We enjoyed a great lineup of speakers and cutting edge scholarship here in Boulder this past semester as part of CU’s Business Law Colloquium. The following papers make for excellent start-of-the-summer reading:
Dan Katz (Michigan State): Quantitative Legal Prediction – or – How I Learned to Stop Worrying and Start Preparing for the Data Driven Future of the Legal Services Industry: a provocative look at Big Data will help clients analyze everything from whether to bring or settle a lawsuit to how to hire legal counsel. Katz examines implications for legal education.
Rob Jackson (Columbia): Toward a Constitutional Review of the Poison Pill (with Lucian Bebchuk): Jackson and Bebchuk kicked a hornet’s nest with their argument that some state antitakeover statutes (and, by extension, poison pills under those statutes) may be preempted by the Williams Act. See here for the rapid fire response from Martin Lipton.
Brad Bernthal (Colorado): What the Advocate’s Playbook Reveals About FCC Institutional Tendencies in an Innovation Age: my co-teacher interviewed telecom lawyers to map out both their strategies for influencing the Federal Communications Commission and what these strategies mean for stifling innovation in that agency.
Kate Judge (Columbia): Intermediary Influence: Judge examines the mechanisms by which intermediaries – both financial and otherwise – engage in rent-seeking rather than lowering transaction costs for market participants. The paper helps explain everything from Tesla’s ongoing fight with the Great State of New Jersey to sell cars without relying on dealers to entrenchment by large financial conglomerates.
Lynn Stout (Cornell): Killing Conscience: The Unintended Behavioral Consequences of 'Pay For Performance': Stout argues that pay for performance compensation in companies undermines ethical behavior by framing choices in terms of monetary reward. This adds to the growing literature on compliance which ranges from Tom Tyler’s germinal work to Tung & Henderson, who argue for adapting pay for performance for regulators.
Steven Schwarcz (Duke): The Governance Structure of Shadow Banking: Rethinking Assumptions About Limited Liability: Schwarcz argues for imposing additional liability on the “owner-managers” of some shadow banking entities to dampen the moral hazard and excessive risk taking by these entities, which contributed to the financial crisis. This paper joins a chorus of other papers arguing to using shareholder or director & officer liability mechanisms to fight systemic risk. (See Hill & Painter; Admati, Conti-Brown, & Pfleiderer; and Armour & Gordon).
[I’ll inject myself editorially on this one paper: this is a provocative idea, but one that would make debt even cheaper relative to equity than it already is. This would encourage firms to ratchet up already high levels of leverage. I looked at the expansion of limited liability in Britain in the 18th Century in Chapter 2 of my book. The good news for Schwarcz’s proposal from this history: expansions of limited liability seem to have coincided and contributed to the booms in the cycle of financial crises in that country that occurred every 10 years in that country. The bad news: unlimited liability for shareholders does not seem to have staved off crises and likely contributed to the contagion in the Panic of 1825.]
The CU Business Law Colloquium also heard from Gordon Smith (BYU), Jim Cox (Duke), Sharon Matusik (Colorado – Business), Afra Afsharipour (UC Davis), Jesse Fried (Harvard), and Brian Broughman (Indiana). Their papers are not yet up on ssrn.
After the jump, is the program for the AALS Mid-year Meeting on Corporate and Financial Law in Washington, D.C. from June 7-9. If you register (site restricted) and attend, make sure to stay until the fireworks at the very last panel!
Saturday, June 7, 2014
4:00 - 8:00 p.m.
6:00 - 7:30 p.m.
Sunday, June 8, 2014
8:45 - 9:00 a.m.
Judith Areen, AALS Executive Director, Chief Executive Officer
Joan M. Heminway, Chair, Planning Committee for AALS Workshop on Blurring Boundaries in Financial and Corporate Law and The University of Tennessee College of Law
9:00 - 9:30 a.m.
Donald C. Langevoort, Georgetown University Law Center
9:30 a.m. - 12:00 p.m.
Sessions on Research
Recent appraisals of the state of legal education have raised questions about the value of legal scholarship. Yet, most law scholars believe that their work contributes meaningfully to important theoretical and policy-oriented discussions-including those involving financial and corporate law. What is the relevance and overall value of legal scholarship in financial and corporate law in an era of blurred and blurring boundaries? What methodologies, forms of scholarly output, and publication venues most effectively and efficiently reach the target audiences for financial and corporate law scholarship? This segment of the program focuses on these and other questions relating to research and writing in financial and corporate law as a matter of current and desired future practice.
Specifically, the segment features a two-part approach to questions involving research in the context of unclear substantive demarcations in financial and corporate law. The first part is a plenary panel discussion, and the second part is a series of small-group networking sessions. More detailed descriptions of each are set forth below.
9:30 -10:45 a.m.
Research Plenary Panel
Robert P. Bartlett, III, University of California, Berkeley School of Law
Jill E. Fisch, University of Pennsylvania Law School
Claire A. Hill, University of Minnesota Law School
The prevalence of economic analysis is one element that unites legal scholarship across the many areas of business law. Scholars in the various business law fields of endeavor (e.g., business associations, securities regulation, financial institutions, insurance) have used other disciplines and methodological approaches to a far lesser extent. Do we have the right mix of interdisciplinarity to most effectively respond to current challenges involving financial and corporate law? How, if at all, do traditional legal scholars re-tool to address any perceived need for interdisciplinary research that engages academic disciplines outside their areas of expertise (or areas of expertise in which their knowledge is superficial or outdated)?
This panel explores the capacity of a variety of methodologies and disciplines to enrich the study of financial and corporate law in an era of blurring substantive and regulatory boundaries. The panel also addresses cutting edge questions and controversies regarding blurring boundaries in particular research traditions. The panel comprises scholars who use different quantitative and qualitative analytical methods in their work. The panel is designed to allow these scholars to discuss techniques and tools they use and to yield valuable insights into questions that cut across financial and corporate law, such as the behavior of consumers, investors, financial institutions (and the individuals who work inside them), lawyers, and regulators.
10:45 - 11:00 a.m.
11:00 a.m. - 12:00 p.m.
Research Small Group /Networking Sessions
Michelle M. Harner, University of Maryland Francis King Carey School of Law
Christine Hurt, University of Illinois College of Law
Anne M. Tucker, Georgia State University College of Law
Others to be announced.
This part of the program is designed to offer participants the opportunity to share their thoughts on blurred lines in financial regulation research. Topics will vary from session to session but may include: how individual research approaches and methods have changed and are changing; how law academics keep up with emerging research approaches and methods-e.g., where research content is now found and how it is processed; whether (and, if so, how) individuals with different substantive law and research backgrounds "talk" to each other to help bridge gaps; and what optimal work product outcomes look like as substantive and regulatory lines continue to blur. Facilitators will report out the ideas from their sessions.
12:00 - 1:30 p.m.
Elizabeth Warren, U.S. Senator for Massachusetts (Invited)
1:45 - 5:00 p.m.
Associated legal and regulatory challenges and changes force us to reconsider our pedagogy and the business law curriculum in very fundamental ways. Structuring courses and choosing and employing effective teaching tools are, of course, part of the discussion. But teaching financial and corporate law in an era of blurring boundaries also engages larger issues, such as the role of different types of courses (e.g., clinics, practicums, externships, field placements, simulation courses) and pedagogies in teaching business law courses. Also important are pedagogical methods geared to develop the financial literacy, numeracy, and professional values that students concentrating in financial and corporate law should have when they graduate from law school. Finally, it seems that it would be beneficial to address the value for law students, if any, in joint degree (e.g., JD/MBA) and advanced degree (LLM, Masters in Law, Juris Masters, etc.) programs and the overall place and prominence of financial and corporate law in the current and future program of legal education in the United States. The program is designed to involve a significant amount of "show and tell," rather than predominantly focusing on traditional academic presentations.
1:45 - 3:00 p.m.
Teaching Plenary Panel
William A. Birdthistle, Chicago-Kent College of Law, Illinois Institute of Technology
James A. Fanto, Brooklyn Law School
Edward J. Janger, Brooklyn Law School
John Henry Schlegel, University at Buffalo Law School
David A. Westbrook, University at Buffalo Law School
This panel, populated with presenters culled from a call for proposals, explores the challenges and opportunities for legal educators in an era of blurring substantive and regulatory boundaries. A range of possible teaching methods and tools can assist in the task. But difficult questions exist as to how to best use these methods and tools in individual courses and across the curriculum-in and outside business law teaching. Course selection and curricular options (including those external to the standard Juris Doctor courses and curriculum) deserve important consideration at both the individual (student and faculty) and institutional levels. The panel is designed to allow academics specializing in financial and corporate law to discuss these and other issues relevant to educating business law students in light of blurring financial and corporate law boundaries.
3:00 - 3:15 p.m.
3:15 - 5:00 p.m.
Teaching Concurrent Sessions
This portion of the program features concurrent sessions on teaching led by law faculty chosen from a call for proposals. Each session has a different topical focus and is offered twice-once in each breakout period. Accordingly, each attendee has the opportunity to attend two sessions, each on a different topic. These sessions are designed to involve significant interaction between the selected discussion leader and the attendees.
3:15 - 3:45 p.m.
Consumer Protection Clinicas as a Site for Blurring Boundaries
Bryan L. Adamson, Seattle University School of Law
Teaching Banking Law
Mehrsa Baradaran, University of Georgia School of Law
A Multi-Disciplinary Approach to Real Estate Investment and Finance Law
Andrea Boyack, Washburn University School of Law
Teaching the Federal Reserve in Law School: Crossing Disciplines, Paradigms and Vantage Points
Timothy A. Canova, Nova Southeastern University, Shepard Broad Law Center
From the Balance Sheet to Beta: A Hands-On Approach to Teaching Accounting & Finance Concepts
Virginia Harper Ho, University of Kansas School of Law
3:45 - 4:15 p.m.
Repeat of Concurrent Session Presentations
4:15 - 5:00 p.m.
5:30 - 6:30 p.m.
Monday, June 9, 2014
9:00 - 10:15 a.m.
Complexity Plenary Panel
Henry T. Hu, The University of Texas School of Law
Kristin N. Johnson, Seton Hall University School of Law
Tom C.W. Lin, University of Florida Fredric G. Levin College of Law
Saule T. Omarova, University of North Carolina, School of Law
Modern financial markets, as well as the firms that operate within these markets, have become increasingly complex over the last several decades. This trend is attributable to various developments, including the accelerating sophistication of technology, the increasing size of firms, the more heterogeneous and sophisticated needs of users of financial services, and the inevitable desire of firms to seek out regulatory gaps. This ever-growing complexity creates a broad set of new challenges for law and regulation. For instance, complexity may confound the efforts of regulators to monitor financial markets for systemic risk or to erect rules to prevent or mitigate that risk. Similarly, it can frustrate the capacity of law to promote more informed consumer and investor protection tools such as disclosure or financial literacy education. Increasing complexity also raises new challenges about the optimal modes of regulation: according to some, it demands greater reliance on regulatory approaches such as self-governance or "new governance," while others argue that it may counter-intuitively necessitate simpler and blunter rules. Finally, market and firm complexity complicates the targets of regulation, which now consists not only of banks, insurers and broker-dealers, but also shadow banks, hedge funds, and participants in derivatives markets.
10:15 - 10:30 a.m.
10:30 a.m. - 12:00 p.m.
Modern Regulatory Approaches
Historically, scholars have studied law and regulation within a particular substantive area, such as banking, corporate, insurance, or securities regulation. However, modern regulatory approaches frequently require knowledge of multiple topics and raise challenges that cut across different areas of legal study. These two concurrent sessions will feature four approaches to understanding modern regulation, each led by a scholar whose work has been focused in the area.
Regulatory arbitrage and cost-benefit analysis are issues that cut across many areas of modern regulation. Many costly rules create incentives for parties to transact in ways that are economically equivalent, but lead to differential regulatory treatment. Both regulators and courts increasingly are required to, and do, use cost-benefit analysis to justify new regulation.
10:30 - 11:15 a.m.
Modern Regulatory Approaches Concurrent Session #1
Jordan M. Barry, University of San Diego School of Law (confirmed)
Modern Regulatory Approaches Concurrent Session #2
Yoon-Ho Alex Lee, University of Southern California Gould School of Law (confirmed)
11:15 a.m. - 12:00 p.m.
Modern Regulatory Approaches Concurrent Session #1
Adam J. Levitin, Georgetown University Law Center (confirmed)
Modern Regulatory Approaches Concurrent Session #2
Dana Brakman Reiser, Brooklyn Law School (confirmed)
12:00 - 1:30 p.m.
Daniel K. Tarullo, Governor, Board of Governors, Federal Reserve System, Washington, DC
1:30 - 3:00 p.m.
New Frontiers: Innovation, Competition and Collaboration in International Financial Markets
Wulf Kaal, University of St. Thomas School of Law
Eric J. Pan, Associate Director, Office of International Affairs, U.S. Securities and
Exchange Commission, Washington, DC
Roberta Romano, Yale Law School
Innovation and the mobility of capital have changed global financial markets in profound and consequential ways. Advances in technology and developments in the infrastructure of financial markets have engendered new levels of interconnectivity. The creation of new financial products, the increasing prominence of market participants such as private equity and hedge funds, and the birth of complex trading strategies (namely algorithmic and high-frequency trading); have permanently altered the landscape of financial markets. Operating in this new frontier, significant financial institutions face historically unparalleled vulnerabilities. The financial crisis of 2008 demonstrated the broad range of concerns that challenge government efforts to regulate financial markets.
Responding to the crisis, authorities propose a diverse array of regulatory reforms. For example, the U.S. Congress and regulators have adopted an aggressive and extraterritorial policy governing domestic and international over-the-counter derivatives, creating a Financial Stability Oversight Council and articulating formal processes to address the insolvency of an international financial market conglomerate. In addition, the highly debated and not-yet-finalized Volker Rule promises to reduce excessive risk taking by systemically important financial institutions and minimize the likelihood of future crises. Other countries' proposed solutions take a different tack, adopting Vickers- and Liikanen-style "ring-fencing" policies. The trend toward diversity in regulatory approaches overshadows central bankers' collaborative efforts to craft, implement and enforce the third round of Basel accords.
The debate over uniformity or diversity in regulation provides a forum for evaluating the merits of these various regulatory approaches and the domestic and international actors who inform the discussion. Questions arising from the debate explore the value of efforts to adopt uniform regulatory approaches; the contributions of international regulatory bodies and trade organizations such as the BIS, the G-20, and IOSCO; the benefits and shortcomings of microprudential policies governing banking institutions; and the limits that political accountability and legitimacy pose for each of the governments whose regulatory policies may heighten or mitigate the potential for future financial crises.
3:00 - 3:15 p.m.
3:15 - 4:45 p.m.
Political Dynamics Plenary Panel
Erik F. Gerding, University of Colorado School of Law
M. Todd Henderson, The University of Chicago, The Law School
Steven Ramirez, Loyola University Chicago School of Law
Hillary A. Sale, Washington University in St. Louis School of Law
Financial and corporate regulation no longer fits within the comfortable regulatory silos so familiar to scholars of previous decades. The efforts to design and implement new regulatory structures after the financial crisis are taking place in sometimes unfamiliar political cross-currents that reshape prior theories. This plenary panel will address the political dynamics of financial and corporate law in contexts framed by a series of important questions: Have financial and corporate law become more political (e.g. the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Jumpstart Our Business Startups Act within 20 months of each other)? Have the roles of courts, legislators, the president, and independent agencies changed and what should those roles be, (with the Citizens United, Business Roundtable, and American Petroleum cases as recent relevant examples)? How has the blurred world of financial and corporate law changed? Who are the constituencies to be considered in evaluating these laws? For example, whose primacy should be our focus and is there new space for occupiers, crowds, and those pursuing social benefit enterprises? Does globalization stress our traditional reliance on state regulation and complicate our existing theories of political economy?
Oops, says BofA, we messed up our capital calculations. We don't have as much money on hand for shocks or emergencies as we thought. Since that's the principal thing that banking regulators care about, you might wonder what happens to banks who do this. Perhaps it would be interesting to consider some alternatives, might offer a sense of what bank supervision does and doesn't involve these days.
- The Fed could prosecute BofA executives for fraud. Call that the securities regulator/white collar approach. One problem, fraud must be intentional, so this would have to be not an error, but at the very least some sort of reckless accounting. It punishes individuals in management who contributed to the fraud.
- The Fed/FDIC could revoke their license or pull the inspectors. This is the USDA approach. The problem is that it is too nuclear - both of those things would shut down a bank that is far too big to fail.
- The Fed could fine them. This is the money laundering approach, and those fines are often imposed not just for tolerating the laundering of money, but for having inadequate controls in place to prevent it. We may see a fine here, BofA is pretty much saying that it had inadequate controls in place by acknowledging that it did the calculations wrong to the tune of billions of dollars.
- Or the Fed could do what the Fed is, for now, doing. It is suspending any dividend increases by the bank until it submits an accurate account of the state of its capital reserves, and has that account approved by the agency as sufficient. This is a somewhat new thing in high level banking oversight - punish the shareholders, thereby encouraging them to monitor management. Does it work? It is perhaps a little untested, although suspending capital distributions has been a tool used by the FDIC on the sorts of distressed small banks that were its old stock in trade. Seeing that tool applied to Citi and now BofA, however, is a dfferent thing altogether. It will be interesting to see if this trend continues.
Dealbook has reprinted a series of tweets by Marc Andreessen explaining the sometimes lofty valuations of acquisitions in the tech sector. The key idea is "attach rate," which Andreessen describes as follows: "acquirer Y can attach company X's product to Y's sales engine."
We used to have another word for this idea: synergy.
Just because it's not new doesn't mean it's not real. But Andreessen rightly cautions: "Of course, for the deal to be good, I have to deliver that attach rate. But when it works, and it often does, it's magical & worth doing."
I am probably more skeptical -- "often" should probably be "sometimes" -- but I generally agree with the thrust of the tweets. Thanks to Matt Jennejohn for the pointer.
You may remember Greg Shill blogged about Mr. Gox--at that time I just had some vague, "Mt. Gox-bad-virtual-currency-shady" bitcoin association in my head. Since then, I've heard 2 student presentations on Bitcoin , and I thought I'd pass along what I have learned. Dear reader, I will presume that you, like me, really don't know anything about it. It may well be that in this matter, like so many, I am wrong.
Both presentations started out with this video (It's less than 2 minutes, just go ahead and watch it):
Ok, what struck you? Was it the miners? How bizarre is that? Bitcoin crowdsources its processing of individual transactions to "miners," who earn bitcoins for their trouble. And bitcoin has a built-in limit. From bitcoin.org:
Bitcoins are created at a decreasing and predictable rate. The number of new bitcoins created each year is automatically halved over time until bitcoin issuance halts completely with a total of 21 million bitcoins in existence. At this point, Bitcoin miners will probably be supported exclusively by numerous small transaction fees.
Here is another video that shows a large scale bitcoin miner. This one is longer, and a little local-news cheesy:
I'm now much more interested in bitcoin. Here are some random thoughts:
- I love the "stick it to the man" "down with the banks" angle. No user fees! Fight the power!
- Much to say about the auto-limiting feature. Supposedly it's built into the code. But clearly bitcoins have been hacked before. Who's to say the 21 million ceiling is a unhackable?
- What if it can't be hacked? What does it mean to have a currency that can't be devalued by a government in need of quick cash? Sounds pretty cool.
- How important is anonymity in purchasing? Is it just a drugs and porn thing, or for more mainstream industries?
- What role does/should law have here?
Update: Urksa Velikonja in the comments linked to a great article giving more info about mining. Have miners created securities? Sounds like a great fact pattern...
Also, on the hacking front, here's a link to a chronology of bitcoin hacking incidents. The idea of hackers making off with my virtual wallet has me rocking me back and forth humming and holding my hands over my ears. I don't think I could do more than dabble in the world of virtual currency.
- "That one million hours a year devoted to resolution planning is 500 full-time employees"
- "There are 8,000 employees 'dedicated solely to building and maintaining an industry-leading Anti-Money Laundering (AML) program.' JPMorgan employs more AML compliance officers than the Treasury and the Fed combined."
- Stress testing required 500+ FTEs
- Compliance with Basel's new securitization rules has required 35,000 hours of work (at 2000 hours per year, that's only 17.5 FTEs, so you can see why they moved to hours there).
That's a lot of compliance, and indeed, at these rates, way more people do compliance for JPMorgan than, probably, do actual investment banking. Of course, maybe we want all of this given that the firm is far too big to fail, and maybe we want to make banking burdensome and unprofitable. If so, we are on our way!
The leverage rule agreed to internationally is 3%, and you should think of a it as an alternative minimum tax. Worried that banks might be able to game capital requirements, which require them to hold funds in reserve to deal with shocks, the world's regulators also decided to forbid, on pain of cutting dividends and executive compensation, large banks froms from taking positions that would mean that more than 3% of their assets are capital. American banking regulators are going further - they are disincentivizing bigness by requiring the 8 largest banks to comply with a 5% leverage ratio. Some thoughts:
- The giveback to industry is that this rule isn't effective until 2018. Only in financial regulation do you ever see such long-dated rules.
- American banks might have to add $68 billion in capital to comply with this requirement. Would you sue to avoid that kind of a charge? Of course you would! But the banks probably won't. The Fed just doesn't face the sort of Total Litigation regulatory contest that the SEC faces.
- Ditto, you'd think that such a big deal rule would require review by OIRA. Nope!
The answer is no, it won't kill monetary policy, but here's the way it might constrain the Fed, which relies on primary dealers (that is, big banks, who would now be subject to leverage requirements) to help it set the federal funds rate. This reliance has been cited as a reason to delay the leverage rule. Felix Salmon also thinks that's no reason to delay the imposition of the rule, but here's how the argument works, in his nicely straightforward words:
The way that the Fed conducts monetary policy is by instructing the traders at the New York Fed to buy and sell certain financial instruments so that a particular interest rate — the Fed funds rate — is very close to a certain target. Through a complex series of financial interlinkages, setting the Fed funds rate at a certain level then has a knock-on effect, and ultimately helps determine every interest rate in America, from the Treasury yield curve to the amount you pay for your credit card or your mortgage.
Those interlinkages are so complex that they’re impossible to model with any particular accuracy: all the Fed can do, really, is set the Fed funds rate and then see what happens to everything else. And directionally the causality is clear: if the Fed wants rates to rise, then it pushes the Fed funds rate upwards, and if it wants rates to fall, then it brings the Fed funds rate down. That doesn’t always work at the distant end of the yield curve, but it’s still most of what monetary policy can do.
Especially early on in the chain, a lot of the interlinkages take place at the level of big banks. And so it stands to reason that if you change the leverage requirements of big banks, that might change what happens to interest rates when you move the Fed funds rate.
In my last post—also a shameless plug for my recent article, “Boilerplate Shock”—I argued that boilerplate terms governing securities could serve as a trigger that transforms an isolated credit event into the risk of a broader systemic failure. I’ll now briefly explain why I see this danger—which I call “boilerplate shock”—as a general problem in securities regulation, not just some quirky feature of Eurozone sovereign debt (the focus of the paper and post). Any market where securities are governed by uniform boilerplate terms is vulnerable to boilerplate shock.
The nature of this phenomenon—systemic risk—is of course familiar, but its source in contract language is a little unintuitive. How could private contracts unravel an entire securities market or the world economy?
Coordination around uniform standards.
In the back of our mind most of us probably still conceive of contracting as an activity that occurs among two, or perhaps a few, individuals or firms. But when standard terms are used by virtually all actors within a given market, it’s worth considering the collective impact of those terms as a distinct phenomenon.
Coordination’s benefits are well known. Consider uniform traffic signals. But coordination can also compound the effects of bad individual decisions.
As Charles Whitehead has argued, widespread “destructive coordination” among banks during the precrisis days helped generate systemic risks. When the credit markets froze, for example, firms using the same risk management formulas reacted in the same way at the same time. This helped transform isolated events into systemic ones—e.g., Lehman, the canonical example of a failure that triggered a de facto coordinated panic.
A similar risk, I argue, is present where participants in a securities market rely on the same standardized contract terms. Whether they were intended to or not, these terms will often control what happens in the event of certain legal emergencies, like a country departing the euro or Lehman declaring bankruptcy.
For example, if an effort by Greece to pay its bonds in “new drachmas” is rejected because of Boilerplate Contract Terms A and B, the market will surely be concerned that Terms A and B also govern the bonds of similarly situated borrowers, like Spain, Italy, etc. You’ll see that the borrowing premium the “peripheral” euro countries (the uppermost five lines: Ireland, Italy, Greece (biggest spike), Portugal, Spain) paid versus richer euro countries (Germany, France, the Netherlands, the three lowest lines) zoomed higher as worry over a Greece exit gripped markets in late 2011/early 2012, and again (to a lesser extent) because of Cyprus exit talk in early 2013:
Bloomberg. Click to enlarge.
Moreover, this panic occurred against a backdrop of unduly rosy assumptions (namely, that a departing euro country could convert its bonds into a new currency and thereby avoid default, a likely contagion trigger). I argue that the uniformity of boilerplate across these bonds would intensify these problems significantly since it’s likely to result in a declaration of default.
To my mind, this demonstrates that boilerplate securities contracts, in the aggregate, can be systemically significant. “Boilerplate Shock” introduces this concept and offers a modest proposal to mitigate its dangers in the Eurozone.
Beyond the euro, what about the risks of boilerplate shock in general?
Boilerplate shock is probably an inherent and permanent risk in any securities market.
Securities contracts are quintessential candidates for boilerplate. They are used by sophisticated parties for repeat or similar transactions and are drafted quickly—sometimes in three and a half minutes. The (correct) assumption is that they are more efficient for the parties that use them.
I’d like to begin thinking about how contracts can be drafted with a view to systemic risk mitigation, or at least to avoid exacerbating existing risks. But I think this is a hard problem that lacks an off-the-shelf solution:
- The nature of the risk is that it is a byproduct, not the result of intentional choices about risk allocation. This is the reason for the information-forcing default rule I propose in the Eurozone.
- The risk is also an externality: it is severe because of its collective impact. The parties do not bear the primary risk that uniform contracts will result in a meltdown, and in the unlikely event a crash happens (1) no individual party will be to blame and (2) at least one party to the initial transaction (the initial purchaser of a bond, for example) will probably no longer hold the asset, because most systemically significant securities are actively traded on the secondary market.
But banning or discouraging boilerplate is not the answer:
- The risk that a bunch of assets governed by the same terms will plummet in value is not only an externality. Risk allocation among parties might improve if scrutiny of existing securities boilerplate improves. The terms can evolve.
- A requirement to craft unique, artisanal terms—disclosures, subordination provisions ("flip clauses"), choice of governing law—for each individual securities transaction would be criminally inefficient.
- A requirement to craft unique contract terms might even be unjustified on risk-management terms alone, because it would increase drafting errors.
It's tricky to mitigate the risks of securities boilerplate.
Some options for places to start:
- Validation by third parties: perhaps issuers could use risk-rated contract templates. For example, see credit ratings…but see credit ratings.
- Culture: inculcate systemic risk mitigation as a professional norm among private sector lawyers? In principle, this could work. The number of lawyers who draft these contracts is pretty small. In practice, one could envision many complications.
- Insurance: encourage the development of derivatives to account for the possibility of boilerplate shock? Like some of the other solutions, this one presumes some agreement on what terms create the risk of boilerplate shock. It could also encourage new forms of moral hazard.
- Mandatory regulation: some public entity could be tasked with the mission of proactively identifying and combating the risk of boilerplate shock in contract practices. Arguably a natural choice given that the risk is an externality. Nevertheless, I’m a little skeptical. First of all, who would do it? A domestic regulator, like the SEC or CFTC, that might be dodged on jurisdictional grounds? An international institution, which is arguably more subject to capture? More generally, regulation seems like a heavy-handed first choice.
In sum, when standardized and aggregated, choices that determine legal risks—e.g., contract terms designating governing law, payment priority—can create the same hazards as choices about business risks. This suggests that contract terms should be taken seriously as possible sources of systemic risk alongside more familiar sources, like leverage and credit quality.
Securities contracts as a source of systemic risk—what do you think?
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By now, the risk that a distressed European nation such as Greece might leave the Eurozone and thereby spark global economic calamity is well known. Regular readers of this blog may even privately relish the prominence of the issue. Not since the days of the gold standard has international monetary policy come so close to being a socially acceptable topic of dinner conversation.
As I noted in my first post, observers rightly perceive the Eurozone sovereign debt crisis to be driven by political and economic forces. But many consequences of a euro breakup would be determined by law, including sources of American (specifically New York) private law.
This is a complex issue. I try to address it more fully in a new article, "Boilerplate Shock," which I've just posted on SSRN.
In brief, and to continue picking on Greece, one key question in the event of a euro breakup would be: would a court recognize an attempt by Greece to convert its euro-denominated debt into its new currency, or would it instead insist that Greece pay in euros, the currency of contract? The answer is important because, as a practical matter, requiring payment in euro would be tantamount to forcing a default.
That's the familiar narrative, anyway. And I agree. But I believe that the ubiquity of boilerplate terms in these bonds—specifically, clauses selecting governing law (usually foreign) and currency of payment (euro)—is likely to make any dispute over redenomination even more damaging than this suggests.
In the article, I argue that the sparse literature on the question of redenominating sovereign bonds overlooks some sources—especially cases interpreting New York contract law and private international law—that, if extended to Eurozone sovereign bonds, could surprise the market and cause serious global repercussions. I argue that the reason for this is not only that the dominant view overlooks what are likely controlling sources of law. It is that standardization of contract terms across the Eurozone sovereign lending market makes the stakes of surprise that much higher.
If Greece's attempt to redenominate its bonds is declared a default, then the fact that the operative terms in Italian, Spanish, Irish, etc. sovereign bonds are the same or similar makes markets likely to demand unsustainable premiums from those countries. Capital and investor flight could be very rapid. We have seen several previews of this movie over the past few years in the Eurozone, and each time official-sector bailout institutions have saved the day. But the European Union/European Central Bank and IMF probably do not have the resources to stop a broad-based bank run of this nature, to say nothing of the political support necessary to attempt it.
Maybe none of that will happen. Nevertheless, the potential for uniform contract terms to create risk not just to individual third parties but to securities markets seems likely to grow at least as fast as those markets. Using Eurozone sovereign bonds as a case study, I introduce the term "boilerplate shock" to describe the potential for standardized contract terms—when they come to govern the entire market for a given security—to transform an isolated default on a single contract into a threat to the market of which it is a part, and, possibly, to the economy in general. My larger objective here is to foster a discussion of the potential for securities law and private-sector securities lawyers to manage (or alternatively, to contribute to) systemic risk.
I've posted an abstract below and will be returning to the subject. I look forward your comments.
Boilerplate Shock abstract:
No nation was spared in the recent global downturn, but several Eurozone countries arguably took the hardest punch, and they are still down. Doubts about the solvency of Greece, Spain, and some of their neighbors are making it more likely that the euro will break up. Observers fear a single departure and sovereign debt default might set off a “bank run” on the common European currency, with devastating regional and global consequences.
What mechanisms are available to address—or ideally, to prevent—such a disaster?
One unlikely candidate is boilerplate language in the contracts that govern sovereign bonds. As suggested by the term “boilerplate,” these are provisions that have not been given a great deal of thought. And yet they have the potential to be a powerful tool in confronting the threat of a global economic conflagration—or in fanning the flames.
Scholars currently believe that a country departing the Eurozone could convert its debt obligations to a new currency, thereby rendering its debt burden manageable and staving off default. However, this Article argues that these boilerplate terms—specifically, clauses specifying the law that governs the bond and the currency in which it will be paid—would likely prevent such a result. Instead, the courts most likely to interpret these terms would probably declare a departing country’s effort to repay a sovereign bond in its new currency a default.
A default would inflict damage far beyond the immediate parties. Not only would it surprise the market, it would be taken to predict the future of other struggling European countries’ debt obligations, because they are largely governed by the same boilerplate terms. The possibility of such a result therefore increases the risk that a single nation’s departure from the euro will bring down the currency and trigger a global meltdown.
To mitigate this risk, this Article proposes a new rule of contract interpretation that would allow a sovereign bond to be paid in the borrower’s new currency under certain circumstances. It also introduces the phrase “boilerplate shock” to describe the potential for standardized contract terms drafted by lawyers—when they come to dominate the entire market for a given security—to transform an isolated default on a single contract into a threat to the broader economy. Beyond the immediate crisis in the Eurozone, the Article urges scholars, policymakers, and practitioners to address the potential for boilerplate shock in securities markets to damage the global economy.
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Over at DealBook, I’ve got a piece on the analysis of FOMC transcripts – a cottage industry, now that the Bernanke era version of the committee has released its 2008 (that is, depth of the crisis) records. There’s lots of counting that can be done, including some, in honor of Jay Wexler’s Supreme Court study, on the number of times the FOMC broke into laughter. Easy enough to actually do for the Greenspan FOMC, and so I do it:
For what it is worth, the mood lightened as the chairman aged, although the F.O.M.C. certainly went through turbulent times during both the beginning and the end of Mr. Greenspan’s tenure. Meeting transcribers recorded laughter on a per-transcript-page basis increasing from an average of less than 20 percent from 1988 to 1992 to more than 20 percent from 2001 to 2006. In a few years, we will be able to make comparable statements about the F.O.M.C. when Ben S. Bernanke was the Fed chairman. Mr. Greenspan used wit far more than any other single Fed official (although he spoke far more at F.O.M.C. meetings than the others did) – laughter ensued after something he said 556 times over the course of his tenure.
Do give it a look.
The Bitcoin exchange Mt. Gox appeared to be undergoing more convulsions Tuesday [February 25], as its website became unavailable and trading there appeared to have stopped, signaling a new stage in troubles that have dented the image of the virtual currency. . . .
Investors have been unable to withdraw funds from Mt. Gox since the beginning of this month. The exchange has said that a flaw in the bitcoin software allowed transaction records to be altered, potentially making possible fraudulent withdrawals. No allegations have been made of wrongdoing by the exchange, but the potential for theft has raised concern that the exchange wouldn't be able to meet its obligations.
The apparent collapse of Mt. Gox is just the latest shock to hit Bitcoin, the price of which is now off more than 50% from its December 2013 peak:
For those better acquainted with the dead-tree/dead-president variety of money, Bitcoin is a virtual currency not backed by any government. Rather than being printed or minted by a central bank, Bitcoins are created by a computer algorithm in a process known as "mining" and are stored online or on your computer. They are bought and sold on various exchanges, including until recently Mt. Gox (whose troubles have been reported for a few weeks now).
There are many reasons, some of them even lawful. Bitcoins can be regarded as a medium of exchange, an investment, a political statement...or a way of avoiding capital controls and other pesky laws like bans on drug trafficking and human smuggling.
But the criminal potential of Bitcoin is probably overstated. The Chinese have gotten wise to its use for avoiding capital controls. Using Bitcoin for criminal or fraudulent activity would be difficult at scale (PDF). The Walter White method is still far and away the best way to ensure your criminal proceeds retain their value and anonymity.
I don't share the utopian fervor for Bitcoin expressed in tech and libertarian circles (see, e.g., this supposedly non-utopian cri de coeur), but it may have some positive potential as a decentralized and lower-cost electronic payments system. We'll see if that ever gets off the ground.
In the meantime, the Mt. Gox collapse is pretty huge news for Bitcoinland. Unlike the NYSE (the failure of which would be hard even to imagine), Mt. Gox does not benefit from any systemic significance and thus is unlikely to receive a lot of official-sector help. The situation has some early adopters running for the Bitcoin exits, like this leading Bitcoin evangelist.
Despite (because of?) my agnosticism on the currency, I'll be writing more about Bitcoin soon. (Mainly, I wanted to stake a claim to being the first to write about Bitcoin on The Conglomerate.) If your Palo Alto cocktail party can't wait, however, this explainer (PDF) from the ever-impressive Chicago Fed should tide you over.
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Below you'll see the first of what I suspect will be many interesting posts from guest blogger Greg Shill. Do welcome him.
And here you'll see a neat graphic of the money that the big American banks are agreeing to pay to settle their financial crisis suits; the tl;dr is poor Bank of America! Here's USC's worthy effort to track all the settlements.
Greetings, Glommers! (and hello, Janet and Mario*!)
It’s an honor to join this extremely sharp and thoughtful community of corporate and commercial law scholars for the next two weeks. The Conglomerate has long been one of my favorite law blogs and it’s truly a privilege to walk among these folks for a time (if a bit daunting to follow not just them but Urska Velikonja and her excellent guest posts). Thanks to Gordon, David, and their Glom partners for inviting me to contribute.
By way of biographical introduction, I’m currently a Visiting Assistant Professor at the University of Denver Sturm College of Law, where I teach International Business Transactions and International Commercial Arbitration. Last year, I did a VAP at Hofstra Law School (and taught Bus Orgs and Contracts).
In the next few weeks, I’ll be exploring a number of issues related to law and global finance. I have a particular interest in currencies and monetary law, or the law governing monetary policy. Two of my current projects (on which more soon) address legal aspects of critical macroeconomic policy questions that have emerged since 2008: U.S. monetary policy and the Eurozone sovereign debt crisis.
Without further ado, I will take a page from Urska and kick off my residency here with a somewhat meta question: should scholars refrain from writing about legal issues in macroeconomics, specifically monetary policy?
One thinks of monetary policy decisions—whether or not to raise interest rates, purchase billions of dollars of securities on the secondary market ("quantitative easing"), devalue or change a currency—as fundamentally driven by political and economic factors, not law. And of course they are. But the law has a lot to say about them and their consequences, and legal scholarship has been pretty quiet on this.
Some concrete examples of the types of questions I’m talking about would be:
- Pursuant to its dual mandate (to maintain price stability and full employment), what kinds of measures can the Federal Reserve legally undertake for the purpose of promoting full employment? More generally, what are the Fed’s legal constraints?
- What recognition should American courts extend to an attempt by a departing Eurozone member state to redenominate its sovereign debt into a new currency?
When it comes to issues like these, it is probably even more true than usual that law defines the boundaries of policy. Legal constraints in the context of U.S. monetary policy appear fairly robust even in times of crisis. For example, policymakers themselves often cite law as a major constraint when speaking of the tools available to the Federal Reserve in combating unemployment and deflation post-2008. Leading economics commentators do too. Yet commentary on “Fed law” is grossly underdeveloped. With the exception of a handful of impressive works (e.g., by Colleen Baker and Peter Conti-Brown), legal academics have largely left commentary on the Fed and macroeconomics to the econ crowd.
A different sort of abstention characterizes legal scholarship on the euro crisis. Unlike the question of Fed power, there is a burgeoning literature on various “what-if” euro break-up scenarios. But this writing tends to focus on the impact on individual debtors and creditors, not on the cumulative impact on the global financial system. Again, the macro element is missing.
It is curious that so many legal scholars would voluntarily absent themselves from monetary policy debates. The subtext is that monetary policy questions are either normatively or descriptively beyond the realm of law. If that is scholars’ actual view, I think it is misguided. But maybe the silence is not as revealing as all that.
- One issue is sources. You will not find a lot of useful caselaw on the Fed’s mandate or the Federal Reserve Act of 1913, and the relevant statutes and regulations are not very illuminating. Further, it’s a secretive institution and that makes any research (legal or otherwise) on its inner workings challenging.
- Another issue is focus. Arguably the natural home of legal scholarship on domestic monetary issues, for example, should be administrative law. But the admin scholarly gestalt is not generally as econ-centric as, say, securities law. Meanwhile, securities scholars tend to focus on microeconomic issues like management-shareholder dynamics.
- A final possibility, at least in the international realm, is historical. After World War II, Bretton Woods established a legal framework intended to minimize the chance that monetary policy would again be used as a weapon of war. The Bretton Woods system collapsed over forty years ago, the giants of international monetary law (Frederick Mann, Arthur Nussbaum) wrote (and died) during the twentieth century, and now even some of the leading scholars who followed in their footsteps have passed away. At the same time, capital now flows freely across borders and global financial regulation has become less legalized in general. These factors plus the decline of exchange-rate regulations (most countries let their currencies float) may have undermined scholars’ interest in monetary law. But as the ongoing euro saga demonstrates, international monetary law and institutions remain as critical as ever.
These are some possible explanations for why legal scholars have largely neglected questions of monetary law, but I’m sure I’ve overlooked others. What do you think?
*Pictured are Janet Yellen and Mario Draghi, chiefs, respectively, of the Federal Reserve and the European Central Bank.
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Better Markets is an advocacy group worried about the failure of the government to hold banks accountable for misdeeds that lead to the financial crisis. No problem there, I'm mystified by it myself, though there might be a normative case to be made for the policy, depending on how you feel about how the government treated Arthur Andersen and varous Enron executives during the last crisis.
But the group's suit against the government for violating separation of powers principles and FIRREA for settling with JPMorgan without filing the settlement with a court must have made the lawyers who filed the complaint a little nervous, in the "is this frivolous and will I get sanctioned?" kind of way.
Are you depriving courts of their Article III jurisdiction if you settle a case, instead of trying it to completion (and presumably then filing an appeal)? Owen Fiss thought so, in an article that I really love, but perhaps we should put the piece under the "seminal Yale thought experiment" rubric.
Settlement isn't exactly unprecedented in our federal system. Sometimes the government announces that it won't be defending a statute like DOMA in court, thereby depriving the judges of their Article III powers to assess the constitutionality of the law. Sometimes it changes policies when a powerful senator complains, thereby depriving Congress of its Article I right to reverse the executive branch's overreaching through legislation. And sometimes it enforces statutes - Title VII is an example - that deprive millions of potential plaintiffs of their right to file constitutional suits, in that case invoking the Equal Protection Clause. Sometimes, it also just settles cases before they go to trial, just like every other institution in America.
And yet somehow these dramatic examples of executive branch overreaching have never resulted in a colorable separation of powers claim. Indeed, separation of powers claims are almost never colorable; as a rule of thumb, they are step one towards losing a lawsuit, because they can be made about all cases, which is basically the same thing as saying they can be made about no cases. I'm generally not a fan of holding the government to particularly different standards than, say, Amnesty International, but even if you feel differently, you might do so because of the government's criminal powers, which the JPMorgan settlement doesn't involve.
The FIRREA count isn't a whit better, by the way. FIRREA authorizes the Attorney General to file suits against banks who violate the substantive principles of that banking statute. But just because a statute permits such litigation hardly means that it means that courts will be reviewing the AG's decisions as to whether to bring a case under it or not. THAT would be a separation of powers problem; courts would get to micromanage every decision whether to prosecute a case, supposedly one of the most core executive branch functions there is. Just ask Justice Scalia.
And don't even get me started on whether Better Markets has standing to sue over a settlement between the government and some other party that has nothing to do with Better Markets.