Meet Eliot Spitzer
The most destructive politician in America.

This piece is the cover story in the June 14, 2004, issue of National Review.

There's a story Eliot Spitzer likes to tell about the Federalist Society. Spitzer had started to make a name for himself as an aggressive and activist attorney general for New York, and the conservative legal group invited him to speak. Spitzer told the group that he too was a federalist: Conservatives had cut the federal government down to size; that devolution of power, he said, had freed him to sue the tobacco companies. The conservatives, he says, were "ashen." Sometimes he adds that he was not received graciously.

Spitzer's story does not hold up in all particulars. Leonard Leo, the executive vice president of the Federalist Society, says, "He was not greeted stonily. He has a wildly different recollection of his one appearance than anyone else who was in attendance." Leo says the society has invited him back.

The underlying point of Spitzer's story, however, is true. A generation of conservative rhetoric about federalism and states' rights has made the political culture receptive to state-level activism. And nobody better embodies the new legal activism of the state attorneys general than Eliot Spitzer. Nor does anyone better illustrate the damage that activism is doing to our form of government. If conservatives are going to resist that activism, as they should, they will have to rethink some of their slogans.

Spitzer now cuts a large figure. He is feared on Wall Street, loved by the press, and considered a strong candidate for governor in 2006. But he almost didn't make it into public office. After Princeton, Harvard Law, and a brief stint at a law firm, Spitzer went to work fighting the mob for the Manhattan district attorney's office. In 1994, he ran for attorney general - and placed fourth out of four in the Democratic primary. In 1998, he spent even more of his father's real-estate millions to unseat the incumbent Republican. This time, he won - barely. The recount went on for six weeks.

The photo finish did not make him cautious as AG. The list of targets Spitzer has gone after seems endless: gun makers, tobacco companies, Internet spammers, drug companies, Microsoft, brokerages, predatory lenders, mutual funds, power plants, the Bush administration, former New York Stock Exchange chairman Richard Grasso. Spitzer's activism has earned him an exceedingly good press. He is most famous for going after Wall Street brokers who sought to woo corporate investment-banking clients by touting their lousy stocks to investors. After that episode, Time magazine named him "Crusader of the Year" and compared him to Moses.

Spitzer's critics - he does have them - allow that he is smart and hardworking. But they fault him for being an ambitious publicity hound. He replies that he's happy to have people impugn his motives when they can't challenge the merits of his actions. It is a fair retort: In a healthy political system, public officials will often do the right thing for the wrong reason. If pursuit of the governor's mansion has led Spitzer to advance the common good, we should be glad of it.

The crucial question, then, is whether Spitzer's activism has advanced the common good. There is room for doubt.

Guns. Lawsuits against gun manufacturers have been one of Spitzer's major causes. In 1999 and 2000, he worked hard to get Smith & Wesson to agree to adopt trigger locks, develop "smart gun" technology, change the marketing of its product, and support gun-control legislation. At the last minute, Andrew Cuomo, then Clinton's secretary of Housing and Urban Development and a man who wanted to be governor of New York himself, took over the negotiating, snatching credit away from Spitzer. But what both men were doing was using the threat of litigation to get the company to agree to government regulations that Congress and state legislators were unwilling to enact. Moreover, they were trying to exploit Smith & Wesson's market power to get other companies to follow suit. According to the settlement, Smith & Wesson would be able to sell only through dealers who accepted a variety of restrictions. As Walter Olson, a critic of the arrangement, put it, "If dealers and gun shows wanted to stock the dominant manufacturer's line, they'd have to agree to stop promoting disfavored, competitive product lines."

It didn't work. Dealers started dropping Smith & Wesson, and other gun companies pulled out of a joint legal defense with it. Spitzer's response was to threaten lawsuits against the non-cooperating companies.

Spitzer and Cuomo also made another run at gun makers. Working with big-city mayors, Spitzer sued the firearm manufacturers on the theory that guns are a "nuisance," just like drifting smoke or stray dogs, that keeps people from enjoying their homes. The case was thrown out of court. Spitzer appealed, and it was thrown out again. The appeals court ruled that "[s]uch lawsuits could be leveled not merely against these defendants, but well beyond them, against countless other types of commercial enterprises, in order to address a myriad of societal problems - real, perceived or imagined - regardless of the distance between the causes of the problems and their alleged consequences, and without any deference to proximate cause." Also: "Courts are the least suited, least equipped, and thus the least appropriate branch of government to regulate and micro-manage the manufacturing, marketing, distribution and sale of handguns."

Tobacco. Spitzer was a latecomer to the states' litigation against the tobacco companies, which began before his tenure. He has since become a key player in defending the settlement of that litigation.

The states alleged that the tobacco companies owed them because smoking increased their Medicaid costs. The suits were proceeding successfully through the courts - in some states, because the legislature changed the law so that the tobacconists could not use the same defenses available to other companies. The attorneys general, the tobacco companies, and the trial lawyers reached an agreement. It was submitted to Congress for approval, but opponents blocked that approval. So the leading attorneys general reached a very similar agreement with the companies and the lawyers, this time cutting Congress out.

Under this deal, the companies have to pay the states billions of dollars. They could raise the money by hiking prices - and without worrying about losing market share. Under the terms of the agreement, a company's payments would rise if its market share did. So nobody had an incentive to keep prices low. Small companies that weren't part of the deal were invited to join it at favorable payment rates, in return for not trying to grow larger. The states took additional steps to make sure that any new companies entering the market would also enter the agreement.

The results: a de facto national tax on cigarettes that Congress never passed, and a tobacco-industry cartel protected by the states. The state attorneys general are now quite prepared to help quash private lawsuits against the tobacco companies that might threaten the flow of cash to state governments.

"Predatory mortgage lending." Until the Treasury Department told him to back off, Spitzer was contemplating action against subprime mortgage lenders, whose predation has "become a new scourge" (to quote an article he co-wrote in The New Republic). In the 1990s, the financial markets started selling mortgages to people who don't qualify for prime mortgages and thus have to pay more. The interest rates and fees for these products are higher than Spitzer would like. In Spitzer's view, most of the people who buy them "would be better off with no loan at all." But if predation is taking place, subprime lenders should have abnormally high profits. They don't. It is a competitive market, and its peculiarities are not insidious: There are high prepayment charges because a lot of people prepay. The fee structure is complex and high because regulation effectively keeps interest rates from rising to their market level. Spitzer complains that subprime lending is racially discriminatory. Whether that's correct depends on whether minority borrowers are more capable of judging their own interests than he is.

Brokerages. This was the issue that made Spitzer a national name, and he deserves credit for his work on it. He got his hands on e-mails from Henry Blodget, Merrill Lynch's high-flying Internet-stock analyst, in which Blodget confessed that he thought the stocks he was touting were junk. He was selling them because Merrill wanted the companies to which those stocks belonged as investment-banking clients.

New York's Martin Act gave Spitzer sweeping powers to prosecute securities fraud. As Nicholas Thompson summarized some of that act's distinctive features in a recent article in Legal Affairs: "People called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination. Combined, the act's powers exceed those given any regulator in any other state. . . . To win a case, the AG doesn't have to prove that the defendant intended to defraud anyone, that a transaction took place, or that anyone actually was defrauded."

The Martin Act (1921) had not been used against Wall Street for a long time. But Spitzer had occasion to learn about its existence: During his 1998 race, his opponent accused him of financing his campaign in a way that violated the act - a charge for which the evidence was suggestive but not definitive. Once in office, Spitzer started to use the act aggressively.

Merrill Lynch settled. Soon afterward, Spitzer started actions against several other Wall Street companies and got them to settle, too. The settlements included fines, which critics said were too light. No matter: Spitzer was more interested in restructuring the industry to reduce conflicts of interest.

Perhaps the government was right to crack down on these abuses. Perhaps the regulations he devised are worthwhile, although there are plausible criticisms. But state attorneys general are not supposed to be in the business of issuing securities regulations. Spitzer justifies his activism by pointing to the inaction of the federal Securities and Exchange Commission. (The SEC has nothing like the Martin Act, and is also constrained by federal rule-making procedures.)

And what about the responsibilities of investors? Shouldn't they have known to take investment advice with a grain of salt? "I don't want to say the public shares responsibility," Spitzer told Money. The Merrill Lynch case grew out of a private suit brought by a man who lost half a million dollars through recommended investments. If you've got half a million to lose, you might want to consider buying some financial sophistication. Merrill Lynch customers who have followed Spitzer's suits with their own have lost their cases. One federal judge concluded: "The facts and circumstances show beyond doubt that the plaintiffs brought their own losses upon themselves when they knowingly spun an extremely high-stakes wheel of fortune." It may be that Merrill Lynch was undone not by the legal merits, but by the threat that Spitzer would pummel its reputation by using his Martin Act powers.

The "mutual-fund scandal." Spitzer next went after mutual funds. Supposedly, they had cost investors $4.9 billion a year by allowing a few people to engage in "late trading" and "market timing." But according to Henry Manne, the former dean of the George Mason University law school, the damage to investors was much less, and the benefits they received greater, than Spitzer claimed.

Late traders and timers exploit the 4 p.m. market closing time: If new information comes out after that time, trading at the "stale" closing price can be profitable. The $4.9 billion figure came from estimating the maximum amount that short-term traders could make from these practices and then assuming that all of their gains were made at the expense of long-term investors.

The mutual-fund industry is, however, highly competitive, with hundreds of companies and thousands of funds. If long-term investors were getting lower returns from some funds because the funds allowed timing, the investors could easily have gone elsewhere.

Some of the funds' activity was clearly illegal. But serious harms to investors have not been demonstrated. Moreover, the settlement Spitzer imposed - lower fees - has no relation to the charges. Stephen Bainbridge, a securities-law professor at UCLA, wrote, "It's as though you got busted for pot possession and the DA said you had to give up snowboarding." Spitzer isn't supposed to be setting fees for the mutual-fund industry, however popular that may be to New York voters.

GOVERNMENT BY LAWSUIT
Spitzer argues that his lawsuits and enforcement actions make markets more efficient and fair. He isn't hostile to free markets; he just recognizes that they require strong government. Moreover, he claims that he is making government work better: He takes action only when legislators have failed to. But it is unlikely that establishing cartels or suppressing voluntary transactions really strengthens markets. There is a deeper problem with Spitzer's style of regulation through litigation: When legislators "fail" to regulate guns, they may be choosing inaction over the alternatives. When Spitzer tries to override that decision, he exalts his own policy preferences above democratic procedures.

And what is the attorney general of New York doing setting national policy on guns, securities regulation, pollution, or any other issue? During one phase of his Wall Street campaign, the editors of the Wall Street Journal asked whether Spitzer was running for governor of New Jersey - the worry being that investment houses might decamp. The Journal has made many warranted criticisms of Spitzer, but this one was off the mark: It understated his ambitions. Spitzer does not claim jurisdiction over Wall Street because it is located in his state; he claims jurisdiction because some of its clients are. If firms moved to New Jersey, or New Mexico, they would find that Spitzer and the Martin Act had followed them there.

We are used to thinking of the "litigation explosion" or "liability crisis" as an economic problem. It has an overlooked political dimension: It is a breakdown of federalism. Under the current dispensation, an Alabama plaintiff can sue an Ohio company in an Alabama court, before an Alabama judge and jury, so long as the company has at least "minimum contacts" with Alabama. The court can decide to apply Alabama law, because the Alabama government has an "interest": It's the forum state. If Alabama's laws are better for plaintiffs than Ohio's, over time Ohio will find its liability rules becoming irrelevant. Alabama will be able, effectively, to create national rules for product liability. That's the dynamic that brought the liability crisis into being.

Michael Greve, the director of the American Enterprise Institute's Federalism Project, argues that the activism of the attorneys general represents a new, more virulent strain of the tort crisis. Now the trial lawyers have badges. They want liberal social policy, not just cash awards. The old tort shakedowns often featured exaggerated or even non-existent harms. Lester Brickman, in Pepperdine Law Review, argues that the asbestos litigation was based on fraudulent claims. The new lawsuits hardly even bother to demonstrate harms: An arcane theory of what the world would look like if the target industry followed different marketing practice, or adopted a different pricing structure, suffices.

Greve calls the emerging system of state-government power "neo-Confederate," in contrast to the federalism found in the Constitution. He's got a point. The fact that the Articles of Confederation effectively allowed states to commit economic aggression against one another was a major reason the Constitution was adopted.

That doesn't mean the system will now degenerate into a war of all against all. The states can find an equilibrium point of collusion. Spitzer himself is mindful of the threat of regulatory balkanization, which corporate America detests. The attorneys general will make sure that we have uniform national policies - they just won't be set in Washington.

The tobacco settlement offers a model for this future. How did the states, including the tobacco-producing ones, come to a unanimous agreement? Simple: Once a critical mass of states had reached a deal with the companies, the other states were left with two options. They could take the companies' payments or refuse them. Either way, their smokers were paying the higher fees. Even Alabama's Bill Pryor, the attorney general most opposed to the deal, eventually signed on. The new activism of the attorneys general may be one reason the position is now dominated by Democrats. It certainly accounts for why Republican AGs act the same way as the Democrats.

Federalism properly conceived would leave room for regulatory activism, but that activism would be constrained because state laws would have little extraterritorial reach. Washington should probably back off on subprime mortgage lending: Let Spitzer take whatever action he wishes. So long as the costs of regulation are borne inside the state, there is a limit to how far it will go. Georgia passed a draconian law on subprime lending, saw its market collapse, and had to repeal the statute.

Delaware is the corporate-chartering capital of the country because corporations get to choose which state's legal regime to adopt. If securities regulation were handled under the same choice-of-law principle that governs corporate law, Spitzer's reign would not be troubling. As Greve puts it, brokerage houses "could accede to Spitzer's regime and wear his oversight as a badge of honor and integrity or else migrate to a more hospitable jurisdiction." Spitzer would then "function as credible intermediary agent in a market where private, self-regulatory institutions, as well as federal regulators, seem to have failed. Not as exalted a role as that of Global Investors' Avenger - but a vastly more valuable and appropriate one."

A VACUUM OF POWER
Spitzer often says that he is acting because the federal government has not. He is right, in a sense. The state attorneys general can exercise the powers they do only because neither Congress nor the federal courts have imposed constraints on them. It is hard, however, to see who is going to stop the AGs.

It won't be the business lobby. A lot of companies are afraid to take on Spitzerian activists for fear they will be the target of the next enforcement action. Besides, life on the inside of cartelizing deals is rather cozy. Spitzer is not some left-winger out to bankrupt industries. Indeed, he can offer protection from other attorneys general and from private litigants who might be so inclined. Don't be surprised if, in a few years' time, America's pharmaceutical industry decides to become a regulated public utility in everything but name, with a lot less innovation but a guaranteed rate of return. If it happens, the deal will be made with the attorneys general, not Congress.

The U.S. Constitution is an obstacle to the AGs - or would be, if anyone remembered what it was. The Constitution does not contain any provisions that mention "federalism." It does, however, include provisions that limit the reach of the federal government over states, and provisions that limit the states' ability to plunder one another's citizens. The compact clause, for example, requires a congressional majority to authorize agreements among the states. Dairy-producing states can't just form a cartel to mulct all the other states; they can do that only when Congress says it is okay (as it does). Under the clause, the tobacco deal should have been required to get congressional approval. The full-faith-and-credit clause requires that state courts show some deference to sister states' laws - a rule that would bring the tort crisis under control by restraining forum shopping.
But while the Supreme Court has seen a modest revival of federalist limits on the national government in recent decades, limits on state governments' ability to set national policies remain dead. The liberal justices are voting for regulation by litigation, and the conservatives are voting for "states' rights" - at the risk, Greve notes, of transforming the Constitution into a "trial lawyers' bill of rights."

Conservatives, too, seem inclined to bless anything the states want to do as "federalism." In various debates over the last decade, many Republicans have acted as though unlimited discretion on the part of state governments in spending federal money was part of the Founders' design. In the name of taxing Internet sales, most of the nation's governors are trying to create a tax-collection system that will ensure that when a family from Maine goes on vacation in Florida, it will bring Maine's taxes with it. People seem at least to understand that a state sales-tax cartel requires congressional approval. But too many self-described conservatives are leading the charge for that approval (as are important companies such as Wal-Mart). We now have a "federalism" that subverts the goals of citizen choice and political accountability that it was meant to serve.

Eliot Spitzer may never become governor. He is said to be concerned that Sen. Charles Schumer is better positioned for the 2006 primaries. Given the trend lines, however, he may want to consider whether the job would be a demotion.