When Does This Get Pierced?

If you’ve made it through the content of complaints, some data about who gets sued, and descriptive statistics about wins and losses, you basically are pot committed to this veil piercing project. In this post, I’m going to exploit that commitment by describing the results of our statistical analysis of two different kinds of success that plaintiffs may achieve in veil piercing cases: (1) on motions; and (2) at the case level. If you don’t care to follow me beyond the jump, here’s the bottom line (from our abstract):

“Voluntary creditor causes of action promote veil piercing; LLCs are in very limited circumstances better insulated from veil piercing claims than corporations; undercapitalization is strongly associated with success while conclusory grounds like [...]]]>

When Does This Get Pierced?

If you’ve made it through the content of complaints, some data about who gets sued, and descriptive statistics about wins and losses, you basically are pot committed to this veil piercing project. In this post, I’m going to exploit that commitment by describing the results of our statistical analysis of two different kinds of success that plaintiffs may achieve in veil piercing cases: (1) on motions; and (2) at the case level. If you don’t care to follow me beyond the jump, here’s the bottom line (from our abstract):

“Voluntary creditor causes of action promote veil piercing; LLCs are in very limited circumstances better insulated from veil piercing claims than corporations; undercapitalization is strongly associated with success while conclusory grounds like “façade” and “sham” are not; and defendants’ legal sophistication is predictive of plaintiff failure. Extra-legal factors play a more striking and counterintuitive role. Plaintiffs suing companies with few employees are much more likely to win veil piercing motions, and obtain relief in cases, than plaintiffs suing companies employing many workers. This results holds even when controlling for legally-relevant variables. Contrary to both theory and previous empirical work, we also find that judicial liberalism is inversely related to the likelihood of plaintiff success.”

Veil Piercing Motions

Let’s start with the motions level. We ran a logistic regression, where the dependant variable is plaintiff succeeding at the motions level – - either advancing the veil piercing case (e.g., getting VP discovery), or actually winning – - and a number of our variables of interest reach statistical significance (at p ≤ 0.05 (two-tailed)), including judge ideology, defendant firm size, voluntary creditor-based causes of action, and the presence of the shell, façade, and undercapitalization grounds for piercing in the complaint.* Generally, and in accord with our theory, we get much better model performance when we look at motions-level success than at case-level success.

What does this mean?  Well, consider the effect of being a veil piercing target with more (or less) employees.  For example, the figure indicates that the probability of successfully asserting a veil piercing motion against companies with less than 300 employees being is around 0.80. For companies with more than 2100 employees, that number drops below 0.20.  These results hold when controlling for variables like “being an LLC, or not”, “being incorporated in Delaware, or not”, asserting “informalities as a ground in the complaint, or not”, etc.

By contrast, we find that as a judge’s ideology moves in a conservative direction, the mean likelihood of having successful interstitial veil piercing activity increases.  Motions in cases with very liberal judges have a mean predicted probability of being successful of under 50%, while that probability is around 75% for moderate district court judges and near 95%  for conservative district court judges.  This is, in a word, surprising!

Discrete factors also correlate with success on veil piercing motions.

The bottom portion of the figure to the left contains the plots for the substantive effect of the three veil piercing grounds (in complaints) that have a statistically significant effect on veil piercing motion success: shell, façade, and failure to adequately capitalize (or undercapitalization).  The addition of façade and shell grounds to a veil piercing complaint each provide strong negative effects on the likelihood of veil piercing motions in that case, with a shell ground decreasing the likelihood of veil piercing motion success by over 39%, on average, and a façade ground doing the same by nearly 53%, on average.  Stated undercapitalization grounds have the opposite, albeit more modest, effect.  The addition of an undercapitalization ground to a veil piercing complaint makes an interstitial veil piercing motion 14% more likely to be successful.  We also find (but do not illustrate) that corporations owned by artificial shareholders are more likely to be subject to successful veil piercing motions than LLCs owned by artificial shareholders.

Here’s what this suggests to me: facade and shell grounds in complaint signal/reflect a case that is pretty thin — the grounds are totally conclusory — such claims fall away in cases at higher-than-usual rates.  By contrast, undercapitalization signals a strong case — one that evidences a certain about of seriousness about the veil piercing claim.   With respect to voluntary creditors (i.e., contract claims) recall that plaintiffs can bring both voluntary and involuntary creditor claims in the same complaint.  Still, the expectation from theory was that voluntary creditors ought to win less often than involuntary ones.  We don’t find that.  We find instead that complaints with voluntary creditor causes of action in them are more likely to be associated with veil piercing claims that survive longer.

The corporation-LLC finding is expected.  LLCs are designed to be more informal.  They ought to be pierced less often.

Case Level Success

As I discussed in an earlier post, figuring out what veil piercing success at the case level means is a little bit complicated. We decided to treat veil piercing at the case level as successful if: (1) the veil has been affirmatively pierced by a court through veil piercing motion activity OR (2) when, after veil piercing has been litigated on the record (through motion activity), the case settles while veil piercing is still “alive” in the case (i.e., having never been dismissed or denied).  In the paper, we provide alternative set of results based on the coding of veil piercing success both more narrowly (excluding all settlements) and more broadly (including all settlements where veil piercing is still “alive,” regardless of the affirmative presence of veil piercing motions in the case).

We again find that employee size has an important relationship to success.  Very small firms have a probability of case level veil piercing of around 20%; that number quickly approaches zero as firm size increase. Similarly, the more conservative a district court judge is, the more likely the case he is presiding over is to have a case-level veil piercing success.  This result, of course, mirrors that in the veil piercing motion context.  While the most liberal judge’s case has around a 15% probability of having ultimate veil piercing success, the most conservative judge’s case has around a 30% probability.

Individual factors also matter.  When companies are incorporated in different states from where they operate (holding their size constant) the presence of such sophistication decreases (by about 10%) the likelihood that the firm’s veil will be pierced.  The inclusion of undercapitalization as a ground increases (by about 10%) the likelihood of there being a successful case-level veil piercing.

The last post in this series will discuss these results.

* * *

FN*  We generally do not find statistical significance at the motions level for our variables regarding entity choice,  shareholder identity, defendant sophistication, judge gender or race, appellate court control, or the increased incidence of success when failure to observe formalities, inadequate capitalization, and domination and control were cited as veil piercing grounds against corporations compared to LLCs

There’s value in this approach, not least because opinions shape reality. But there’s a problem too.  Not only are opinions unrepresentative, but they come late in cases.  The result is an extreme form of selection.  It’s not clear (to me, anyway) what the null hypothesis regarding the effect of independent variables  ought to be for late-stage dispositions.

Dockets offer the promise of a different approach: asking which factors correlate [...]]]> If you look at opinions, winning in a veil piercing case is pretty easy to define: did the court agree to pierce the veil, reaching through an entity to its shareholders. If you were inclined, you could model success at those terminal moments in cases, asking which factors (described in the opinions) correlated with courts agreeing to pierce.

There’s value in this approach, not least because opinions shape reality. But there’s a problem too.  Not only are opinions unrepresentative, but they come late in cases.  The result is an extreme form of selection.  It’s not clear (to me, anyway) what the null hypothesis regarding the effect of independent variables  ought to be for late-stage dispositions.

Dockets offer the promise of a different approach: asking which factors correlate with success or failure early in cases.  Further, assuming that adjudicated motions teach the parties about the strength of their cases, and that they settle strategically, we can even start to learn from the timing and incidence of settlement.

In this post, I’m going to relay some descriptive statistics about the veil piercing successes that plaintiffs achieved in our data. (I’m continuing to pull the data and some text from our paper.)  To those who are getting annoyed by all of these posts, I’m sorry!  I’ve been living with this project for a long time — I’m excited to finally share it publicly.

We coded 550 motions raising veil piercing problems, and 580 non-veil piercing motions, in our 690 cases.  Overall, about half of all veil piercing motions result in plaintiffs advancing their veil piercing claims (but not ending the case), about fifteen percent involve judicial determinations against the veil piercing claim, twenty percent success on the merits (if defaults are included), and the remainder of motions were pending at the time of settlement. (Recall that 2 of 3 cases overall ended in settlement).

Excluding defaults, and dropping pending motions, veil piercing litigation is a story of wild early success: plaintiffs prevailed — in one form or another – on approximately 85% of all veil piercing motions in our dataset.  Many cases had their veil piercing claims still “alive” at the time of settlement.  Indeed, using the most liberal definition, which includes settlement after motion practice as victory, 78% of cases resulted in plaintiffs realizing some value from their veil piercing claims.

But very few cases actually led to veil piercing, on the merits, outside of defaults: only 37 cases, out of 690, contained a judicially-enforced veil piercing on the merits.  That’s around 6%.

Moving parties were less likely to win non-veil piercing discovery motions  than veil piercing discovery (a 67% success rate versus 90% in resolved motions) and plaintiffs were less successful at fighting off motions to dismiss (61% plaintiff prevail rate versus 88%) and summary judgment (62% versus 90%).  One explanation for this effect is that veil piercing motions (i.e., demanding VP discovery, or fighting of a motion to dismiss) are somehow not selected out of cases to the same degree that ordinary motions are: defendants either are too attached to them (think they are going to win when they won’t) or plaintiffs insufficiently so (think they lack settlement leverage when they have it).

The advantage of looking at success and failure at the motion-by-motion level is that it promises a chance to move the problem of selection back in cases to a moment where we wouldn’t reasonably expect for plaintiffs and defendants to have a realistic sense of their chances. We can fairly hypothesize that some independent variables — judicial demographics, plaintiffs and defendant characteristics, legal rules and planning — will affect the parties’ respective successes and failures on (say) the grant rate in motions to dismiss.  As I’ll discuss in penultimate post in this series, that intuition turns out to be basically correct.

Confused?  Read the paper!

Citation studies as a proxy for judicial quality are all the rage.  I concur with Larry that the effort spent often seems disproportionate to the result.  Selection is the culprit here, not just academic modesty: it’s hard to imagine that any truly dramatic effects of judicial character, or legal rule, would not be washed away by parties’ ability to settle strategically.

Exogenous shocks open windows – of limited scope – which may help us penetrate this fog.  There’s one ongoing today that I think could in several years allow us to test one of the most important, but obscure, questions about judicial performance.  Although there have been a few studies about the usage, hiring, and quality of law clerks, I haven’t seen work that [...]]]>

Judge food.

Citation studies as a proxy for judicial quality are all the rage.  I concur with Larry that the effort spent often seems disproportionate to the result.  Selection is the culprit here, not just academic modesty: it’s hard to imagine that any truly dramatic effects of judicial character, or legal rule, would not be washed away by parties’ ability to settle strategically.

Exogenous shocks open windows – of limited scope – which may help us penetrate this fog.  There’s one ongoing today that I think could in several years allow us to test one of the most important, but obscure, questions about judicial performance.  Although there have been a few studies about the usage, hiring, and quality of law clerks, I haven’t seen work that really convinces me that clerks change judicial performance (rather than match it).  That question of influence is pretty important for all kinds of reasons — not least because if law clerks were really influencing their judges, we might want to spend a little bit more time thinking about their roles, ethics, hiring, etc.

So what’s the shock?  I think that the period of 2008-2011 will prove, in retrospect, to be bumper years for clerk quality.  Anecdotally, I’ve heard that the clerkship market has never been more competitive: Yale grads have been encouraged to take state court clerkships (the horror); judges in popular jurisdictions are receiving literally four to five thousand applications per clerk year; individuals who before might have taken firm jobs are instead throwing their hats in the ring; magistrate judges are taking clerks previously destined for district judges; alumni in practice for five years are going back into the clerk market and competing with fresh-faced 3Ls.  As an organ of the government, the judiciary simply eats better brains when the economy stinks.

Assuming the effect is real (which we could test by looking at placement statistics), I’d propose that eight to ten years from now – in 2018 or thereabouts – we test whether opinions arising from this bumper-clerk period are cited at a higher rate than opinions from the ordinary market periods immediately preceding and following.  The hypothesis would be that if clerks influence judges to write better opinions, better clerks will produce to more citable opinions.  Notably, we can’t perform this same analysis on the effect of past recessions, as (1) they reportedly didn’t have the same effects on the clerkship market; and (2) opinion collection practices were really sporadic before 1995.  It’s 2018 or bust.  Mitu et al., I call dibs!

No idea? Here’s some help.

Answers follow the jump.

According to a new study, seven percent of U.S. workers are self-employed, and eleven percent of manufacturing workers are at small firms.   The [...]]]> Quick: what percent of the U.S. manufacturing workforce labors in workplaces of twenty employees or less. What percent of all workers are self-employed?

No idea? Here’s some help.

• 18 percent of the British manufacturing workforce labors in small firms, and 15 percent of all workers are self-employed.
• 13  percent of the German manufacturing workforce labors in small firms, and 12  percent of all workers are self-employed.
• 31 percent of the Italian manufacturing workforce labors in small firms, and 26 percent of all workers  are self-employed.
• 18  percent of the French manufacturing workforce labors in small firms, and 9  percent of all workers are self-employed.

Answers follow the jump.

According to a new study, seven percent of U.S. workers are self-employed, and eleven percent of manufacturing workers are at small firms.   The US, contrary to common belief, is not a nation of small businesses.  We’re basically last in small-business employment, research, and enterprise  among the sample of countries studied.

This finding leads me to question the common claim that the large-firm, Delaware-centric, focus of corporate law scholarship and teaching ignores the real world.  To the extent that most employees are found at larger firms, and (compared to other countries) our economy is not really founded on small firm development, the relative paucity of law about the governance of small firms makes some sense.

Now this isn’t to say that economic growth theory ought to focus on established, larger firms. This summer, I was at a conference in which I heard the claim that a very, very small number of new firms (less than 100) drive most of economic growth in the country.  Studies of entrepreneurship, if this theory holds, ought to focus on increasing the number of these small, high-growth firms by figuring out what makes them tick.   Doctrinal reforms (tort, tax, etc.) might be crucial.

That data supporting such a focus on exceptionally high-growth small  firms feels weak to me.  The best case I can see is anecdotal, and summed in this video about the explosive growth in  social media. And to think, social media is all about men checking out pictures of women. Warning: before starting the video, turn off your sound. It will be mildly less irritating.

(H/T: Growthology)

The Google Book Search settlement will be, if approved, the most significant book industry development in the modern era [emphasis added]. . . . The Authors Guild has about 8000 members. [...]]]> The Google Books litigation has inspired a lot of commentary on the web. As an early October fairness hearing approaches, a consensus appears to be building: the proposed settlement is too important and complex for a court to approve in its current form. Agent Lynn Chu has complained that “No one elected the[] ‘class representatives’ to represent America’s tens of thousands of authors and publishers to convey their digital rights to Google.” Pamela Samuelson, by all accounts one of the leading academics in American intellectual property law, has this to say:

The Google Book Search settlement will be, if approved, the most significant book industry development in the modern era [emphasis added]. . . . The Authors Guild has about 8000 members. OCLC has estimated that there are 22 million authors of books published in the U.S. since 1923 (the year before which books can be presumed to be in the public domain). Jan Constantine, a lawyer for the Authors Guild, is optimistic that authors and publishers of out-of-print books will sign up with the Registry, but there are many reasons to question this.

For one thing, the proposed settlement agreement implicitly estimates that only about 750,000 copyright owners will sign up with the Registry, at least in the near term. Second, many books are “orphans,” that is, books whose rights holders cannot be located by a reasonably diligent search. Third, many easily findable rights holders, particularly academic authors, would much rather make their works available on an open access basis than to sign up with the Registry. Fourth, signing up with the Registry will not be a simple matter, since the Registry won’t just take your word for it that you are the rights holder. You are going to have to prove your ownership claim.

The non-representativeness of the class is one ground on which it is possible to object to the proposed Book Search settlement. Other reasons to object or express concerns will be explored in subsequent articles. Objections must be filed with the court by September 4, 2009.

A suitable platform for hosting public discussions of the deal only launched a few weeks ago, thanks to the diligent efforts of James Grimmelmann (who is also organizing an academic conference on the issue in October). The proposed settlement raises a number of issues, which may only be addressed by extensive regulation of the project — or a public alternative dedicated to serving those marginalized by the current proposal.

The issues fall into at least four categories:

1) Antitrust: Randal Picker, Christopher Suarez, and James Grimmelmann have addressed the proposed settlement’s likely effects on competition in the field. On the surface, it appears that Google Books would be a good alternative to companies like Amazon and Elsevier, offering a new intermediary designed to drive down the cost of access to knowledge. However, academics have pointed out several specific terms of the proposed settlement that threaten to reduce competition in the field of digitized books in the long term.

2) Pricing: Here the basic worry is that Google Books could become like the big intermediaries criticized by the open access movement for excessive pricing of academic, scientific, and technical works. Universities have been burned in the past by nonchalantly accepting big publishers’ mergers and growing control over a corpus of academic journals. Though Google is supposed to bargain on behalf of book users to reduce prices charged by book owners, the record of private insurers in accomplishing the same “middleman” role is not heartening.

The proposed settlement envisions that Google will stand between consumers and producers of knowledge. It will play a role similar to that of private insurers in standing between providers and patients—determining what access people get, how much they have to pay, etc. The worrisome aspect of that arrangement is that providers and private insurers are both very concentrated in the US, and consumers (i.e., the businesses and individuals who buy insurance plans) are not. That’s a key reason why the US spends so much more on health care than other industrialized nations, without getting better results, access, or quality.

I’d expect to see the same dynamics play out in the context of books if this settlement goes through, because it promises to create parallel levels of concentration in the Registry (imagine all hospitals combined into one bargaining unit) and Google (similarly, imagine a merger of Cigna, United Health, and WellPoint). Bilateral monopolies aren’t pretty for those on the outside — think of ever-rising ticket prices for fans that result from the negotiations of the players’ union and baseball owners. That’s why I think a “public option” is as important in digitized books as it is in health care. And at the very least, ongoing antitrust supervision, like that provided for similar schemes in the past, should apply here.

3) Privacy: Here I can’t do better than EPIC, a leading group on these issues. Here are their concerns:

Civil liberties organizations are urging Internet users to tell Google to adopt privacy protections for the Google Book Search. A judge in New York will determine later this year whether to approve the proposed settlement that would establish the service and give Google access to detailed personal information without any privacy safeguards.

The chart at the bottom of that page shows how the settlement threatens the “right to read anonymously.”

4) Cultural Power: Authors are concerned about Google’s power over the distribution, visibility, and pricing of their work. The Registry’s proposed leadership is not sufficiently representative of the wide range of publishers and authors. Perhaps a) different types of books should be subject to different types of boards of leadership, and b) all decisions about distribution, visibility, and pricing be made in an open manner. As for 4a), I think academic author in particular should worry about their books being subject to the types of revenue strategies pursued by, say, romance novelists or self-help authors. We need a separate board to handle academic books, or at least university press books. As for 4b): Google will counter that it needs to be secretive here, as it is in so many other areas, because unsavory actors could game the system. But Google should at least concede that concerns about gaming are lower in the book space than in the search space, since search engine optimizers are unlikely to publish fake books to game the system. Also, there could be a relaxation of these terms of openness as long as there is some open alternative.

In conclusion: for me, the key problems law can address are

a) extraordinary pricing power by Google/Registry alliance,
b) lack of transparency about how terms will be set,
c) lack of a public alternative to serve the people that Google fails to serve, and
d) threats to privacy

How do we solve these problems? I would propose the following responses:

a) guarantee of some form of free or subsidized access for those making under 300% of federal poverty level wages,
b) either open all Registry proceedings or at least follow Danny Weitzner’s approach to “extreme factfinding” here,
c) condition the settlement on either i) Google’s giving a copy of the digitized corpus to the government in exchange for the cost of scanning and a reasonable rate of return and/or ii) the government requiring all works copyrighted after 2009 to be digitally deposited and part of a corpus that the government could operate and make available on its own terms, and
d) allow EPIC and others to negotiate with relevant FTC policymakers to build in privacy safeguards.

I know these terms are all likely to be controversial. A public option in particular should respect the autonomy and growth of private search in this field — the organization of knowledge is an exciting field for private sector innovation. But I hope one thing is clear: it would be unjust to allow the parties to settle the case without giving a wide range of stakeholders an opportunity to fully vent their concerns. And given the likely need to involve the FTC, DOJ, and Copyright Office in ongoing supervision of the settlement terms, it is time for some inter-branch cooperation and coordination on the issue.

Image Credit: *keng.

[G]lobally interconnected and integrated financial networks just may be too complex to prevent crises like the current one from reoccurring. . . . A 2006 report co-sponsored by the Federal Reserve Bank of New York and the National Academy of Sciences concluded that even defining systemic risk was beyond the scope of any existing economic theory. Actually managing such a thing would be harder still, if only because the number of contingencies that a systemic risk model must anticipate grows exponentially with the connectivity [...]]]> The “optimal size and complexity of developing countries’ financial systems” has been hotly debated in the economics community. Writing for the Harvard Business Review & Boston Globe, Duncan Watts focuses on our own dilemmas in a provocative account of complex systems:

[G]lobally interconnected and integrated financial networks just may be too complex to prevent crises like the current one from reoccurring. . . . A 2006 report co-sponsored by the Federal Reserve Bank of New York and the National Academy of Sciences concluded that even defining systemic risk was beyond the scope of any existing economic theory. Actually managing such a thing would be harder still, if only because the number of contingencies that a systemic risk model must anticipate grows exponentially with the connectivity of the system.

So if the complexity of our financial systems exceeds that of even the most sophisticated risk models, how can government regulators hope to manage the problem? There is no simple solution, but one approach is close to what the government already does when it decides that some institutions are “too big to fail,” and therefore must be saved – a strategy that, as we have seen recently, can cost hundreds of billions of taxpayer dollars. . . .

An alternate approach is to deal with the problem before crises emerge. On a routine basis, regulators could review the largest and most connected firms in each industry, and ask themselves essentially the same question that crisis situations already force them to answer: “Would the sudden failure of this company generate intolerable knock-on effects for the wider economy?” If the answer is “yes,” the firm could be required to downsize, or shed business lines in an orderly manner until regulators are satisfied that it no longer poses a serious systemic risk. Correspondingly, proposed mergers and acquisitions could be reviewed for their potential to create an entity that could not then be permitted to fail.

Of course, our system has been headed in precisely the opposite direction, largely thanks to the “best and brightest” now at Treasury and the Fed. As Simon Johnson puts it, we “pay too much deference to the expertise and presumed wisdom of a sector that screwed up massively.”

D IS FOR DIGITIZE: A Conference on the Google Book Search Lawsuit

New York Law School, Thursday, October 8 through Saturday, October 10, 2009

Everything about the Google Book Search project is larger than life, from [...]]]> Writing in Slate, Mark Gimein knocks down a number of straw man arguments against the Google Book search deal. I look forward to seeing how he grapples with more serious concerns, like those raised by James Grimmelmann. I’ve also been impressed by Christopher Suarez’s working paper on the need for antitrust scrutiny of the proposed deal . Suarez proposes a number of sensible settlement modifications that I hope the court will take seriously. It doesn’t have much time to get this right, as the following conference announcement shows:

D IS FOR DIGITIZE: A Conference on the Google Book Search Lawsuit

New York Law School, Thursday, October 8 through Saturday, October 10, 2009

Everything about the Google Book Search project is larger than life, from Google’s audacious plan to digitize every book ever published to the gigantic class action settlement now awaiting court approval. D is for Digitize will give this complex lawsuit the sustained attention it deserves. An interdisciplinary lineup of academics and practitioners will examine the settlement through the lenses of copyright, civil procedure, antitrust, the publishing industry, information policy, and literary culture. The conference is timed to coincide with the rescheduled fairness hearing in the Google Book Search case, which will be held on Wednesday, October 7 in New York City, just five blocks from New York Law School.

I look forward to seeing those interested in the future of access to knowledge at the conference, which I plan to attend.

On April 16, 2009, the Thurston County Court ruled in favor of a Vietnamese man who sued for defamation. This case was the first of its kind in the state of Washington. . . . The court found the five defendants . . . guilty for wrongly accusing the plaintiff . . . of having communist sympathies.

[I]n this case, both the defendants and plaintiffs fought against communism during the Second Indochina War. All those interviewed invoked a word commonly used within the Vietnamese émigré community to describe the act of wrongly accusing someone of communist sympathies: chụp mũ. [...]]]> I was recently listening to a program on the rise of “red-baiting” in some Vietnamese-American communities. It’s apparently becoming a common rhetorical strategy:

On April 16, 2009, the Thurston County Court ruled in favor of a Vietnamese man who sued for defamation. This case was the first of its kind in the state of Washington. . . . The court found the five defendants . . . guilty for wrongly accusing the plaintiff . . . of having communist sympathies.

[I]n this case, both the defendants and plaintiffs fought against communism during the Second Indochina War. All those interviewed invoked a word commonly used within the Vietnamese émigré community to describe the act of wrongly accusing someone of communist sympathies: chụp mũ. As this trial brought to light, chụp mũ is a widespread practice among Vietnamese community leaders. However, it is very rare for a person who has been chụp mũ to sue his/her accusers.

This might be an interesting precedent for those accused by shock jocks of being socialist, Marxist, Bolshevik, or in favor of concentration camps.

It also brought to mind the vituperative attacks often directed at Gretchen Morgenson of the New York Times. As a recent profile noted, many are bizarrely dismissive of her pathbreaking work:

“The consensus view of her among actual business people I know is pure contempt,” says [a source who] has represented high-profile business-press targets. “Her work has a sort of drive-by, potshot quality to it that leads to habitual mistakes and ideological laziness. She is reflexively opposed to free markets and assumes bad faith in almost every subject or person she examines.”

[But] many will be surprised to learn she’s a moderate Republican. “I believe in capitalism,” she says. “To me it’s natural that I would go after the people who are wrecking it.”

What becomes apparent over several conversations is that Morgenson is a business reporter–no more, no less. She’s more likely to mention investors as her main concern than readers or “the public.” Her views are pragmatic, sometimes small-bore to the point that her detail-laden writing can turn off casual readers. Her fixes are meliorative and not particularly original–better regulation, more competition. Her radical idea is, basically, that regulators should regulate, rating agencies should rate according to the merits of the credit, corporate compensation committees should set executive pay at arm’s length, directors should look to the interests of shareholders first, large shareholders should act like the owners they are and mortgage lending should be something other than a game of three-card monte. That these views are seen as “antibusiness” in some circles tells us less about Morgenson than about the ethical breakdown among this generation’s corporate elites.

People like Morgenson realized that the abuse of the capitalist system could lead to its decline around the world. It’s sad to think that in today’s lapdog business press, shibboleths have often supplanted sober appreciation of the stellar work she’s done.

There are good reasons for all the attention in health reform circles. But there’s a paradox here, too, because Gawande doesn’t believe that changes to health care finance and regulation can deter the wasteful and uncoordinated provider behavior which he sees at the root of the present crisis. I respectfully disagree. Law may not be doing a good job at this now—largely because health care regulators over the past 20 years vastly overestimated the degree to which the market [...]]]> Atul Gawande’s article “The Cost Conundrum” has become a cause celebre in policy circles. The Obama White House is reading it, leading journal Health Affairs has sponsored a roundtable on it, and pundits across the political spectrum are invoking it.

There are good reasons for all the attention in health reform circles. But there’s a paradox here, too, because Gawande doesn’t believe that changes to health care finance and regulation can deter the wasteful and uncoordinated provider behavior which he sees at the root of the present crisis. I respectfully disagree. Law may not be doing a good job at this now—largely because health care regulators over the past 20 years vastly overestimated the degree to which the market would improve quality and access. But we have a rare window of opportunity to correct for those assumptions. Moreover, without real reform, the profit-obsessed providers who are the villains of Gawande’s piece will systematically outcompete the integrated delivery systems he champions. Gresham’s Law applies in health care, too.

First, some background. Gawande compares a high-cost Texas town (McAllen) with a nearby, low-cost one (El Paso). He finds very little in the McAllen extravagance that is actually improving the longevity or quality of life of its residents. The piece describes in some detail how commercial imperatives affected medical practice in McAllen:

[M]any physicians are remarkably oblivious to the financial implications of their decisions. They see their patients. They make their recommendations. They send out the bills. And, as long as the numbers come out all right at the end of each month, they put the money out of their minds.

Others think of the money as a means of improving what they do. They think about how to use the insurance money to maybe install electronic health records with colleagues, or provide easier phone and e-mail access, or offer expanded hours. They hire an extra nurse to monitor diabetic patients more closely, and to make sure that patients don’t miss their mammograms and pap smears and colonoscopies.

Then there are the physicians who see their practice primarily as a revenue stream. They instruct their secretary to have patients who call with follow-up questions schedule an appointment, because insurers don’t pay for phone calls, only office visits. They consider providing Botox injections for cash. They take a Doppler ultrasound course, buy a machine, and start doing their patients’ scans themselves, so that the insurance payments go to them rather than to the hospital. They figure out ways to increase their high-margin work and decrease their low-margin work. . . .

In every community, you’ll find a mixture of these views among physicians, but one or another tends to predominate. McAllen seems simply to be the community at [the high-cost] extreme.

Gawande describes a market gone wild in McAllen, where doctors would demand “four or five thousand [dollars] a month” or even sex in exchange for routing their patients to certain home health agencies.

How does such a culture of commercialization develop? Gawande is not a social scientist, but he can extrapolate from his own experience. He knows how physicians mentor one another and provide models of care. He also mentions the work of Woody Powell, who examines how certain leading institutions can set the tone for much of an economic community. These “anchor tenants” led McAllen’s “medical community . . . to treat patients the way subprime-mortgage lenders treated home buyers: as profit centers.”

Gawande contrasts McAllen with several centers of excellence in health care, including the Mayo Clinic and a Grand Junction, Colorado network of physicians. Mayo doctors are salaried, and in Grand Junction “the doctors agreed among themselves to a system that paid them a similar fee whether they saw Medicare, Medicaid, or private-insurance patients, so that there would be little incentive to cherry-pick [and lemon-drop] patients.” A local HMO encouraged the Grand Junction doctors to meet and “focus[] on rooting out problems like poor prevention practices, unnecessary back operations, and unusual hospital-complication rates.” As a result, quality improved, cost declined, and Grand Junction Medicaid patients enjoyed higher rates of effective access than average.

It would seem that a health reform ought to focus on encouraging these types of interventions. But in an interview with Ezra Klein, Gawande is strangely agnostic on whether law can change much:

My vantage point on the world is the operating room where I see my patients. And trying to think about whether a public option would change anything didn’t connect. I order something like $20,000 or $30,000 of health care in a day. Would a public or private option change that?

People say that the most expensive piece of medical equipment is the doctor’s pen. It’s not that we make all the money. It’s that we order all the money. We’re hoping that Medicare versus Aetna will be more effective at making me do my operations differently? I don’t get that. Neither one has been very effective thus far.

I think there are several misconceptions in that quote. First, the public option is not designed to displace private insurance. It’s supposed to be a benchmark for private plans, to incentivize them to act more constructively. Second, Gawande is here invoking his own perspective, that of “good” physicians, those who push “the money out of their minds” as they decide courses of treatment. Law, as Justice Holmes reminds us, should be written and interpreted with the proverbial “bad man” in mind, who “cares only for the material consequences which [knowledge of law] enables him to predict.”

Many of the rules of health care finance and regulation address exactly the types of problematic behavior discussed in the article. Niche facilities and imaging centers are at the cutting edge of the commercialization Gawande worries about. Lawyers have debated them for years, and the policymaking is still ongoing. HHS set a moratorium on the development of specialty hospitals in 2003, but it expired. This led to a flurry of interest in administrative action designed to address specialty hospitals’ “cherry-picking” of lucrative patients and “lemon dropping” of costly cases onto other hospitals. Something as obscure as “certificate of need” rules (operating at a state level) have proven critical in determining the spread of specialty hospitals. Reports from the GAO and the Medicare Payment Advisory Commission have investigated their impact, while CMS rulemakings have focused on re-assessing payment levels for procedures at ambulatory surgical centers. Antitrust litigation could also play a pivotal role in the struggles between general and specialty hospitals for what Gawande calls the “soul of medicine.”

In the article, Gawande repeatedly talks about “blunting financial incentives” for bad medicine or patient cherrypicking. But that’s exactly the charge of the Medicare Payment Advisory Commission (MedPAC) in its examinations of developments like niche providers. State policymakers can also reflect these concerns in various ways–adjusting nonprofit status, facilities licensure rules, taxation, and many other legal variables.

In other words, law matters. Sure, all these laws can be bent in ways that favor the further commercialization of medicine. Much of any book on health care finance regulation is a tale of frustrated hopes and dashed ambitions. But this body of law at least provides some tangible guide to past and potential realignments of incentives–something that can’t be said for the appeals to cultural change at the core of Gawandean quietism.

Gawande concedes that “In the war over the culture of medicine—the war over whether our country’s anchor model will be Mayo or McAllen—the Mayo model is losing.” Calls for cultural change just aren’t being heeded—and why should they be? If an insurer develops an extremely effective protocol for dealing with the chronically ill, it will be rewarded by the market with. . . . more expensive, chronically ill patients wanting to sign up for it. As things stand now, providing high-quality care for the chronically ill is a great way to go out of business in virtually any market where your competitors can “skim the cream” of the healthiest half of the population, who only demand about 3% of health care spending. Health reform (including real risk adjustment to properly compensate such plans) can help change that.

Gawande’s “Cost Conundrum” could be to health reform what Sinclair’s “The Jungle” was to food safety. It explains current trends in the commercialization of medicine better than virtually any journalistic work out there. Sadly, it appears that its author is now more inclined to “stay above the fray” than to try to articulate and lobby for the regulatory infrastructure necessary for the cultural change he so eloquently advocates.

“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.

“Any credit rating agency that relies on an NRSRO rating [nationally recognized statistical rating organization pursuant to the Securities and Exchange Act of 1934], which is effectively a government subsidy, should be subject to lawsuits by investors,” he went on. “It should also be made clear to professional investors that it is not a defense or a sufficient discharge of their fiduciary duties to rely on [...]]]> Jonathan Stempel of Reuters notes that “rating agencies [were] largely spared” in the financial industry regulatory overhaul proposed by the Obama administration. Jonathan Macey of Yale critiques the oversight:

“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.

“Any credit rating agency that relies on an NRSRO rating [nationally recognized statistical rating organization pursuant to the Securities and Exchange Act of 1934], which is effectively a government subsidy, should be subject to lawsuits by investors,” he went on. “It should also be made clear to professional investors that it is not a defense or a sufficient discharge of their fiduciary duties to rely on credit ratings when assembling portfolios.”

Given my recent series of posts on the “public/private” divide, I was heartened to see Macey characterize the government licensure of rating agencies as a “subsidy.” As I noted in my 2007 post “From First Amendment Absolutism to Financial Meltdown?,” the agencies have used a “free expression” shield to protect against legal consequences for their incompetence, malfeasance, and conflicts of interests. Following the reasoning of FAIR v. Rumsfeld, Congress may be able to condition the “subsidy” of requiring investor reliance on ratings agencies’ work on ratings agencies’ willingness to give up First Amendment immunity from lawsuits.

Admittedly, Congress has gone in precisely the opposite direction in the recent past. In 2006, the Rating Agency Reform Act specifically prohibited the SEC from regulating the “substance of the credit rating or the procedures and methodologies.” We can only hope that current Congress is more serious about either really regulating this field, or getting out of the “implicit subsidy” business altogether.

Back in May, Gail Collins editorialized on “the epicenter of the college loan strangeness,” guaranteed student loans. For such loans, she says, the following holds:

We the taxpayers pay the banks to make loans to students.

We the taxpayers then guarantee the loans so the banks won’t lose money if the students don’t pay.

We the taxpayers then buy back the loans from the banks so they can make more loans to students, for which [...]]]> I know, you’re expecting a post on the new compensation czar. But before commenting on that, I want to think a bit about the way in which Sallie Mae–once a GSE, now “fully privatized”–may amount to a de facto end-run around the usual pay scales for government work.

Back in May, Gail Collins editorialized on “the epicenter of the college loan strangeness,” guaranteed student loans. For such loans, she says, the following holds:

We the taxpayers pay the banks to make loans to students.

We the taxpayers then guarantee the loans so the banks won’t lose money if the students don’t pay.

We the taxpayers then buy back the loans from the banks so they can make more loans to students, for which we will then pay them more rewards.

As she noted in another column, “The White House believes that if it cuts out the middlemen, and just gives the loans to the students directly, it can save $94 billion over 10 years.”

Predictably, the middlemen have furiously lobbied to preserve their prerogatives. Sallie Mae has “hired two prominent lobbyists, Tony Podesta, whose brother, John, led the Obama transition, and Jamie S. Gorelick, a former deputy attorney general in the Clinton administration.” The lobbyists are to press the case that private lenders create value via “marketing, customer relations, billing, default prevention and collection of delinquent loans.” Collins counters that “The real competition among the lenders is not to win over students so much as the school financial aid officers . . . [leading to] thinly disguised bribes and kickbacks.” The Wall Streeting of higher education encourages such shenanigans.

I only have a couple of comments on the situation.

First, I have to wonder if we really can say that Sallie Mae has been fully privatized. All the guarantees it enjoys suggest a great deal of government intervention here. It spent $2,758,700 for lobbying “in the first half of 2007, and gave $572,000 to federal candidates in the 2006 election.” Though perhaps it’ll never be a state actor under what Michael Froomkin calls “our deeply twisted and narrow state action jurisprudence,” it seems more like an agency of the government (or perhaps a QUANGO?) than a contractor. Stephan Padfield gives several compelling reasons to think of such entities in this way.

So while Sallie Mae has many of the prerogatives of an agency, it can pay very high salaries to executives–such as the $13.2 million earned by its vice chair last year. Perhaps the ultimate rationale for keeping Sallie Mae around is to break the Procrustean bed of the Government Pay Scale. Do readers have any other rationales to offer? If it is superior to direct federal lending in “marketing, customer relations, billing, default prevention and collection of delinquent loans,” is that superiority worth $94 billion over 10 years? I think Chris Sagers’ article “The Myth of Privatization” (59 Admin. L. Rev. 37) suggests an answer to that question:

the basic choice in the organization of society is not between organization by government bureaucracy on one hand, and markets on the other–a choice that is assumed in the privatization literature. Rather, the basic choice is between two kinds of bureaucracy, which really do not differ much at all. Indeed, the chief difference seems to be that one of them lacks even a nominal obligation toward the public interest.

If the student loan status quo continues, Sagers’ pessimistic conclusion may well be warranted.*

*The pessimistic conclusion: “We have evolved to a state in which neither the individual franchise nor individual buying and selling decisions have any real significance at all, and all individual decisions are constrained by an astonishing array of restrictions set in ways that are neither democratic nor efficiently incentivized.”

I agree with Klein that a public option can help us achieve the trifecta of health [...]]]> Ezra Klein has given a nice explanation of the advantages of public options in our health insurance ecosystem. He summarizes three different types of options that could develop, including a “trigger plan” (which be “triggered into existence [where] the private insurance market” failed), a “weak public plan” (which “couldn’t use the low rates that Medicare sets” and would just act as another insurer) and a “strong public plan” (which would basically be modeled on Medicare). Klein argues that, whatever public plan were adopted, “The existence of another option changes the market. Individuals will have access to private insurers, but they’ll no longer be stuck with them.”

I agree with Klein that a public option can help us achieve the trifecta of health reform–increasing access, reducing costs, and improving quality. Tyler Cowen challenged Klein today, and I’ll try to answer Cowen.

First, Cowen argues that the public plan will be very expensive, for if “public and private plans are to coexist, the public plan must be attracting the higher-cost customers, namely the higher medical risks.” Even if that’s the case, other industrialized nations have used prospective and retrospective risk adjustment to level the playing field between plans. As I noted yesterday, even private health insurance lobbies have conceded that “spread[ing] costs for the highest-risk individuals” is necessary to guarantee coverage for all. Risk-adjustment should not be seen as a subsidy—rather, it’s a way to keep a level playing field between the public and private plans.

Private insurers’ apparent acceptance of risk-adjustment may seem irrational if you think that they are only in the business of trying to gain the healthiest customers and shed the sickest. Tempting as it is, that cream-skimming is only one part of the broad range of things that insurers do. Many large insurers make substantial “administrative services only” revenue–for example, by administering self-insured employers’ plans. (In that way they avoid financial risk from sick insures–that risk is assumed by the employer funding the plan). Risk adjustment would further reduce their incentives to avoid people with pre-existing conditions. In terms of quality, private insurers can compete with the public plan on several dimensions, including identifying good providers, incentivizing best practices, and fairly determining access to treatment and payments for providers.

It’s that last function—coverage and payment determinations—where the public plan really has a chance at improving insurance for everyone. Today’s default for private insurers is secrecy in pricing, and opaque “gotchas” buried in thick plan documents. As Uwe Reinhardt has noted,

Whatever an insurer’s base for paying hospitals might be, the dollar level of payments is negotiated annually between each insurer and each hospital. . . . These actual dollar payments have traditionally been kept as strict, proprietary trade secrets by both the hospitals and the insurers. Recently Aetna announced that it will make public the actual payment rates it has negotiated with physicians in the Cincinnati area. That this small, tentative step toward transparency made national news speaks volumes about the state of price-transparency in U.S. health care.

Medicare’s payment determinations are complicated, but at least they are done openly. A public plan should offer the same types of baselines here that Medicare currently offers in its National Coverage Determinations, which are routinely followed by private insurers. Private insurers heretofore have had little incentive to clearly explain what the exact consequences of cost-sharing in the face of illness would be. Competition from a public plan that had no profit motive to obscure those consequences might lead to “truth in labeling” like the proposed disclosure chart appearing below:

As Tim Greaney has argued, the public plan is “a benchmark to hold up against private plans’ quality and cost performance.” Cowen focuses on cost competition between the public and private plans, and suggests that competition from the public plan may lead insurers to get even sneakier to offer plans at lower costs. (Cowen claims that “‘cruelty and capriciousness’ would be a comparative advantage of the private companies and maybe it would be milked more strongly in a more competitive environment.”). But more transparent quality competition could help euthanize gotcha capitalism in health care, where it really has no place.

Greaney reminds us that private insurance in many parts of the country simply is not a competitive market:

[A] majority of the country is served by a few dominant insurers. (In 16 states, one insurer accounts for more than 50 percent of private enrollment; in 36 states, three insurers have more than 65 percent of enrollment). Likewise, because of lax antitrust enforcement, most markets are characterized by dominant hospital systems and little competition among high-end physician specialists.

After fighting providers in the late 1990s, many private insurers scared by the “managed care backlash” have cozily upped their premiums and provider payments in tandem. A strong public option can shake up that status quo.

Finally, the public option has a clear incentive to keep people healthy. While churn among private insurers’ customers leaves them little incentive to keep their insureds’ healthy, the public options’ insureds will eventually be entering the Medicare program. As cost-benefit analysis influences the public option, any benefits it achieves by skimping on preventive care may well need to be budgetarily balanced against the ensuing bad health outcomes imposed on the Medicare program. Similar incentives led to extraordinary improvements in the VA program.

In short, private insurers often dominate their markets, their plans are often opaque, and they have little incentive to invest in their customers’ health for the long term. A public option will help us begin to address all those problems.

Hat Tip: Andrew Sullivan.

Bob’s opening post about the ALI Principles of Software Contracts project alludes to commentators who criticized Section 3.05(b)’s purported immutability.   As a commentator to Bob’s post noted, a joint letter between rivals Linux and Microsoft is the most prominent example of this critique.  According to lawyers representing the software concerns, a “far better way” of addressing the implied warranty of no material hidden defects would be to make it disclaimable, since implied warranties are ordinarily disclaimable under the UCC.

As Bob’s post points out,  3.05 isn’t strictly speaking immutable at all: the vendor can “contract out” by simply disclosing the defect!  And even were that not true, contracts transferring goods with defects that are (i) material; (ii) known to the seller [...]]]>

The ALI Delegates at Work

Bob’s opening post about the ALI Principles of Software Contracts project alludes to commentators who criticized Section 3.05(b)’s purported immutability.   As a commentator to Bob’s post noted, a joint letter between rivals Linux and Microsoft is the most prominent example of this critique.  According to lawyers representing the software concerns, a “far better way” of addressing the implied warranty of no material hidden defects would be to make it disclaimable, since implied warranties are ordinarily disclaimable under the UCC.

As Bob’s post points out,  3.05 isn’t strictly speaking immutable at all: the vendor can “contract out” by simply disclosing the defect!  And even were that not true, contracts transferring goods with defects that are (i) material; (ii) known to the seller at the time of sale; and (iii) hidden would create a serious problem of good faith, which is not generally disclaimable under the common law or under the UCC.   Providing a good that the seller knows is materially defective — when the buyer can not learn that fact before the purchase is completed – would very likely be bad faith.  But why not permit such bad faith conduct to be disclaimed?  Can’t Microsoft simply come out and say

“There is an implied warrant out there that promises you that the copy of Windows you are about to buy isn’t materially defective.  Without admitting, or denying, that this particular copy of windows contains a material, hidden, defect, we hereby disclaim that warranty.  Go pound sand.”

On a particular variant of economic theory, permitting sellers to disclaim the warrant of no material hidden defects would provide useful information to buyers about goods, enabling a market about such warranties to develop.  If buyers wanted to buy software without material hidden defects, they would demand such terms from sellers, paying a premium over buyers who are content to live with the possibility of the software crashing their computer through a defect known to sellers.  On the other side of the sale, sellers might seek to develop & sell reputations as companies that don’t wish to behave in bad faith toward purchasers.  By standing by implied warranties, such companies would be able to differentiate themselves from others.  Thus, Microsoft might continue to deploy buggy software at a cheap price, while Apple would burnish its status as a luxury seller.

A serious problem with this story is that groups of consumers don’t react to warranty terms for software in a way that creates the possibility of a virtuous cycle.  (Bob’s the expert on that topic, and I hope he’ll engage with it in a later post.)  But another problem is definitional.  We don’t permit contracting entities to contract out of good faith because good faith is a necessary condition for contractual enforcement.  It’s part of what makes a contract worth enforcing.  Thus, both willful breach (the topic of some great recent work) and willful bad faith both take promissors and promisees outside of the ordinary contractual framework, where everything is subject to private agreement, and encourage judges to instead impose public, redistributive, values.

But why would that be?  My pet theory turns on the extraordinary remedy for breach of contract:  expectation damages available even for wholly executory agreements.  Expectation protects a very odd social interest – reliance on another’s promise – by dispensing with its proof.  Think about it.  You can recover your expected profit for a breach of a contract that you’ve just agreed to, though you haven’t invested one cent in reliance on the bargain.  The expectation interest thus gives parties entering contracts with a tremendous subsidy.  But like most government subsidies, there is a string attached. Here, the price of expectation is a moderate degree of unselfishness, and thus an immutable good faith doctrine.

Take a typical trader at a bank, investment bank, hedge fund or whatever. . . .[W]hen they place financial bets [they face the following odds]: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. These bright young people are no dummies. Faced with such skewed incentives, they place lots of big bets. If tails come up, OPM [other people's money] will absorb almost all of the losses anyway.

[Now] let’s consider the incentives facing the CEO and other [...]]]> Former Fed Vice Chair Alan S. Blinder’s column “Crazy Compensation and the Crisis” offers a sensible perspective on some origins of the current economic crisis:

Take a typical trader at a bank, investment bank, hedge fund or whatever. . . .[W]hen they place financial bets [they face the following odds]: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. These bright young people are no dummies. Faced with such skewed incentives, they place lots of big bets. If tails come up, OPM [other people's money] will absorb almost all of the losses anyway.

[Now] let’s consider the incentives facing the CEO and other top executives of a large bank or investment bank (but, as I’ll explain, not a hedge fund). For them, it’s often: Heads, you become richer than Croesus ever imagined; tails, you receive a golden parachute that still leaves you richer than Croesus. So they want to flip those big coins, too.

After this flash of insight, Blinder retreats into quietism, counseling that “fixing compensation should be the responsibility of corporate boards of directors and, in particular, of their compensation committees.” I don’t know why he doesn’t consider the power of an income tax system that’s much more progressive at the very top income levels. As David Leonhardt observes,

Today . . . the very well off and the superwealthy are lumped together. The top bracket last year started at $357,700. Any income above that — whether it was the 400,000th dollar earned by a surgeon or the 40 millionth earned by a Wall Street titan — was taxed the same, at 35 percent. This change [from the past] is especially striking, because there is so much more income at the top of the distribution now than there was in the past.

Of course, we may need to be sensitive to the rising costs of living for the wealthy.

For example, consider the sad tale of relative deprivation in Franklin Lakes that was chronicled in “Real Housewives of New Jersey:”

“We’re definitely the poor people out here,” [one] said of her leafy Franklin Lakes neighborhood, an assertion that belied the message of her ornate gilded and faux-painted interiors. “We had no landscaping for seven years. The pool isn’t gunite. I’m not spending that kind of money. Is there a liner, can you swim? So who’s stupid, you or me? I don’t look to impress.” [Her husband] added, “People can take us or leave us.”

[After touring a few rooms, the] great room was next, yardage the family crosses to reach the television room or the kitchen, which lie on either side. Downstairs was the “man cave,” as the home improvement shows say, more acreage but this time accessorized with pinball machines, a Skee-Ball setup, an Atlantic City-style card table, a pool table, a black velvet bean bag the size of a Manhattan studio apartment, a suite of leather furniture in front of a giant flat screen TV, and a gym as big as the one on your corner.

Any plan to limit or tax compensation in the financial sector needs to take full cost of these necessities into account.

In the United States, the top 1 percent of the population doubled its share in national income from around 8 percent in the mid-1970s to almost 16 percent in the early 2000s.* That eerily replicated the situation that existed just prior to the crash of 1929, when the top 1 percent share reached its previous high watermark. . . . . . But the richest people and the hundreds of thousands somewhat less rich, could not invest the money themselves. They needed intermediaries, the financial sector. Overwhelmed with such an amount [...]]]> Yale Global Online Magazine has been publishing some interesting articles on the global economic crisis. I found Branko Milanovic’s observations on the origins of the crisis a refreshing new take on the matter:

In the United States, the top 1 percent of the population doubled its share in national income from around 8 percent in the mid-1970s to almost 16 percent in the early 2000s.* That eerily replicated the situation that existed just prior to the crash of 1929, when the top 1 percent share reached its previous high watermark. . . . . . But the richest people and the hundreds of thousands somewhat less rich, could not invest the money themselves. They needed intermediaries, the financial sector. Overwhelmed with such an amount of funds, and short of good opportunities to invest the capital (as well as enticed by large fees attending each transaction), the financial sector became more and more reckless, basically throwing money at anyone who would take it. . . . The increased wealth at the top was combined with an absence of real economic growth in the middle. . . . [as] household debt increase[d] from 48 percent of GDP in the early 1980s to 100 percent of GDP before the crisis.

The root cause of the crisis is not to be found in hedge funds and bankers who simply behaved with the greed to which they are accustomed (and for which economists used to praise them). The real cause of the crisis lies in huge inequalities in income distribution which generated much larger investable funds than could be profitably employed. The political problem of insufficient economic growth of the middle class was then “solved” by opening the floodgates of the cheap credit.

In other words, rather than being directed toward concrete projects that would satisfy real human needs, the money went round and round in speculative games, as the notional value of global OTC derivatives doubled three times between 2000 and 2008. As Martin Wolf observes, those able to skim compensation from those games “now sit on fortunes earned in activities that have led to unprecedented rescues and the worst recession since the 1930s.” Why would they invest in, say, renewable energy here, or infrastructure in Africa, or heating equipment for China when they could make a quick buck on the US housing bubble?

Another Yale Global writer, David Dapice, argues that US health care costs are the root cause of a different (but related) form of waste and malinvestment. Dapice argues that “lowering US health care costs may help the world:”

US healthcare costs are nearly double that of other developed nations, and are without any attendant benefits: US life expectancy is no greater. . . . In one sense, the US is starving investment in growth by swallowing up so much of the world’s savings. With a lower budget deficit, capital flows that are directed to funding US debt might now go toward developing nations. . . .

Definitely a valuable addition to the usual debate over the effect of reform on the US economy alone. I think Dapice is overstating the case to say that there are no attendant benefits–our pioneer therapies do occasionally diffuse to other regions. But his larger point is sound: there are many zero-sum aspects to today’s economy. As Raymond Tallis argues, in a more philosophical vein:

Affluent societies whose members are eaten up with ambition, competition, jealousy, unrequited longing for recognition, love, or sexual conquest, may be deaf to the basic hungers of the wretched of the earth, even if they accept their own role in making them wretched. That is why we should be aware of the extent to which deliberately, accidentally, or even unconsciously, we fuel the hungers of others.

If the economic crisis teaches anything, it is that no one is an island, and the type of “spontaneous order” praised by Hayek can be as dangerous as it is tempting.

*Just to give a fuller sense of the inequality discussed by Milanovic, consider these observations from Charles Morris’ great, balanced book, The Trillion Dollar Meltdown:

Between 1980 and 2005, the top tenth of the population’s share of all taxable income went from 34 percent to 46 percent, an increase of about a third. The changing distribution within the top 10 percent, however, is what’s truly remarkable. The unlucky folks in the 90th to the 95th percentiles actually lost a little ground, while those in the 95th to 99th gained a little.

Overall, however, income shares in the 90th to 99th percentile population were basically flat (24 percent in 1980 and 26 percent in 2005). Almost all the top one-tenth’s share gains, in other words, went to the top 1 percent, or the top “centile,” who doubled their share of national cash income from 9 percent to 19 percent.

Even within the top centile, however, the distribution of gains was radically skewed. Nearly 60 percent of it went to the top tenth of 1 percent of the population, and more than a fourth of it to the top one-hundredth of 1 percent of the population. Overall, the top tenth of 1 percent more than tripled their share of cash income to about 9 percent, while the top one-hundredth of 1 percent, or fewer than 15,000 taxpayers, quadrupled their share to 3.6 percent of all taxable income. Among those 15,000, the average tax return reported $26 million of income in 2005, while the take for the entire group was $384 billion.

Morris’s book is exceptional because he simultaneously grasps the technical details of the financial crisis and the money-driven politics that gave us the regime that made it possible. I can’t recommend this book highly enough. These chilling words are as accurate a portrait of our current direction as I’ve read in some time:

A broad pattern of official and unofficial initiatives . . . seem aimed at permanently locking in the advantages of America’s new baronial class. There is no conspiracy against the poor and the middle class. It’s more the inevitable outcome of our current money-driven political system combined with ‘the disposition to admire, and almost to worship, the rich and powerful,’ which Adam Smith fingered as ‘the great and most universal cause of the corruption of our moral sentiments.’”

[I am] trying to get one problem (the lousy market for law graduates) to help solve another (South Florida’s foreclosure crisis). . . . South Florida is ground zero for the national foreclosure crisis. The courts and the legal system are overwhelmed by this legal tsunami. In all of 2006, fewer than 10,000 foreclosures were filed in the Miami-Dade courts. In the first month of 2009, more than 6,000 foreclosures were filed in those same courts . . . and the rate of foreclosure filings has increased since then. . . . This is an unprecedented legal crisis [...]]]> I wanted to highlight an effort by University of Miami Professor Michael Froomkin to create public interest positions designed to help those in South Florida facing foreclosure:

[I am] trying to get one problem (the lousy market for law graduates) to help solve another (South Florida’s foreclosure crisis). . . . South Florida is ground zero for the national foreclosure crisis. The courts and the legal system are overwhelmed by this legal tsunami. In all of 2006, fewer than 10,000 foreclosures were filed in the Miami-Dade courts. In the first month of 2009, more than 6,000 foreclosures were filed in those same courts . . . and the rate of foreclosure filings has increased since then. . . . This is an unprecedented legal crisis for our community. As the Daily Business Review recently put it, “thousands of families are being displaced. Some end up on the streets or in shelters.”

As George Packer’s article The Ponzi State noted, “government oversight of the real-estate market was so negligent that more than ten thousand convicted criminals got jobs in the mortgage industry.” Riddled with fraud, the housing market in Florida recapitulated the 1920’s boom and bust that John Kenneth Galbraith described. Now a welter of interests on Capitol Hill are likely to make an already formidable legal landscape ever more complex.

Given Katherine Porter’s work on the dubious fees that are a staple of the foreclosure landscape, I applaud Froomkin’s effort to improve the legal prospects of homeowners in distress. As Dean Baker has testified, even the sea of money now unleashed by the Fed probably won’t be enough to prop up housing markets there:

In some of the most bubble-infected markets, like Phoenix, San Diego, Los Angeles, and Miami, the rate of price decline is closer to 30 percent. By every measure, inventories of new homes, inventories of existing homes, and vacant ownership and rental units, there is an unprecedented excess supply of housing. As a result, it is almost inconceivable that house prices will stop deflating in these markets any time soon.

I think Baker’s “right to rent” proposal is a sensible one. (As Stephanie Stern has shown, the “benefits of ownership” have been greatly exaggerated by housing policy makers.) But given the unlikelihood of its adoption, proposals like Froomkin’s are probably the best way to level the playing field between homeowners and the powerful banking lobbies now influencing policy on Capitol Hill. He’s accepting donations for the program at Discourse.net.

Via: Brian Leiter.

A draft paper by Raymond Fisman (Columbia Business),  Shachar Kariv (Berkeley Economics) and Daniel Markovits (Yale Law) has gotten surprisingly little attention given its potentially radical implications.  Maybe it’s the title: Exposure to Ideology and Distributional Preferences. I would have gone with something different.  Perhaps “Law and Economics Eats Law Students’ Hearts.”

The authors looked at first-year students at Yale Law School taking contracts and torts.  They labeled the students’ professors by their purported tendency to emphasize economic and “humanist” rhetoric in class.*  They then used the natural experiment of law school sorting to determine the effect that exposure to economic ideology had on law students’ distributional preferences in the dictator game. That is, did students taught by economically-minded [...]]]>

Richard Posner. Founder. Latter-Day Apostate?

A draft paper by Raymond Fisman (Columbia Business),  Shachar Kariv (Berkeley Economics) and Daniel Markovits (Yale Law) has gotten surprisingly little attention given its potentially radical implications.  Maybe it’s the title: Exposure to Ideology and Distributional Preferences. I would have gone with something different.  Perhaps “Law and Economics Eats Law Students’ Hearts.”

The authors looked at first-year students at Yale Law School taking contracts and torts.  They labeled the students’ professors by their purported tendency to emphasize economic and “humanist” rhetoric in class.*  They then used the natural experiment of law school sorting to determine the effect that exposure to economic ideology had on law students’ distributional preferences in the dictator game. That is, did students taught by economically-minded professors behave differently than those taught by professors disposed toward humanism or critical-legal studies?

The bottom line: students taught by economically-minded professors were both more selfish and more likely to see fairness as a form of kaldor-hicks efficiency.  By contrast, students taught by humanists were more generous and also  likely to see fairness as a matter of equity.

These are important results for those interested in legal education.

• First, and most obviously, it suggests that our preferences for altruism and the content of fairness are highly manipulable — one semester of teaching by a professor – at Yale, no less – can affect them.  I admit to being a bit surprised by the size of the effect, given the mixed results from earlier work on the relationship between economics and altruism.  It’s also surprising that Yalies are so impressionable!  I wonder whether the effect persists past a semester, and whether better coding of actual classroom discussion would have changed the results.
• Second, it suggests yet more reasons for researchers to think hard about the effect that law school teaching has on the content of legal doctrine.  As I’ve argued, it’s quite likely that some law school professors who never published a lick have had more effect on substantive legal doctrine than those who’ve written reams, simply by influencing how their students (who went on to be lawyers and judges) thought about the content of rules and the byways of arguments.  We should do more work like this!
• Third, and most personally, this makes me nervous.  I’m a highly socratic teacher who places lots (and lots) of emphasis in the first-year on efficiency-arguments and on the need to look beyond questions about distributional equality in the present case.  I thought that by doing so I was helping students to think critically about the dynamic nature of contract law – the relationship between contract rules and market price; the usefulness of an intelligent system of defaults; the importance of getting beyond gut intuitions.  But maybe I’m also indoctrinating the students to grab more of the pie for themselves.  Nuts.

*The method they used to code economic preferences was, to be frank, a little mystifying.  They gave points for PhD’s in economics, but had to make exceptions for Alan Schwartz, PhDless but L&E to the bone, Guido, for obvious reasons, and both Robert Gordon and Carol Rose, who are similarly off-set.  Why not simply ask the professors themselves how much they emphasized economic rhetoric in class?  Or the students?

In 1998, as chair of the Commodity Futures Trading Commission (CFTC), Brooksley Born unsuccessfully tried to bring over-the-counter financial derivatives under the regulatory control of the CFTC. The government’s failure to regulate such financial deals has been widely criticized as one of [...]]]> While public intellectuals like Richard Posner assure us that “no one could have foreseen” today’s financial crisis, many voices called for the types of sensible regulation that may well have prevented it. Today one of them, Brooksley Born, is being honored at the John F. Kennedy Presidential Library with a Profile in Courage Award. It is given to “to one or more public officials who took a stand that took a lot of integrity and nerve.” Here is Born’s citation:

In 1998, as chair of the Commodity Futures Trading Commission (CFTC), Brooksley Born unsuccessfully tried to bring over-the-counter financial derivatives under the regulatory control of the CFTC. The government’s failure to regulate such financial deals has been widely criticized as one of the causes of the current financial crisis. In the booming economic climate of the 1990’s, Born battled other regulators in the Clinton Administration, skeptical members of Congress and lobbyists over the regulation of derivatives, warning that unregulated financial contracts such as credit default swaps could pose grave dangers to the economy.

Her efforts brought fierce opposition from Wall Street and from Administration officials who believed deregulation was essential to the extraordinary economic growth that was then in full bloom. Her adversaries eventually passed legislation prohibiting the CFTC from any oversight of financial derivatives during her term. She stepped down from the CFTC in 1999 and returned to a distinguished career in public interest law.

The silencing of Born was just one more sad consequence of the Clinton administration–whose tilt to Wall Street lobbies was almost indistinguishable from that of Reagan and the Bushes. As Frank Partnoy has said,

History already has shown that [Alan] Greenspan was wrong about virtually everything, and Brooksley was right . . . I think she has been entirely vindicated. . . . If there is one person we should have listened to, it was Brooksley.

Born is the same person whom Larry Summers accused of “cast[ing] the shadow of regulatory uncertainty over an otherwise thriving market, raising risks for the stability and competitiveness of American derivative trading.” Would that our present director of the National Economic Council had a bit more concern about the shadow banking system back in the 90s, and a little less eagerness to make Born the Cassandra of American finance.

Photo Credit: From this site.

[This] scheme. . . boils down to the fact that some large financial institutions peddled mortgages to people who could not possibly pay the monthly rates and then put this snake-oil debt into cardboard boxes with impressive labels on them and sold them to institutions and hedge funds that thought they were worth something.

I’d only add one amendment, to recognize the last step in the agency problem: the products were sold by and to institutions whose managers believed that they could still pocket fees and bonuses without being liable to principals for gross malfeasance. As [...]]]> Could you describe the financial crisis in a sentence? Margaret Atwood’s description (in Payback: Debt and the Shadow Side of Wealth) appears to me as good as any:

[This] scheme. . . boils down to the fact that some large financial institutions peddled mortgages to people who could not possibly pay the monthly rates and then put this snake-oil debt into cardboard boxes with impressive labels on them and sold them to institutions and hedge funds that thought they were worth something.

I’d only add one amendment, to recognize the last step in the agency problem: the products were sold by and to institutions whose managers believed that they could still pocket fees and bonuses without being liable to principals for gross malfeasance. As the former head of AIGFP enjoys his fortune, the joy in passing on the proverbial hot potato must daily bring a smile to his face.

As these black boxes continue to blow up, the WSJ Opinion page recently featured a proposal to open up some of them. Professors Viral Acharya and Robert Engle argue that “derivative trades should all be transparent,” in refreshingly plain English:

Most financial contracts are arrangements between two parties to deliver goods or cash in amounts and at times that depend upon uncertain future events. By their nature, they entail risk, but one kind of risk — “counterparty risk” — can be difficult to evaluate, because the information needed to evaluate it is generally not public. Put simply, a party to a financial contract might sign a second, similar financial contract with someone else — increasing the risk that it may be unable to meet its obligations on the first contract. So the actual risk on one deal depends on what other deals are being done. But in over-the-counter (OTC) markets — in which parties trade privately with each other rather than through a centralized exchange — it is not at all transparent what other deals are being done.

This makes it likely that some institutions will build up excessively large positions in OTC derivatives without the full knowledge of other market participants. If these institutions were to default, their counterparties would also incur significant losses, creating a systemic risk.

Acharya and Engle criticize Treasury Secretary Timothy Geithner’s proposed new regulations on derivatives trading for not going far enough to address these issues. I’m not surprised at their inadequacy, but I think Acharya and Engle may underestimate the growth of secrecy as a linchpin of contemporary capitalism. Trade secrecy is a key part of the business practices of all manner of middlemen, ranging from search engines to health insurers. We can debate its utility in those fields. But it appears totally out of place where a Gordian knot of gambles can put the entire global financial system at risk. Trade secrecy has little or no place in a financial world wrecked on the shoals of black box derivatives trades and an opaque “shadow banking system.” As Stephen Mihm has noted,

The drumbeat of bad news . . . is [according to many experts] only a symptom of something new and unsettling – a deeper change in the financial system that may leave regulators, and even Congress, powerless when they try to wield their usual tools. That something is the immense shadow economy of novel and poorly understood financial instruments created by hedge funds and investment banks over the past decade – a web of extraordinarily complex securities and wagers that has made the world’s financial system so opaque and entangled that even many experts confess that they no longer understand how it works.

Even if the Acharya and Engle proposal is deemed too extreme by team Geithner/Summers, it would be inexcusable not to have some group within the SEC given this information in real time. Think of it as a FISA court for finance.