holding company, but they’re in the process of changing that), and SunTrust Bank.

Comments

This is actually good news. The Fed seems to have been blindsided by the route of U.S. banks in the 2008-2009 crisis – and obviously the capital structures of so many of our financial institutions were grossly inadequate. Indeed, our investment banking industry – leveraged in some cases by as much as 30 to 1, was nearly wiped out.

The banks are squawking, of course, because the Fed was too mean. They objected to the Fed using a criteria that was more severe than the 2008 crisis itself.

This isn’t Ping Pong, though. The consequences of the failure of banks to maintain adequate capital reserves are severe. The U.S. government will not abide depositors paying the price for bank profligacy – but the resources of the Federal Deposit Insurance Corporation are paper thin compared to the potential liability. The FDIC can afford to take over the odd small bank and make depositors whole, no problem.

But if Citigroup and SunTrust both went under, it would take a lot of smaller players with them – and overwhelm the resources of the FDIC. We were lucky last time. Citi and Bank of America held together, and were even able to buy up the resources of some troubled banks. We were able to have Chase take over Washington Mutual. It may not be so easy next time.

But there is a price to be paid for this kind of caution: Banks will certainly read the tea leaves and work to shore up their tier one capital – at the expense of lending. And our economic recovery depends, in part, on a prudent revival of our credit markets. Less lending means further pressure on home prices, for example.

The Fed is also firing a shot across the bow at any bank considering boosting its dividend payments to shareholders, or for engaging in a share buy-back program. This won’t be great for shares of bank stocks going forward, though it’s not the end of the world – unless all you own are bank stocks.

If that’s the case, though, we need to talk about diversification.

Fiscal Vs. Monetary Policy – and What It Means For You

This is an election year (in case that you hadn’t noticed). Which means the rhetoric is flying on both sides. And both sides have historically twisted the facts about monetary policy – and who benefits from what kinds of policies – in their favor.

To vote intelligently, though, you need to be able to see through the campaigning and make your own assessment based  on the actual economics – and not the veneer the campaigns put on it.

The twin engines of economic policy-making

The government has two basic avenues for economic policy: Fiscal policy and monetary policy. Let’s talk first about how they differ:

Fiscal policy is the policy the government makes through its spending decisions, but also through changes in the tax code. Congress – with the Constitutional “power of the purse,” directs fiscal policy, though the executive branch – under the President – also has  substantial ability to tinker with fiscal policy at the margins, through regulatory changes.

If the government spends more money than it takes in, and it doesn’t maintain significant sovereign reserves (the U.S. does not have a huge sovereign reserve fund, in practice), then the government must borrow the difference. That is, it must issue bonds.

In a nutshell: Deficit spending, all things being equal, is pro-jobs and pro-growth. It tends, also, to be pro-inflation – which means that foreign investment tends to fall and money has an incentive to leave the country – so deficit spending is only pro-growth to a point.  If world investors believe the U.S. cannot control its spending, they become worried that the U.S. will either default on its bonds, eventually – or inflate the currency so much that Treasury holders will lose money. Then the U.S. has to spend more money in interest payments to attract investors.

We’re seeing the beginning of this phenomenon with S&P’s downgrade of U.S. debt from AAA to AA last summer. However, that doesn’t hurt too badly yet – European sovereign debt looks even worse! American bonds are still buoyed by money fleeing the euro. Continued expansion of Asian economies, together with their huge savings rate of 30 percent plus (Americans, in contrast, save around 4 percent of their incomes, if that) also helps support U.S. bond prices – and keep yields low.

If Asia slows down, or if Asian consumers begin spending their money instead of banking it (all those savings have to go somewhere!), and if Europe gets its act together and starts  attracting “safe money” investors again, demand for U.S. debt may well fall – and interest rates will rise, which is really saying the same thing.

Monetary policy, on the other hand, seeks to control the overall money supply.

Here’s the dirty secret – which isn’t a secret: Congress does not directly control monetary policy – nor does the president, nor any other elected official. Instead, since 1913, monetary policy has been under the purview of the Federal Reserve – currently under the chairmanship of Ben Bernanke, in concert with a less well-known board of governors.

Originally, the Federal Reserve was founded in 1913 to take the edge off of the severe booms and busts that plagued Americans following the Civil War and through the turn of the century. These radical inflationary and deflationary cycles were wreaking havoc on workers, laborers, farmers and bankers alike. The Federal Reserve came about with a mission to act as a counterweight – moderating runaway growth cycles, and helping to stimulate the economy  during down times.

So how does the Fed do it? Mostly by controlling the money supply:

Buying and Selling Treasuries

Inflation is the result of too much money chasing too few goods.  If the Fed senses inflation, they can take money out of the economy by selling Treasury bonds. Any money they receive is essentially retired from circulation.

Similarly, if the Federal Reserve wants to stimulate the economy, they can increase the money supply – by buying Treasury bonds. The Reserve then credits the sellers’ balance sheets – and allows them to lend money against those reserves – magnifying the infusion of cash, and increasing the money supply.

This, in turn, makes it easier for borrowers to get credit.

The Federal Reserve has lately been increasing the money supply on a massive scale, in response to the fallout from the mortgage crisis. Normally, this is inflationary. But the Federal Reserve did so in order to prevent (they think) a massive deflationary cycle as a result of the collapse of the real estate and mortgage world.

Bank Reserve Requirements

The Federal Reserve can also encourage more or less lending by increasing bank reserve requirements. For example, the Federal Reserve could slow lending down – while shoring up bank stability – by requiring them to have six cents on hand for every dollar loaned out instead of four.

There’s a cost for this, though: If it gets too difficult to borrow, businesses don’t get opened, cars and homes don’t get financed, and workers lose their job.

The second major mechanism the Fed uses to impact monetary policy is setting the rate at the discount window. This is the rate the Fed charges banks to borrow overnight to maintain their reserve requirements – and it affects the Reserve Rate, which is the rate banks charge each other to provide overnight loans.

The lower the reserve rate, the easier it is to borrow – and the more banks are willing to lend, all else being equal. But if they get too willing to lend, then inflation heats up. If inflation rises above interest rates, it doesn’t pay to save.

The result is a massive transfer of wealth from savers to borrowers – which ultimately discourages investment and slows down the economy.

The Federal Reserve, then, is constantly walking a tightrope between trying to encourage reasonable growth and a very modest rate of inflation, without restricting too much and sending the economy into recession.

So Who Benefits? Borrowers vs. Savers

When it comes to monetary and fiscal policy, where you stand depends a lot on where you sit.

If you’re a net borrower – that is, if your balance sheet consistently shows you have borrowed more cash than you have on hand in financial instruments – you benefit from “easy money.” That is, you benefit from low interest rates, and policies that encourage growth even at the expense of accepting inflation.

This isn’t limited to credit card users and irresponsible borrowers. If you borrow a lot to finance your farming operation, or you borrowed to fund college, or real estate, or a small business, you’re in the same boat. Inflation lets you borrow today’s big dollars, and pay back smaller dollars tomorrow. If inflation is higher than your interest rate, you win,

If you’re a net lender, on the other hand, the opposite is true. Low interest rates hurt the returns you get on your savings – and allowing inflation to eat away at your wealth. High interest rates, however, go into your pocket – ideally to reinvest! This is true of anyone who lends, saves or invests more than they borrow.

And neither party is a reliable ally. For either of you.