Welcome to Cato Audio for November 2023. I'm Caleb Brown. In this month's offering, FDIC Vice Chair Travis Hill evaluates the state of banking in the wake of high-profile bank failures. Adam Thierer discusses looming regulation of artificial intelligence. And I speak with Cato's Norbert Michelle about the new push in Congress to cap credit card interest. We're dispensing with our typical Cato roundtable this month to bring you a speech from the Cato Institute's Constitution Day festivities.
At the Cato Institute's Constitution Day event, we were joined by the Honorable Bridget Mary McCormack, President and CEO of the American Arbitration Association and former Chief Justice of the Michigan Supreme Court. She discussed the manifold problems in our civil justice system and suggested ways to fix them. My topic today is the massive market failure of the civil justice system and its role in undermining the rule of law. I'm going to start with a description of the current state of civil justice in America. I want us all to be on the same page before I turn it to diagnosing some of the causes of the brokenness. After my diagnosis, I'm going to describe some of the ripples of change I see on the horizon and what's at stake. Here's my thesis. We can't go on like this. But before I begin, a word about what I am not talking about and what not to infer from that. Please don't take my focus on the civil justice system to mean the criminal justice system is currently serving the rule of law ably. It's not great for the rule of law.
that in most jurisdictions you can be punished for conduct a jury has said you're not guilty of. And did you know that if you're represented by ineffective counsel when the state seeks to terminate your parental rights, and as a result of that inadequate representation, you lose your kids, there is no process for addressing that wrong. It's a too-bad-so-sad rule when that happens in most jurisdictions. Okay, back to the topic I came to discuss. Justice system data is very hard to come by, but there is some data about the civil justice system that captures its failures.
The Legal Services Corporation's 2022 Justice Gap Report found that 92% of civil legal problems with low-income people get either no or inadequate legal help. That's a 6 percentage point increase over the prior study from 2017, and it's not a pandemic blip. During that same period, total revenue to legal aid programs increased by 31%. And there's this. The National Center for State Courts estimates that both parties have lawyers in only 24% of civil cases in state courts.
where about 95% of civil litigation occurs. In other words, in more than three quarters of civil cases, at least one party struggles to navigate a legal system where rules are written in a language they don't speak or understand. And this, every year the World Justice Project ranks the world's countries on their compliance with various measures of the rule of law. One of those measures is the accessibility and affordability of civil justice. The most recent rule of law index released late last year ranks the United States 115th out of 140 countries on the accessibility and affordability of civil justice. Among the 43 wealthiest countries in the world, the United States ranks 43rd.
A lot of other countries do justice better than we do. The popular idea of our justice system, the one we see on TV and teach in our law schools, where both parties are represented by lawyers who present evidence and make legal arguments for their clients, and the best legal argument wins, is a fiction in the vast majority of civil cases in the United States today. The rate of lawyerless litigants is particularly troubling because of the kinds of cases they're managing on their own. High-stakes cases. High stakes, not because billions of dollars are at stake, but because they often involve something more fundamental. Shelter, personal safety, family, financial stability.
This is relatively new. While state court data is especially opaque, the evidence we have shows that as recently as the start of the last quarter of the previous century, lawyerless litigants were the exception. There was then a steady rise over the remainder of the 20th century until by the early 2000s, we were seeing the numbers we have today. In 1977, two students at Yale Law School did a study of 2,500 divorce cases in two trial courts in Connecticut and published their results in an unsigned project in the Yale Law Journal. The students were Deborah Rohde and her husband-to-be, Ralph Cavanaugh. They found that 2.7% of the divorce cases they studied involved an unrepresented litigant.
They also cited a then-recent study in San Mateo County, California, showing that 20% of divorce petitioners were proceeding without lawyers there, a figure they characterize as an unprecedented surge in self-representation. Of course, there are lots of government services people navigate without experts. What does not having an expert for a justice matter mean, you might wonder? The lawyers in the room know the fundamental legal fiction that we're all charged with knowing the law. For those of you who are not lawyers, and I heard there are a few in the room, ignorance of the law is never a defense to any claim or charge, and there's a lot of law to know. Take crimes, for example. According to best estimates, and estimates are all we have, there are about 4,500 federal crimes in the United States Code, and more than 300,000 federal crimes dispersed throughout the federal regulations. I can't figure out the numbers for any individual states, and nor can any of the generative AI tools I consulted. But fortune-telling is still a crime in most jurisdictions. In North Carolina, it's a crime if your bingo game lasts more than five hours, or if you play bingo while intoxicated.
In Vermont, it's still a crime for a woman to get false teeth without getting permission from her husband. There isn't one place to find out what the law is. No resource explains in plain language what exactly the law requires of you or provides for you. Do you know what happens to your stuff if you die without a will? Lawyers probably do. I wasn't sure, so I asked Google, and I got this answer. If you die without a will, you are intestate, and a probate court, is it intestate? Doesn't matter. If you die without a will, you are intestate or intestate, and a probate court will apply the intestacy laws of the state where you reside to determine how to distribute your property among your next of kin. Naturally, I next asked what the intestacy laws of Michigan are. Things went downhill from there.
One result seemed to be a link to a Michigan statute, but it didn't work. The rest were lawyers' websites, one scarier than the next. Here's one example. Dying without a will may become a less than ideal situation. For example, the court could find that a distant relative that you never intended to give your money or property to could be entitled to your estate. Yikes, like my cousin Tommy. I can't stand Tommy if he gets my stuff. This is a very devastating scenario, and at a minimum, you should have a last will and testament drafted that outlines who should receive your money and your property.
Many people have some familiarity with some parts of the U.S. Constitution, but even when we know the particular words in a constitutional provision, we don't generally know what they mean in practice. The words have been interpreted, as we know, by judges for some 200 years or so, and it's those interpretations that are in fact the rule of law, and they aren't always intuitive. Most of us know that we have a constitutional right to be tried by a jury of our peers if we're accused of a crime. But in most cases, exercising that right will mean exposing yourself to significantly longer punishment if convicted. And that consequence, judges have found, is perfectly constitutional. Right to a jury trial-ish.
And as for statutes, you might find your way to reading them online, but after spending 10 years trying to make sense of many of them with six other people trained and paid to do that, who disagreed regularly, well, best of luck. Then there are other legal principles, rules of decision, that are also judge-made and a little bit more freewheeling and can overlay constitutional or statutory law. These are generally not tied directly to any language of a constitutional provision or statute. Google mootness, rightness, standing, qualified immunity, you can go on and on. To have access to a comprehensive collection of all these judicial pronouncements of the law, also known as the law, you need a subscription to the most user-unfriendly search engine you will ever interact with. There's more still.
There are also sets of rules that govern how you can use the law in courts. And a particular rule of law will be different from state to state and sometimes from courthouse to courthouse. The rules for how to interact with a court can be different from courtroom to courtroom. That's right. In addition to sorting out the legal rules and principles and court rules that govern your dispute, you better check Judge What's-Her-Name's website for any special rules you have to follow if she has a website. If she doesn't, you can call her office and see if she will fax you her standing order. I watched some eviction cases recently before a thoughtful judge in Michigan. We can still watch a little bit of court online in Michigan. I'm going to read you one short...
Transcript from an eviction hearing. The judge says, we'll come to order. The record may reflect the next summary proceedings matter involving courtyard apartments versus Joshua Salinas and all other occupants. Counsel is appearing on behalf of the plaintiff. The defendant has failed to appear as I understand it. Not in the hallway either. Counsel, he's not. The judge. All right, counsel, anything for the record? Good afternoon.
Counsel, good afternoon, Your Honor. For the record, if it pleases the court, P64392, with a law firm of Swiss Stack Levine, I represent courtyards. This matter is set for a second hearing after a magistrate call a week ago. Mr. Salinas failed to appear at that time as well. So this is a second consecutive failure to appear. This matter is a health hazard matter. We're seeking immediate turnover of the property. So we would ask for a judgment for possession to be entered at this time, and that we be allowed to submit a writ immediately, and that in order for eviction be issued as soon as the fees and the form is received by the court, the judge. All right. Do you have someone available for brief testimony in support of the default judgment today? Counsel, I don't. Ms. Soto, she has been with us before.
She's the property manager. She's ill. She's ill at the moment. And this was a summary proceeding, and I thought that we could possibly do that. The judge.
So on this, the notice to quit was served August 4th. I would note that notice to quit indicated in boldface type, landlord will seek immediate issuance of writ of restitution. The options given to the tenant were to remove the health hazards, repair and allow inspection by the landlord within seven days or move out. Again, that was served and proof of service shows August 4th on the defendant. Complaint was then filed in this particular matter for termination of tenancy based upon health hazard or damage to property. And paragraph nine, it's the standard scale, DC form 102B, checked in boldface. The plaintiff requests that these, that in regular type, an immediate order of eviction. That was filed with the court properly and the lawsuit was mailed. Certificate of mailing protected.
on August 17th. And the lawsuit is posted for proof of service, indicating it was posted attached to the premises on August 26th under MCR 4.201. Blah, blah, blah. I will sign both the possession of judgment, the rate of restitution, as well as if they're provided to the court. How much of that would Mr. Salinas have understood if he were there? Why did the judge ask for a witness and then not require one? Is there a rule that requires testimony? Is it a court rule? Is it a statute? How would you figure that out if you were not a lawyer? How would you figure it out if you were a lawyer? Did the tenant have any defenses? How would you figure that out?
When you say it all out loud, it starts to sound not very fair. It's not justice to compel people who can't afford a lawyer to play by the rules of a system designed only for those who can. It's wrong. How did we get here? The American legal system was built by lawyers for lawyers at a time when everyone had a lawyer. Four industrial revolutions passed, and the complexity of our economy and society changed dramatically, yet almost no updates have been made to our legal processes.
A surgeon dropped from 1890, that's a surgical suite from 1890, on the top left corner of the slide, dropped into a modern surgical suite, the photo right beneath it, would have no idea where he was. But a lawyer, who appeared in the Iron County Michigan Courthouse in 1890, in the middle, would be just fine in that same courthouse today. Almost nothing has changed. Why hasn't change come for the legal profession in the way it's come for so many other industries? Where is the civil justice Netflix? Why are lawyers so terrible at solving problems that require innovation, collaboration, and also excellent at boxing out others who might be better at it? Part of it's cultural. Our training and culture are risk-averse and backward-looking. We're trained that incremental change leads to lasting solutions with less conflict. And lawyers are committed to the way we've always done things. One of our most essential decision-making norms is stare decisis. What was decided before governs what we decide today, and there is a strong cultural norm that favors the status quo. We all did it this way, and you should too.
Part of it is practical. We lawyers and judges attend to emergencies first, and we always have emergencies. We focus on lots of critical immediate problems, which keeps us from focusing on structural problems. Each stakeholder group may work in good faith to address the immediate problem squarely in its wheelhouse, but none have time to step back and explore upstream solutions. Part is lack of resources. Except for those lawyers in big law, a small minority of those in the profession, lawyers' priorities are structured around financing their practices and paying their employees. Courts struggle to keep the lights on, judges strain and pay court staff a living wage. Funding for technology, data collection, evidence-based study, and reform is minimal.
and the competing priorities of dispensing justice daily are formidable. And part is bar federalism. I think I missed a slide, yeah. Part is bar federalism. Bar examiners in each state work separately, often duplicating work and often missing each other's insights. Legal system stakeholders react to one another, but rarely collaborate. Law schools have primarily built their curriculums to accommodate a complex web of state licensing requirements, educational accreditation requirements, and university policies, further structured by a ranking system built on criteria that locks in an anachronistic vision of the profession.
While law schools and courts operate independently, they are in fact interlocking systems, each dependent on and reactive to the other, and each bound by funding models, traditions, and cultures that have, over time, magnified the gap between those who become lawyers and those who need the justice system to protect their rights. Neither has direct control over the other. Both serve many other stakeholders. In most jurisdictions, state supreme courts and law schools interact very rarely. In a self-regulation and licensure federalism system, there is no obvious first mover for system-wide reform, and lawyers are resistant to allowing others to help. Let me focus for a minute on the supply side.
According to American Bar Association data, in 2018, around 84% of law school graduates were employed in positions requiring bar passage or where a J.D. provides an advantage. The ABA data has been criticized for overstating employment rates by including short-term and non-professional jobs, and some suggest that full legal employment is likely 10% to 20% lower. America's lawyers devote three years and hundreds of thousands of dollars to learn the law, some graduating with crippling debt, and a significant number of them are underemployed. Now, I don't mean to suggest that this market mismatch is a solution waiting to happen. We're not going to lawyer our way out of the civil justice problem.
If the paying work available now is not enough to keep our current roster of lawyers fully employed, the 92% of our neighbors who can't afford to pay lawyers to help with their justice problems will not close that gap in our current models. But they can't get help from anyone else either. In most states, anyone who's not a lawyer risks criminal punishment for the unlicensed practice of law. The definition of the practice of law and the unauthorized practice of law are not uniform and are not easily understandable. See above, impossible to find the law.
But most UPL restrictions prohibit people from giving out-of-court legal advice or helping prepare legal documents. This wasn't always the case in the United States. At the founding, when only lawyers could advocate in most courts, you could still get help from your family and friends with legal problems outside of court. That started to change in the early part of the 20th century when courts prohibited legal help by people who were not lawyers outside of courthouses too, first when done for a fee, and then eventually when done at all. Now lawyers monopolies around the country restrict anyone who is not a lawyer from helping another person with a legal problem.
It isn't like this in other professions where resources are critical to basic human needs. You don't see a surgeon or a doctor every time you have a medical problem. Sometimes a PA or a nurse practitioner is all you need. 82% of healthcare workers have a bachelor, associate, or vocational degree, and only 9.3% have an MD or a DO. In contrast, 80% of legal service workers have a law degree. This might sound a little bit like a requiem for the legal system we love, but I see lots of hopeful ripples. It's a bit of a Jenga tower.
And if the right pieces are pulled out, it could topple quickly and you could rebuild something that made a little more sense. And a number of pieces have been pulled out of the tower recently, which I'm going to organize today in three buckets, regulatory reform, litigation, and other stuff. So starting with regulatory reform, you likely know this story. Two state Supreme Courts have attempted to be first movers to address the civil justice crisis. In 2020, the Utah Supreme Court established a licensed paralegal practitioner program, I'm going to call that LPP, that allows qualified non-lawyers to provide limited legal services in debt collection, landlord-tenant disputes, and family law matters. Critics, mostly lawyers, initially argued that LPPs might increase consumer confusion and harm.
To become an LPP, individuals must possess an associate or bachelor's degree and then complete an approved LPP education program, exams, and an apprenticeship. LPPs must adhere to professional conduct rules and complete 12 hours of continuing education annually. In the first two years following the launch, over 75 individuals have been approved as LPPs and began providing legal services in Utah. In 2021, the Arizona Supreme Court adopted rules to create a new licensing program, allowing qualified non-lawyers to provide specific legal services. Arizona licenses legal paraprofessionals who meet specific education and training requirements set by the court.
To qualify, individuals must possess an associate's degree or higher and complete an LP education program approved by the court. LPs must adhere to rules of professional conduct and complete annual continuing education. LPs can provide specific legal services in family law, land or tenant disputes, deck collection defense, and administrative appeals. They can prepare legal documents, advise clients on procedural issues, and represent clients in certain administrative hearings. They can't appear in court or negotiate on a client's behalf. The program launched in January 2022. From January 1 to December 31, 2022, 25 legal paraprofessionals were approved. As of January 23, 10 more were approved, and I don't have more recent data than that.
In addition to creating the legal professional program, the Arizona Supreme Court amended Rule 5.4 of the Rules of Professional Conduct. Rule 5.4 prohibits lawyers from sharing legal fees or forming partnerships with non-lawyers for law practice. The rationale for the rule is, allegedly, to prevent outside influence over lawyers' independent professional judgment. Arizona's revised 5.4 allows for alternative business structures and non-lawyer ownership of law firms in Arizona, provided specific requirements are met. For example, lawyers must still retain majority control over the firm and be responsible for ethical and professional conduct, and firms must not allow non-lawyer involvement in matters of legal judgment.
Arizona's rule change aligns with similar rules in England, Australia, and parts of Canada and reflects the view that opening the door to new capital and business structures can increase access to legal services without undermining lawyers' duties to clients. More flexible rules facilitate financial investment in innovations like technology solutions for cost-effective legal services. And so far, the sky hasn't fallen in either state. Early evaluation of both programs has been encouraging. A team at Stanford conducted in-depth interviews and analysis of the authorized entities in Utah and Arizona through June 30, 2022.
They found that innovations have emerged in five primary forms. Traditional law firms have adapted their business structures and service models or capital structures, and they make up about 35% of the authorized entities. Law companies like Rocket Lawyer and LegalZoom represent 38% of authorized entities. These companies have chosen to become regulated so they can employ lawyers. Non-law companies, newcomers to the sector, comprise about 18% of entities. These are companies often set up on service models that combine law with other services, such as accountants.
Intermediary platforms connect lawyers to potential clients. There's a small group of those. And finally, entities using non-lawyers to practice law. These providers use waivers for unauthorized practice of law available in Utah. One example, RASA, uses AI and non-lawyer experts to help Utah residents with criminal record expungements. The Stanford team drew some thematic conclusions from the interviews. They found that lawyers are pivotal in the innovations of these new entities. They're developing new concepts and actively involved in various roles, such as owners, investors, and compliance officers. They found that a significant proportion of these entities are selling primarily to individual consumers and small businesses, the people law market.
And most importantly, they found that the reforms haven't resulted in significant consumer harm. Both Utah and Arizona have reported relatively low complaints about the new entities. The regulatory reform story, however, is a bit two steps forward, 1.5 steps back. 2022 witnessed setbacks. California's initiative to introduce regulatory reforms was met with significant resistance from the bar and the legislature, culminating in a legislative ban on specific reforms. And the ADA issued a non-binding resolution against states considering non-lawyer ownership changes. But Oregon and Alaska both recently introduced legal paraprofessional programs, and other states are considering it.
Regulatory reform isn't the only Jenga piece that's been pulled out. Litigation is also, oops, I forgot that slide. Litigation is also having an impact. The Upsolve litigation is familiar to my friends at Cato who have showed up in it. In April 2019, the nonprofit organization Upsolve challenged New York's UPL law as it applied to their program. Upsolve provides a free web-based platform that helps low-income individuals file for Chapter 7 bankruptcy without an attorney.
Upsolve wanted to also be able to help its users in debt collection actions by having trained workers who are not lawyers provide free legal advice on responding to debt collection lawsuits. That conduct, of course, would trigger New York's UPL statute, hence the litigation. Upsolve argued that New York's ban on the unlicensed practice of law violated the First Amendment. Upsolve's CEO, by the way, pictured there, Rohan Pavaluri, is not a lawyer. The federal district court ruled in favor of UPSOL, finding that New York's ban on the unlicensed practice of law was unconstitutional because it violated the First Amendment by being overbroad and infringing on UPSOL's free speech rights. The attorney general has appealed that decision. The South Carolina branch of the NAACP has filed a federal lawsuit challenging that state's UPL statute. The NAACP wants its members to be able to provide limited but critical guidance to low-income tenants facing eviction, like explaining the eviction process, possible defenses, and the importance of requesting a hearing before losing their homes by default.
Like Upsall, the NAACP believes citizens have a First Amendment right to speak and associate by offering such guidance. Incidentally, you don't have to be a lawyer to be a magistrate who presides over eviction cases in South Carolina. The judge in that case, the federal judge obeyed the case for the plaintiffs to petition the state Supreme Court to determine whether the intended conduct would violate South Carolina's prohibition on the unauthorized practice of law, because, according to the judge, the state Supreme Court has exclusive jurisdiction over interpreting what constitutes the practice of law in South Carolina, which I suppose is true, but the judge does get to decide whether whatever it is violates the First Amendment. Anyway, more on that. More to come, I think.
The Antitrust Division of the United States Department of Justice has also appeared on this issue. Recently, the DOJ submitted a letter in support of proposals to expand access to legal services in North Carolina. In the letter, the DOJ argues that consumers benefit from competition between lawyers and non-lawyers, and with many legal services priced out of reach, lower-priced options are sorely needed. The DOJ noted that unlike at the federal level, where antitrust is statutory, in North Carolina, North Carolina's Constitution, adopted December 1776, says that, quote, monopolies are contrary to the genius of a free state and shall not be allowed. Federal agencies have long allowed non-lawyers to appear in proceedings from patent and trademark tribunals to immigration courts. Then there's the other stuff. The chief justices have kind of had it. They formed a new committee, and they're going to be targeting the barriers to providing better service to people with civil justice problems. They've showed up at the accreditation meetings, and they want to be heard on this problem. They're worried that civil justice crisis undermines all of their work. I don't think they're wrong.
Ask Tommy or me about frontline justice. We both sit on the National Advisory Board. It's a newly launched bipartisan national effort to reform civil justice work and also civil justice workers. And when asked, the public overwhelmingly favors reform. When the Arizona Supreme Court was working on its regulatory reform package, it held public meetings around the state and sought public feedback by survey. It also surveyed lawyers. Lawyers surveyed about the reforms were overwhelmingly against them. The public surveys produced exactly the opposite results. And that input played a significant role in the success of reform in Arizona.
And finally, the disruptor of all disruptors that has just come on the scene, in my view, is generative AI, which I think is poised to knock the tower right over. Large language models are already transforming the business and practice of law, and legal education isn't far off. They're automating many of the repetitive tasks that lawyers do, analyzing data sets, writing code. You no doubt saw that when ChatGPT3 was released in November, it took the bar exam, and it failed. It only passed two of the multi-state sections, contracts and, or maybe it's torts and evidence. It passed only two. It failed the exam.
In March, when GPT-4 was released, it took the bar exam again, and it not only passed, it scored in the top 10%, and it did it in six minutes. These models can democratize legal information. They can democratize law. They can even a lot of playing fields. There are, of course, problems to solve along the way. If AI learns from biased data, which is a lot of data, it can learn biases. But humans who make decisions in courts sometimes also have biases, and there is no code to run to fix those.
Is TikToking the prompts you used in GPT-4 to respond to your eviction notice the unlicensed practice of law? I'm waiting for the legal influencers to take to TikTok and explain exactly what prompts they put into these LLMs to help people across their communities. Getting back out of the weeds, why am I talking about this topic on Constitution Day? Well, there are some meat and potatoes constitutional questions wrapped up in the unlicensed practice of law statute challenges, but you all at Cato know those well. They can infringe on First Amendment freedoms of speech, press, assembly, and petitioning the government. But I have something more fundamental I'm worried about. The rule of law is built on a foundation of public confidence. And what happens if the public loses confidence? Today, about 1,400 eviction cases were heard in the city of Detroit District Court just today, 1,400. Most of them didn't have lawyers. Many didn't show up. Some probably had legal defenses. Others didn't, but might have been able to work out a resolution that might have made a difference for their family. Tomorrow, there'll be another 1,400.
During the pandemic, courts across the country, as you know, pivoted to remote proceedings to continue to administer justice and keep the public safe. It was easier in some places than others, but we all learned a lot. We were running an experiment whether or not we were interested in the results. And we learned that default rates in cases where people navigate courts without lawyers dropped significantly when people had remote options for appearing. In retrospect, duh. Yes, technology can be a barrier for some people.
But do you know what barriers can be more substantial? Transportation, child care, a job with no time off, a disability. A car is more expensive than a smartphone. And legal aid lawyers estimated that their ability to provide representation increased sevenfold when they could eliminate transportation and parking. More people showed up for jury duty than ever before when they could remote in to serve.
When it was safe to go back into courts, we had choices. We could go back to doing things the way we always had done them, or we could take account of this new data that giving people a remote option made it far more likely they could resolve their disputes, and more likely they'd be represented, and that more people could participate in the jury process. Courts make the rules about how we administer justice. With some exceptions, but very few, they return to doing things the way they always had. In Michigan, we published a proposed rule and took public input on whether to continue hearings remotely, at least many hearings remotely.
The public hearing on the rule change was the most attended public hearing in my 10 years on the bench. It took most of the day, and we limit everybody to three minutes of testimony. The court adopted the rule change, but with dissents. I responded to my dissenting colleagues in a concurrence to the order, which ended with this. The judiciary should not and cannot be the only institution that does not benefit from the lessons learned from the COVID-19 pandemic and the accelerated innovation it brought. More importantly, the public, who have traditionally been excluded from full participation in many of our courts, should not lose a valuable new tool for accessing justice. Ours is a government instituted for the people, after all.
Public confidence in courts is declining. Federal courts more than state courts, but I think that's only because federal courts are measured more than state courts. I think if you asked people in their local community who have to navigate state courts all the time, you'd find great dissatisfaction. The rule of law is just a set of ideas, and it's only as strong as the public's confidence in those ideas. When the rules are hostile to you, you might stop caring about the rules. We have a tremendous amount at stake when the rule of law is wobbly. Lawyers and judges are uniquely positioned to shore it up if we want to.
I hope we do. Bridget Mary McCormack is president and CEO of the American Arbitration Association and former chief justice of the Michigan Supreme Court. Less than a year following the collapse of Silicon Valley Bank and Signature Bank and the financial fallout those failures created, Federal Deposit Insurance Corporation Vice Chairman Travis Hill spoke at the Cato Institute to lay out his views on the state of banking and economic conditions, recent regulatory actions, and the outlook for banks and bank regulators. It's been about six months since the high-profile failure of Silicon Valley Bank and the brief banking turmoil that followed. Since then, banking conditions have stabilized but remain somewhat fragile. In the second quarter, deposits decreased for a fifth consecutive quarter, but outflows have moderated following record-setting declines earlier this year. Net interest margin declined for a second straight quarter, but by less than expected, as banks continue to pay more for deposits and competition for funding remain strong. For example, money market fund assets continue to set all-time highs at the same time that total bank deposits continue to fall, further pressuring deposit rates.
Overall, industry conditions are encouraging, but significant uncertainty remains. High rates may persist and continue to pressure the industry, and if rates do fall, the cause might be that an economic downturn, along with deteriorating credit quality, has finally arrived. Meanwhile, the banking agencies are in the midst of an aggressive regulatory agenda, including both a number of items that were under consideration before March and a number of consideration in response to March. While I think that some response to the bank failures is warranted, I worry that an overreaction is underway and that we are moving too quickly to impose a long list of new rules and expectations at a time when conditions remain precarious. Today, I'm going to share a few thoughts on several of the issues on our agenda. Overall, I think that any policies we adopt should be balanced, thoughtful, and targeted, and that we should be mindful of both the aggregate impact of all the changes and the current economic environment. To start, in late July, the banking agencies approved a proposal to substantially revise the capital requirements for large banks, which I view as two proposals in one. One implemented the 2017 International Basel Endgame Agreement, which would substantially revamp how large banks calculate risk-weighted assets. And the second, completely unrelated to the first, undoes almost all of the tailoring of the capital framework for large banks.
With respect to the Basel standards, our capital rules for our largest banks are already meaningfully more conservative than those in other developed jurisdictions. We have already gold-plated the underlying Basel standard that exists today. The proposal would further gold-plate the new Basel standard in a number of ways, at the same time that European jurisdictions appear to be deviating in the opposite direction. The result will be some combination of higher prices and less availability of products and services, and I hope there is openness to revisiting some of these choices as the process progresses. A month later, in late August, the FDIC board approved several items related to large bank resolution. One of the proposals would impose a long-term debt requirement on large regional banks, which I generally support.
The objective is to ensure that if a large bank fails, there is a pool of resources that will always be available to absorb losses in front of the deposit insurance fund and the depositor class, which would significantly reduce both the cost that is socialized across the industry and the tail risk to taxpayers. There were several aspects of the proposal that I would have addressed differently, but I still think the proposal was worth issuing to receive comments, and my hope is that once we receive and review comments, there will be some willingness to seek consensus among board members at all the agencies. The presence of long-term debt would be helpful regardless of how a bank is resolved and regardless of the degree and extent of resolution planning. The FDSE also proposed substantial changes to the IDI resolution planning rule. While resolution plans can provide the FDSE with some useful information, and certain aspects of the proposed changes might be helpful, I think the proposal could have better focused on key areas of resolution planning, such as maximizing the likelihood of a weekend sale in the event of a regional bank failure.
Looking ahead, one topic that has been under consideration at the FDIC for the past couple of years is bank merger policy. If we reopen merger policy, I encourage regulators to keep a few principles in mind. First, the U.S. banking sector and financial services industry more broadly are highly competitive. While the total number of banks in the U.S. has shrunk considerably in recent decades, the U.S. still has more depository institutions than anywhere in the world. And U.S. banks also compete with thousands of other institutions that perform bank-like functions, including credit unions, fintechs, money market funds, retailers, technology companies, independent mortgage companies, private credit, and a range of other non-bank financial companies.
Banks and non-banks are also no longer bound by geographical limits, as any bank with a website or a phone app can offer products to virtually any customer with a computer or a smartphone. While not all banks compete nationwide, all banks, in effect, compete with those who do. This is a notable contrast from when the bank merger framework was put in place decades ago, when banking was generally a much more local business and banks were heavily restricted in their ability to operate in different geographies. To the extent that regulators are concerned about consolidation, rather than make the merger process more difficult, we should instead try to address some of the underlying causes of consolidation, which includes the ever-rising cost of compliance, the steep challenges associated with technology adoption, and the dramatic decline of de novo activity since the 2008 financial crisis.
Additionally, the current merger application process is, in many cases, too long and too opaque. I appreciate that the FDIC has an important role to play in reviewing mergers under the Bank Merger Act and that some applications present challenging complexities that take time to work through. But it is in no one's interest when banks, after publicly announcing a merger, spend months waiting for initial feedback and sometimes much longer before receiving a final decision, while employees and stakeholders wait in limbo. The FDIC began to make improvements to the process under Chairman McWilliams, but there is still much more work to do, and I fear we have been moving backwards since her departure. We should also be mindful that it is helpful for banks that are struggling in this rate environment to seek partners. And it is much, much better for a struggling institution to be purchased on an open bank basis rather than bought from the FDIC out of receivership. One example of this was the announced merger between PacWest and Bank of California. And since then, we've seen more potential interest in the creative reverse merger structure those institutions utilize. With an industry adjusting to high rates and possible credit problems around the corner, this feels like a bad time for a crusade against mergers.
Finally, policymakers have talked about a desire for more competition, but in the banking context, it's worth considering to what end. A primary way banks compete is on price, by offering higher yields on deposits and lower rates on loans. This is good for consumers who can earn more on savings and pay less to borrow. But one way for a bank to get on an FDIC watch list is by paying too much on deposits compared to how much it earns on loans. Banks also compete on loan terms by offering longer maturities, less covenants, and other features that can make regulators queasy. Another way banks compete is through innovation and efficiency, which over the long term can involve things like
transitioning away from higher-cost branches and toward lower-cost websites, and engaging in third-party partnerships or banking as a service. Yet these are all types of activities that bank regulators currently view skeptically. Of course, capitalism is built on competition, and competition has many benefits, but it appears that regulators want a merger policy that encourages more competition, yet dislike many of the things banks do when faced with stiffer competition. Travis Hill is the Vice Chairman of the Federal Deposit Insurance Corporation. What might regulation look like for the emerging artificial intelligence sector? Adam Therer is a senior fellow at the R Street Institute. He discussed the various agencies who already have and would like to have more authority over this new technology.
I've done a lot of writing on this, including in essays like Why the Future of AI Will Not Be Invented in Europe and other things, where I've pointed out that the European Union has created a real predicament for itself over the last quarter century. It's created a highly precautionary, compliance-laden type of regulatory regime for information technology, and it made a choice to basically put information innovators into what I call an innovation cage and basically require them to beg for permission to escape it. And as a result, ideas have consequences, and public policies have consequences in this case. The public policy decisions made by the European Union over the last quarter century for information and communications technology has led to the fact that it's very difficult to name any leading global information technology company based in Europe today because of these heavy-handed regulations and overlapping bureaucracies, kneecapping digital entrepreneurs and forcing a lot of those innovators and investors to come to the United States to get freedom in a more permissionless environment.
The results of that have been wonderful for the United States. I mean, the economic benefits are staggering. According to the Bureau of Economic Analysis, in 2021, the U.S. digital economy accounted for $3.7 trillion of gross output, $2.4 trillion of value added, 8 million new jobs, $1.24 trillion in compensation for workers, and just created household names for American tech companies across the globe. America's companies are household names everywhere. So again, this is the real world results of the sort of innovation culture on either side of the Atlantic that we've seen play out. And I think permissionless innovation has won that in terms of economic opportunity and innovation.
But the United States appears ready now to potentially turn the corner and join the Europeans in taking a much more heavy-handed precautionary approach to AI regulation. The EU is out ahead, as Boniface made clear, and it's clear that they're going to probably get something on the books a lot quicker than the United States will because it's just very hard to get legislation done here in the States. But it seems as if we're seeing a shift in our innovation culture in the United States back towards the more traditional. top-down centralized command and control model of the Ma Bell era where we heavily regulated telecoms and media companies and broadcasting. And we rejected that in the 1990s. We had a bipartisan agreement to reject that for the internet and digital commerce led by the Clinton administration and a Republican Congress. That's the sort of bipartisanship we need. Unfortunately, the bipartisanship we're getting today is Senators Blumenthal and Hawley and others like Lindsey Graham and Elizabeth Warren introducing grandiose new regulatory schemes and huge new overarching bureaucracies for artificial intelligence and digital technology. So stay tuned. It appears that the United States is about to turn the corner and I think a wrong one.
Adam Thurer is a senior fellow at the R Street Institute. Placing caps on credit card interest is a populist policy goal, but the consequences are easy to see. Benefits to cardholders drying up, and the relative price of easy-to-use credit will go up as well. For this Cato Audio exclusive, Cato's Norbert Michelle discusses the push to crack down on credit card interest. Dick Durbin, the senator from Illinois, successfully got included an amendment that effectively did away with a lot of the little bennies that you can get for having a debit card with your bank. And how has that gone? What has changed about the debit cards versus credit cards in that time? So you're not getting rewards on your debit cards anymore and you're probably paying a higher fee. Or if you weren't paying a fee, you probably are paying a fee now just to have the card.
The whole Durban Amendment thing, which is routing requirements and rate caps, or interchange rate caps, rather, swipe fees, you know, the merchants pay. The whole thing was sold as, yeah, you're going to, you know, we're going to pass all these savings on to consumers. And that was never true, I would argue, in that the real thing going on there was that merchants were lobbying for these rate caps because it subsidizes what they're doing, what they're paying. And I mean, no objective economic analysis would have said, yeah, it's probably all going to get passed on to consumers. And it didn't. And it hasn't been.
And so now we see what appears to be a bipartisan effort among some members of the U.S. Senate to extend sort of limitations on credit cards, rate caps on credit card interest. What does that do for those of us who in the credit card industry would be referred to as deadbeats? That is to say, people who never, ever, ever carry a balance on a credit card. Well, in the sense that you pay it off.
So every month in full. So you're probably the only one left. You probably wouldn't care. But what would happen here is you're going to get the people who have the worst credit and who have the worst payment history. They're just not going to get credit. And that's what's going to happen here. Because you have this broad assault on really on profit. You have the CFPB at the same time, all this other stuff's going on. The Biden administration through the CFPB is going on this quote unquote junk fee battle.
And the idea is that businesses shouldn't be able to charge you fees, especially not late fees. And then you have Hawley attacking just the profit on credit and saying, oh, no, it's too high. Well, I don't know how he knows it's too high, but he knows it's too high. And instead of starting up at his own credit card company, of course, he wants to implement price controls, which never work, but we're going to do it this time. And Durbin is extending or trying, Durbin and Marshall are trying to extend the original Durbin Amendment, which was just debit cards, over to credit cards. So you're going to squeeze, absolutely squeeze the daylights out of the credit card companies and the banks that run the networks.
I mean, it should be obvious to anybody. You're going to then force them to focus on only their best customers. You're telling them that they can't really make the profit that they're currently making. Well, I mean, they're going to cut back on the riskier customers. They're going to cut back where they have a harder time making money. That's not people with great credit.
And like a lot of businesses, some group of customers effectively subsidize a different group of customers. And for the deadbeats who are looking for rewards cards for hotels or airline miles or dollars to spend at Amazon, it seems that if you're capping... interest rates, if you're capping and if you're eliminating a lot of fees, you're essentially telling those customers the benefits of having a credit card are going to be lower. That's right. And somehow it's being portrayed as somehow that it's wrong to give people those things. And if they're paying for those things and paying their bills on time, somehow that's wrong. And so the companies that provide rewards and reward cards are going to have to cut back in some way. One way would be to cut back the rewards.
Another way would be to stop providing credit to lower income folks or people who have a harder time paying their card on time or don't pay it on time and do carry a balance. And that's typically not people with the best credit, and it's typically the people who need the credit the most. So that's who's going to lose here in the end. The German Amendment was a part of Dodd-Frank. This seems like it would be a more discreet piece of legislation. And I got to imagine that there are a lot of people who would be very upset to learn that something like this is going to do away with their airline miles benefits or other benefits that they would get for having the convenience of a credit card. I hope they'll be upset. There's a lot of talk about trying to jam this into a must pass bill. So it could be the case that you're going to have, for example, a defense.
spending package or an overall omnibus spending package passed. And then they bury this in there. And then most people don't even know it. And they wake up and say, wait, wait, Congress did what? You know, and then there's like you have this 1500 page spending bill and there's this little provision in there that says, oh, yeah, by the way, we're going to have a rate cap or we're going to have routing mandates and these sorts of things. And it radically alters the landscape of the credit market. Norbert Mischel directs the Cato Institute Center for Monetary and Financial Alternatives.
That will do it for this edition of Cato Audio. I'm Caleb Brown. Talk to you again next month.