Center for Law and Economic Studies | Columbia Law School
Working Papers 401-425
425. Comment on Money Market Funds for SEC (Gordon,Jefrey N.) August 12, 2011
This letter offers a specific proposal for the regulation of Money Market Funds (MMFs). The proposal responds to comments made at the Commission’s Roundtable Discussion on May 10, 2011 and the public comments on the President’s Working Group report on Money Market Fund Reform, per Investment Company Act Release No. IC-29497. I respectfully request that this correspondence be included in the record of the Commission’s rule-making in this area. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2133588
424. Contract and Innovation: The Limited Role of Generalist Courts in the Evolution of Novel Contractual Forms (Gilson, Ronald J., Charles F. Sabel and Robert E. Scott) June 28, 2012, forthcoming in 87 N.Y.U. Law Review (April 2013)
In developing a contractual response to changes in the economic environment, parties choose the method by which their innovation will be adapted to the particulars of their context. These choices are driven centrally by the thickness of the relevant market and the uncertainty related to that market. In turn, the parties’ choice of method will shape how generalist courts can best support the parties’ innovation and the novel regimes they envision. In this Essay, we argue that contractual innovation does not comes to courts incrementally, but instead reaches the courts later in the innovation’s evolution and more fully fledged than the standard picture contemplates. Highly stylized, the trajectory of innovation in contract we find is this: Private actors respond to exogenous shocks in their economic environment by changing existing structures or procedures to make them efficient under the new circumstances. The innovating parties stabilize their newly emergent practices through a variety of regimes, both bilateral and multilateral, whose goal is to establish the context through which the innovation is implemented. It is only at this point that courts step in when a dispute is presented to them. If contract innovation does indeed reach generalist courts through the mediating institution of these contextualizing regimes, then our argument follows directly: If a central goal of contract adjudication is to enforce the context the parties have provided, then the courts’ willingness to defer to the context the parties give them will put the law more directly in the service of innovation. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2095714
423. A Precedent Built on Sand: NorCon v. Niagara Mohawk (Goldberg, Victor P.) June 28, 2012
Under the common law, a contracting party could only demand assurance of performance if the other party was insolvent. If a party had reasonable grounds for insecurity, the UCC §2-609 allowed it demand adequate assurance even if the counterparty were solvent. The Restatement (Second) adopted the same rule for non-goods. In NorCon v. Niagara Mohawk the New York court extended the adequate assurance doctrine for some non-goods contracts. Although the decision seems to imply that there is some relation between the NorCon facts and its conclusion as to the law, there is none. Relying primarily on material available to the court, this paper examines the contract, the context in which it was written, and the events precipitating Niagara Mohawk’s insecurity. While Niagara Mohawk’s insecurity was no doubt justified—NorCon would almost certainly have walked away from its obligation for the last ten years—the assurance question had been a major issue in negotiating this contract, and in similar contracts involving Niagara Mohawk and other public utilities. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2095410
422. The Micro, Macro and International Design of Financial Regulation (Mayer, Colin and Jeffrey N. Gordon) March 28, 2012
Regulation that is designed to enhance the stability of individual financial institutions, micro-prudential regulation, can create and exacerbate systemic instability. This is particularly true of detailed prescriptive rules about corporate governance which are prone to incorrect specification and the imposition of unwarranted homogeneity on the conduct of firms. They can create externalities where none previously existed. Harmonization of micro-prudential regulation across countries elevates this problem to a global level of financial instability and can be a source of, rather than, a cure for global financial crises. Regulation required to protect the financial system as a whole, macro-prudential regulation, is fundamentally different in nature from micro-prudential regulation. It seeks to identify, immunize, isolate and intervene in financial failures and, in contrast to micro-prudential regulation, it requires international harmonization across countries. The focus of harmonization to date has therefore been precisely the opposite of what is required to protect the financial system. In a systemic context, capital is of fundamental significance and the tax system should be employed to encourage banks to hold appropriate levels of capital. The capital provisions of individual institutions should be supplemented by reserves of central banks, the amounts being dependent on the systemically important banks under the central banks’ authority. Bail-ins of convertible debt should be triggered by systemic not individual institutional failures. Costs of intervention and moral hazard should be minimized by writing down debt and equity in failing institutions, and equity but not debt in second round institutions threatened by first round failures. Harmonization of macro-prudential regulation should be overseen by a global committee of central banks which ensures the correct designations of banks, adequate holdings of central bank reserves, and coordinated interventions organized around lead central banks. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2047436
421. Export Pioneers in Latin America (Sabel, Charles, Eduardo Fernandez-Arias, Ricardo Hausmann, Andres Rodriguez-Clare and Ernesto Stein) April 2012
Export Pioneers in Latin America analyzes a series of case studies of successful new export activities throughout the region to learn how pioneers jump-start a virtuous process leading to economic transformation. The cases of blueberries in Argentina, avocados in Mexico, and aircraft in Brazil illustrate how an initially successful export activity did not stop with the discovery of a single viable product, but rather continued to evolve. The book explores the conjecture that costly burdens to entrepreneurial self-discovery (due to the deterrent effects of imitation by competitors) have held back potential exporters in post-reform Latin America. It also considers the conjecture that new export activities are a complex enterprise that can only come to fruition when innovative contributions of many actors are somehow provided jointly. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2080388
420 The Future of European Company Law (Bockli, Peter, Paul L. Davies, Eilis Ferran, Guido A. Ferrarini, Jose M. Garrido Garcia, Klaus J. Hopt, Alain Pietrancosta, Katharina Pistor, Rolf Skog, Stanislaw Soltysinski, Jaap W. Winter, Eddy Wyjmeersch) May 1, 2012
This paper contains the views of the European Company Law Experts (ECLE) on the future of European company law. The paper accompanies the responses of the European Company Law Experts to the European Commission’s Consultation on the future of European Company Law of spring 2012. In the first part of the paper we set out our views on the objectives of European company law and in the following parts we discuss how the European Commission should proceed with rule making in the field of company law. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2075034
419. After the Great Recession: Regulating Financial Services for Low- and Middle-Income Communities (Mann, Ronald J.) March 21, 2012, Forthcoming 69 Wash. & Lee L. Rev. 0000 (2012)
This paper, prepared as a speech at Washington and Lee law school, discusses regulatory strategies for lending to LMI households after the Great Recession. It argues that the CFPB's emphasis on behavioral economics is likely to lead it astray, especially if it relies on assumptions drawn from experience with middle-class behavior to interfere with the choices made by LMI households that face a different set of opportunities than the middle-class households more familiar to regulators. More generally, the paper suggests that most of the financial distress faced by LMI households is a result of broader social and institutional problems, and that relatively little of it is caused by defects in the financial products available to those households. Thus, strategies that limit the financial products available to those households are more likely to exacerbate their difficulties than ease them. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2027095
418. American Finance and American Democracy: Towards an institutionalist "law and economics (Lothian, Tamara) January 30, 2012
This article reconsiders the financial and economic crisis of 2007-2009 and the present debate about the regulation of finance in the light of a vision of how finance can better serve the American economy and American democracy. The central claim is that regulation as conventionally understood cannot adequately redress the problems, and seize the opportunities, revealed by the crisis. We should approach financial regulation as the first step in a series of institutional innovations designed to put finance more effectively at the service of the real economy (financial deepening) while broadening economic opportunity in the country (financial democratization). I develop and defend this thesis by arguing for four subsidiary claims.
A first subsidiary claim is that a major part of the causal background to the crisis was an inconclusive hollowing out of the New Deal regime for the governance of finance. That regime failed to be replaced by an alternative coherent scheme. Instead, it gave way to a ramshackle compromise -- powerful, opaque, recalcitrant, and damaging. Such a situation -- I argue -- represents the rule rather than the exception in the history of law and institutions. The outcome of the hollowing out in the United States was a weakening of the links of finance to the real economy, paradoxically accompanied by the hypertrophy of the financial sector.
A second subsidiary claim is that the New Deal critics and reformers of finance, such as Louis Brandeis and William Douglas, were right in their intuition that a strong link exists between the legal and institutional requirements of financial deepening and of financial democratization.
A third subsidiary claim is that to make good on this intuition in today's circumstances we need a new agenda of reform with an explicit and ambitious institutional content. Such an agenda includes the transfer of sophisticated financial capabilities to the country's remarkable network of local banks as well as a vast expansion and popularization of financial services, channeling long-term saving into long-term productive investment.
A fourth subsidiary claim is that law and legal thought provide the chief storehouse of the ideas and methods needed to conceive and to implement such innovations.
Prevailing styles of economic theory, including those underlying the dominant practice of “law and economics,” remain largely bereft of institutional imagination.
This article illustrates how a revised practice of legal and institutional analysis can help fill this lacuna. In so doing, this piece takes "law and economics" in another direction. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1996653
417. Accepting the Limits of Tax Law and Economics (Raskolnikov, Alex) January 23, 2012
This Article explores the limits of tax law and economics. The inquiry is comparative. The Article argues that outside of the tax context two pivotal insights account for the general success of law and economics in explaining and possibly shaping the law. First, accepting just a few fairly simple and plausible assumptions yields clear, intuitive, powerful and widely applicable policy prescriptions. Second, the normative strand of law and economics benefits greatly from a substantial similarity between several theoretically optimal legal regimes and the corresponding actual systems of rules and sanctions. Neither insight applies in the tax setting because the tax optimization problem is uniquely complex. The optimal tax system must account for the impossibility of deterring socially undesirable behavior, provide for redistribution, and accomplish all of that on the basis of assumptions that are laden with deeply contested value judgments, pervasive empirical uncertainty, or both. Given these challenges, it is hardly surprising that the welfarist theory has a much weaker connection to the content of our tax laws and their enforcement than it does to the content and enforcement of many other legal regimes. This weakness has a profound effect on the debates about the fundamental features of our tax system. It affects many familiar arguments about anti-avoidance rules and sanctions. And it extends to evaluating outright tax evasion. In sum, every aspect of tax policy is affected by the limits of tax law and economics. At the same time, accepting these limits shifts focus to several broad research agendas where tax law and economics will continue to yield invaluable contributions to the project of improving our tax system. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1990430
416. Anticompetitive Regulation in the Payment of Card Industry (Mann, Ronald J.) Published in Competition Policy International, Fall 2011, Vol. 7, No. 2
The payment card industry in the United States has come under increasing scrutiny in recent years. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 reflects a high-water mark of congressional influence for the industry, altering bankruptcy procedures largely for the benefit of card issuers. Since that point, Congress has turned repeatedly to rein in perceived abuses in the industry. The most substantial and direct response to the perception of abuse is the Credit Card Accountability Responsibility and Disclosure Act of 2009. That statute was focused directly on the card industry and outlawed a wide variety of industry practices. More recently, in § 1075 (the “Durbin Amendment”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress cut permissible interchange fees for debit card transactions to amounts that approximate the costs of processing those transactions; the Federal Reserve’s implementing regulation apparently will lead to a more than 50 percent decline in those fees. So why is it at all noteworthy that Congress, in the course of reining in an industry targeted for excessive behavior, should require substantial changes in the industry’s operations? My hypothesis is a simple one. Both provisions make it more challenging to operate profitably in the payment card market. Because both provisions will pose greater challenges for smaller firms than they do for larger firms, both statutes will make it harder for smaller banks to compete in the payment card market. It may not be easy to evaluate the consequences of greater concentration in the industry. But it is clear that industry concentration is not what drove Congress to action: whatever else Congress was trying to do, it certainly was not trying to drive small banks from the payment card market. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1988408
415. Taxation of Financial Products: Options for Fundamental Reform (Raskolnikov, Alex) Tax Notes, Vol. 133, No 12, 2011
The following is testimony to the joint hearing of the House of Representatives Committee on Ways and Means and the Senate Committee on Finance. The testimony discusses three benchmarks for evaluating the taxation of capital income in general and financial instruments in particular, summarizes three broad-based approaches to reforming the tax treatment of financial products, evaluates the impact of other fundamental reforms on the urgency of reforming the taxation of derivatives, and urges Congress to encourage the IRS to make detailed tax return data available for empirical research of revenue costs and other losses arising from derivatives-based tax planning. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1975152##
414. The Political Economy of Dodd-Frank: Why Financial Reform Tends to Be Frustrated And Systemic Risk Perpetuated (Coffee,Jr. John C.) January 2012
Several commentators have argued that financial “reform” legislation enacted after a market crash is invariably flawed, results in “quack corporate governance” and “bubble laws,” and should be discouraged. This criticism has been specifically directed at both the Sarbanes-Oxley Act and the Dodd-Frank Act. This article presents a rival perspective. Investors, it argues, are naturally dispersed and poorly organized and so constitute a classic “latent group” (in Mancur Olson’s terminology). Such latent groups tend to be dominated by smaller, but more cohesive and better funded special interest groups in the competition to shape legislation and influence regulatory policy. This domination is interrupted, however, by major crises, which encourage “political entrepreneurs” to bear the transaction costs of organizing latent interest groups to take effective action. But such republican triumphs prove temporary, because, after the crisis subsides, the hegemony of the better organized interest groups is restored. As a result, a persistent cycle that this article calls the “Regulatory Sine Curve” can be observed: the legislative success of the latent investor group is followed by increasingly equivocal implementation of the new legislation, tepid enforcement, and eventual legislative erosion. This article traces that pattern with respect to both the Sarbanes-Oxley Act and the ongoing implementation of the Dodd-Frank Act. This article does not deny that “reform” legislation often contains flaws (as does much deregulatory legislation). But these are usually quickly eliminated in the latter half of the cycle. The greater dilemma is instead whether the problem of systemic risk can be satisfactorily addressed in the presence of the Regulatory Sine Curve. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1982128
413. Law by Non Sequitur: Norcon v. Niagara Mohawk (Goldberg, Victor P.) December 20, 2011
Under the common law, a contracting party could only demand assurance of performance if the other party was insolvent. If a party had reasonable grounds for insecurity, the UCC §2-609 allowed it demand adequate assurance even if the counterparty were solvent. The Restatement (Second) adopted the same rule for non-goods. In NorCon v. Niagara Mohawk the New York court extended the adequate assurance doctrine for some non-goods contracts. Although the decision seems to imply that there is some relation between the NorCon facts and its conclusion as to the law, there is none. Relying primarily on material available to the court, this paper examines the contract, the context in which it was written, and the events precipitating Niagara Mohawk’s insecurity. While Niagara Mohawk’s insecurity was no doubt justified — NorCon would almost certainly have walked away from its obligation for the last ten years — the assurance question had been a major issue in negotiating this contract, and in similar contracts involving Niagara Mohawk and other public utilities. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1979737
412. Rethinking Finance Through Law: A Theoretical Perspective, (Lothian, Tamara) November 21, 2011
Finance is traditionally studied by lawyers as well as by economists on the basis of the premise that a market economy has, at its core, a single natural and necessary institutional form, expressed, for example, in the basic rules and doctrines of contract and property. The literature about "varieties of capitalism" has proved insufficient to challenge this assumption. A corollary of this premise is the view that, barring particular market defects, a market economy can be counted on to channel the savings of society to its most efficient possible uses. The first task of regulation is supposedly to redress such localized flaws in competitive resource allocation. This brief text outlines the rudiments of another way of thinking about finance. It does by advancing a series of connected propositions. Under prevailing institutions, finance has become evermore decoupled from the real economy. The production system remains largely self-financed on the basis of the retained and reinvested earnings of private firms. Financial intermediation is substantially self-directed, oriented to asset trading and position taking by highly leveraged financial institutions, supported by accommodating monetary and regulatory policies. It need not be this way. A series of innovations in our present institutions and practices can greatly enhance the usefulness of finance and mitigate its dangers. Regulation, as conventionally understood and practiced, is not enough. Regulation, better oriented, can represent a first step toward institutional reorganization. The reorganization of finance should in turn be judged by the standard of its service to broader aims. The most important proximate aim is to increase the likelihood that finance will serve the productive agenda of society rather than serving only itself. One ulterior purpose is to enhance the contribution of finance to socially inclusive economic growth: the most widely professed political-economic objective in the world today. Another is to organize finance in ways that favor active rather than passive globalization: the engagement of a national economy with the world economy without abandonment of its capacity to implement a distinctive strategy of national development and to establish the institutional arrangements that the strategy may require. Such arrangements are likely to contradict the institutional formulas preferred by the interests and ideas prevailing in the great powers of the day. A crucial test of every program of reform is success in establishing the institutional vehicles that the program needs. This imperative gives reason to re-invent comparative law as a handmaiden of institutional innovation. Institutional details matter. They exist only as law. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1962843
411. Beyond Macro-prudential Regulation: Three Ways of Thinking about Financial Crisis, Regulation and Reform, (Lothian, Tamara) November 17, 2011
This paper considers the debate about the "macro-prudential regulation" of finance in the context of a broader view of the relation of finance to the real economy. Five ideas are central to the argument. The first idea is that the two dominant families of ideas about finance and its regulation share a failure of institutional imagination. Neoclassical economists blame localized market and regulatory failures for the troubles of finance. Keynesians invoke the way in which the money economy may amplify cycles of despondency and euphoria. Neither current of thought recognizes that the institutions of finance in particular, and of the market economy in general, can take different forms, with different consequences for the organization of production and exchange as well as for distribution. The second idea is that, under present arrangements, finance readily becomes the master rather than the servant of the real economy and lays itself open to recurrent booms and busts. The third idea is that present arrangements can be reformed in ways that more effectively put finance at the service of the productive agenda of society. The fourth idea is that the regulation of finance, including what we now call macro-prudential regulation, can and should be designed as initial moves in such an institutional reshaping. The fifth idea is that neoclassical and Keynesian conceptions are inadequate guides to the execution of this task. We can find in law and legal thought many of the intellectual and practical tools that we need. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961369
410. Introduction: The Three and a Half Minute Transaction: Boilerplate and the Limits of Contract Design, (Gulati, G. Mitu and Robert E. Scott) October 18, 2011
The Hofstra Law Review has organized an “Ideas” symposium around our book manuscript “The Three and a Half Minute Transaction” (see http://ssrn.com/abstract=1937900). The idea for this symposium came from a debate that occurred at a faculty workshop at the Hofstra Law School some months ago where we were presenting our book manuscript. The topics of conversation included the following: the future of the current big-law-firm model, what value lawyers add in commercial transactions that use boilerplate contracts, why (and whether) boilerplate contracts are so slow to change, why law firms do not generally have R&D departments, the resolution of the Eurozone sovereign debt crisis and more. The Essays in this symposium are from an exceptional group of scholars and practitioners and we are honored that they use our manuscript as their jumping off point to tackle some of the topics mentioned. What we provide here is a brief introduction to the manuscript itself. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1945988
409. We are the (National) Champions: Understanding the Mechanisms of State Capitalism in China (Lin, Li-Wen and Curtis J. Milhaupt) November 1, 2011
While China appears to present a new variety of capitalism, frequently labeled "state capitalism," the features of this system - particularly the organizational structure surrounding China’s most important state-owned enterprises (the national champions) - remains a black box. Corporate governance scholarship on China has focused on listed firms, but listed SOEs in China are nested in vertically integrated corporate groups, and the groups are strategically linked to other business groups, as well as to the Communist Party and to governmental organs. While the parent company of the listed firms has a governmental controlling shareholder in the form of an agency called SASAC, deconstruction of this agency’s control rights reveals that it has both less and more power than controlling shareholders in other regimes. Unpacking the black box of Chinese state capitalism requires moving away from the standard focus on agency costs in listed firms that predominates in the corporate governance literature. Instead, we analyze the relational ecology that fosters production in a system where all roads eventually lead to the party-state. We introduce two analytical constructs to understand key features of industrial organization in China’s state-owned sector: "Networked hierarchy" is our term for the way top-down governance features within individual state-controlled corporate groups are matched with strategic linkages to other state-controlled institutions. "Institutional bridging" is our term for the widespread use of systematized fasteners uniting separate components of the system. We argue that networked hierarchies and institutional bridges have been used in China to assemble what Mancur Olson called an "encompassing organization" - a coalition whose members own so much of society that they have important incentives to be actively concerned about how productive it is. Exposing the mechanisms of state capitalism refocuses several scholarly debates in which China is conspicuous by its absence, including the law and finance literature and the debate over convergence in corporate governance systems. It also raises a question whose salience increases as the global interaction of Chinese firms expands: What forces have the potential to change the current institutional trajectory of corporate capitalism in China? http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1952623
408. Fiscal Policy in an Era of Austerity (Schizer, David M.) October 17, 2011
We face a time of stagnant economic growth, severe unemployment, massive budget deficits, and an increasingly competitive global economy. Monetary policy is tapped out, and there is a great deal of uncertainty about the effectiveness of a traditional Keynesian stimulus – and, not surprisingly, a heated debate among economists. One thing we do know is that a stimulus is quite difficult to execute effectively. For example, it is a challenge to identify “shovel ready” projects that contribute to long-term economic growth, particularly on short notice. There is no uncertainty, though, about the need to address a broad range of specific problems contributing to our economic woes. As an illustrative example, this Article emphasizes the perils of having the highest corporate tax rate in the Organisation for Economic Co-operation and Development (“OECD”) in a competitive global economy. Cutting our corporate tax rate will encourage businesses to invest and hire more employees, while also reducing incentives to engage in wasteful tax planning and to shift taxable income and jobs overseas. In addition to these problems with our substantive law, we also face problems of process that are undercutting our government’s effectiveness. An important (and familiar) one is that politicians are consistently tempted to accommodate organized interest groups, especially if the costs of these favors can be quietly passed on to the general public. This is all the more true if special interest deals can be financed with deficit spending, so that the bill will not come due until long after our current political leaders have retired. Various measures can constrain this familiar political dynamic, and this Article sketches three strategies as illustrative examples. First, we should make the costs of special interest deals more visible through better budgetary accounting. Second, we should enlist specific institutions within our government to target waste and pork. For example, we should empower special House and Senate committees to cut particular budget items or, alternatively, to sever them from the rest of the budget and subject them to a separate public vote. Third, we should create stronger institutional barriers to deficit spending. Scarcity focuses the mind, so that our leaders will have greater incentive to reject initiatives that are not cost-justified. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1948692
407. The Three and a Half Minjute Transaction: Boilerplate and the Limits of Contract Design (Gulati, G. Mitu and Robert E. Scott) October 5, 2011
Theory tells us that the lawyers who draft standard-form contracts will respond to an erroneous court interpretation of a boilerplate contract term by revising the standard formulation of the clause or otherwise clarifying the ambiguity. This is so because lawyers, it is assumed, have the incentive to protect clients from the risk that other courts may adopt the disfavored interpretation or that the apparent ambiguity will, in any event, produce future costly litigation. As many scholars have observed, the reality is often different. Boilerplate terms in standard contracts are sticky. Many of the theories explaining why standard contract terms are resistant to innovation focus on the efficiency benefits of market-wide standardization. Others look to economic or psychological factors that deter the production of innovative terms. In this book, we use both qualitative and quantitative data to explore the reasons for the phenomenon of stickiness in sovereign bond contracts. We focus on a novel judicial interpretation of an obscure clause in cross-border financial contracts--the pari passu clause—that rattled the chandeliers of international finance. One might have expected the practicing bar to quickly clarify their forms before the heresy could spread and gain traction. But that didn’t happen. In over 90% of the contracts subsequently issued, no attempt was made to clarify the imprecise language of the clause. None of the extant theories of stickiness explain what we find. Rather, the story that emerges is about the modern big law firm: the financial pressure on big firms to maintain a high volume of transactions contributes to an array of conflicts that that deter innovation and are largely hidden from the individual lawyers charged with drafting responsibility—conflicts that are hidden in part by the myths that the members of this legal community collectively tell themselves about the origins of boilerplate terms whose meaning has been lost in time. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1937900
406 Fragmentation Nodes: A Study in Financial Innovationm, Complexity and Systemic Risk, (Judge, Kathryn)
This article presents a case study in how complexity arising from the evolution and proliferation of a particular financial innovation increases systemic risk. The subject of the case study is the securitization of home loans, an innovation which played a critical and still not fully understood role in the 2007-2009 financial crisis. The article introduces the term “fragmentation node” for these transaction structures, and it shows how specific sources of complexity inherent in fragmentation nodes limited transparency and flexibility in ways that undermined the stability of the financial system. In addition to shedding new light on the processes through which financial innovations become so complex and how that complexity contributes to new sources of systemic risk, the article considers the tools regulators will need to tackle these sources of systemic risk. The policy analysis shows that disclosure, a tool commonly used in financial regulation, will not suffice. It argues that, at times, regulators should also seek to reduce the length and complexity of the chain connecting investor and investment. It suggests some modest steps regulators could have taken prior to the 2007-2009 financial crisis, such as a transaction tax targeting serial fragmentation nodes, to illustrate how such reforms might work in practice. The article also explains why the dynamics revealed in this case study are almost certain to arise again, even if slightly different form. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1894105
405. The Law and Economics of Blockholder Disclosure (Bebchuk, Lucian A. and Robert J. Jackson, Jr.)
This paper, which is based on our recent submission to the Securities and Exchange Commission, provides a detailed analysis of the policy issues relevant for the Commission’s ongoing examination of changes to its rules under Section 13(d) of the Securities Exchange Act of 1934. These rules, which govern share accumulation and disclosure by blockholders, are the subject of a recent rulemaking petition submitted by Wachtell, Lipton, Rosen and Katz, which proposes that the rules be tightened. We argue that the Commission should not view the proposed tightening as merely “technical” changes needed to modernize its Section 13(d) rules. In our view, the proposed changes should be examined in the larger context of the beneficial role that outside blockholders play in American corporate governance and the broad set of rules that apply to such blockholders. Our analysis proceeds in five steps First, we describe the significant empirical evidence indicating that the accumulation and holding of outside blocks in public companies benefits shareholders by making incumbent directors and managers more accountable and thereby reducing agency costs and managerial slack. Second, we explain that tightening the rules applicable to outside blockholders can be expected to reduce the returns to blockholders and thereby reduce the incidence and size of outside blocks - and, thus, blockholders’ investments in monitoring and engagement, which in turn may result in increased agency costs and managerial slack. Third, we explain that there is currently no empirical evidence to support the Petition’s assertion that changes in trading technologies and practices have recently led to a significant increase in pre-disclosure accumulations of ownership stakes by outside blockholders. Fourth, we explain that, since the passage of Section 13, changes in state law — including the introduction of poison pills with low-ownership triggers that impede outside blockholders that are not seeking control - have tilted the playing field against such blockholders. Finally, we explain that a tightening of the rules cannot be justified on the grounds that such tightening is needed to protect investors from the possibility that outside blockholders will capture a control premium at other shareholders’ expense. We conclude by recommending that the Commission to pursue a comprehensive examination of the rules governing outside blockholders and the empirical questions raised by our analysis. In the meantime, the Commission should not adopt new rules that tighten restrictions on outside blockholders. Existing research and available empirical evidence provide no basis for concluding that tightening the rules governing outside blockholders would satisfy the requirement that Commission rulemaking protect investors and promote efficiency, and indeed raise concerns that such tightening could harm investors and undermine efficiency. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1884226
404. Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide (Mayer, Christopher, Edward Morrison, Tomasz Piskorski and Arpit Gupta) May 9, 2011
We investigate whether homeowners respond strategically to news of mortgage modification programs. We exploit plausibly exogenous variation in modification policy induced by U.S. state government lawsuits against Countrywide Financial Corporation, which agreed to offer modifications to seriously delinquent borrowers with subprime mortgages throughout the country. Using a difference-in-difference framework, we find that Countrywide's relative delinquency rate increased thirteen percent per month immediately after the program's announcement. The borrowers whose estimated default rates increased the most in response to the program were those who appear to have been the least likely to default otherwise, including those with substantial liquidity available through credit cards and relatively low combined loan-to-value ratios. These results suggest that strategic behavior should be an important consideration in designing mortgage modification programs. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1836451
403. Dictionaries Fail: The Volcker Rule's Reliance on Definitions Renders it Ineffective and a New Solution is Needed to Adequately Regulate Proprietary Trading. (Chatterjee, R. Rex) June 2, 2011 Published, Winter 2011, Brigham Young University International Law and Management Review
In the wake of the recent financial crisis, Congress has sought to regulate the proprietary trading activities of Wall Street banks. The Volcker Rule, passed into law as section 619 of the Dodd-Frank Act, bans proprietary trading for deposit-taking banks and bank holding companies with deposit-taking subsidiaries or affiliates. It nevertheless allows these institutions to continue to trade on behalf of customers, a category of transactions necessary for the healthy functioning of both the US and global financial systems. The rule proposes that regulators devise rules to distinguish between permissible, often client-facing, trades and impermissible proprietary trades. The rules themselves rely on definitions and metrics to form bright-line distinctions. The thesis of this paper is that such a system is doomed to failure. The paper analyzes the regulation of banking entities under the Glass-Steagall Act of 1933 in order to demonstrate the successful separation of proprietary trading from deposit-taking institutions' Fed window access through a structure-based regulatory regime that separated investment banks from commercial banks. The paper acknowledges arguments that a return to a regime of discrete structures for banking entities is infeasible given the rise of modern financial institutions after the passage of the Gramm-Leach-Bliley Act of 1999, and gives this as a reason that the Volcker Rule instead focuses on transactions rather than institutional structure. The paper concludes with the proposition of an alternative regulatory plan which would sidestep the problem-laden task of attempting to distinguish proprietary from non-proprietary trading on a bright-line basis and instead would focus on regulating all sales and trading activities together on a structural level. It would cleave trading operations from the banking entities' structures and force them into separate subsidiary entities with capitalization, ownership and other characteristics engineered to isolate traders from the moral hazard of Fed discount window access and to shackle the continuance of their client-serving operations to the risks they take in their proprietary books. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1857371
402. Virtue Ethics and Efficient Breach (Katz, Avery W.) March 19, 2011, Forthcoming, Suffolk University Law Review
The concept of “efficient breach” - the idea that a contracting party should be encouraged to breach a contract and pay damages if doing so would be more efficient than performance – is probably the most influential concept in the economic analysis of contract law. It is certainly the most controversial. Efficient breach theory has been criticized from both within and without the economic approach, but the most prominent criticism is that it violates deontological ethics - that the beneficiary of a promise has a right that it be performed, so that breaching the promise wrongs the promisee. This essay argues that this criticism is misplaced, and that efficient breach theory, properly understood, is entirely consistent with parties’ complying with their deontological obligations. Instead, the intuitive resistance that most people experience to the concept may be better explained by aretaic concerns - specifically, that failing to complete a contractual relationship is not conducive to virtuous character or to the maintenance of a flourishing community. While efficient breach can be squared with deontological ethics, it cannot be squared with virtue ethics unless one is prepared to argue that seeking efficiency is a virtue, or at least that it is not a vice. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1845703
401. Dodd-Frank for Bankruptcy Lawyers (Baird, Douglas G. and Edward Morrison) July 25, 2011
The Dodd-Frank financial reform legislation creates an “Orderly Liquidation Authority” (OLA) that shares many features in common with the Bankruptcy Code. This is easy to overlook because the legislation uses a language and employs a decision-maker (both borrowed from bank regulation) that will seem foreign to bankruptcy lawyers. Our task in this essay is to identify the core congruities between OLA and the Code. In doing so, we highlight important differences and assess both their constitutionality and policy objectives. We conclude with a few thoughts on the likelihood that OLA will contribute to market stability. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1895692