Tagged: financial crisis

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Thanks and Some Additional Comments

I wanted to thank Frank Pasquale for organizing and hosting this symposium and all of the participants for the time they took reading The Economic Dynamics of Law and providing their thoughts. I wanted to say a little about the most recent posts, even though it’s possible that something more might appear before the weekend is out.

I’m happy to accept Livermore’s suggestion that systemic risk avoidance and keeping open a robust set of economic opportunities can be thought of as an incompletely theorized agreement about goals. He may be right that in fact avoiding systemic risk is efficient, but I doubt that all climate disruption cost-benefit analysis (CBA) would necessarily reveal that. Showing that most current CBA would call for some action on climate disruption does not suffice to show the congruence between CBA and avoidance of systemic risk taking into account collateral negative consequences (which is narrower than taking into account all costs under my normative framework). First, there is a historical problem. Prominent early CBA and much of the CBA from a few years ago would not invite vigorous measures to address climate disruption (although some CBA did early on). Even today, there may be a discrepancy between what scientists tell us we need to minimize significant risk, a phase-out of fossil fuels, and what some of the CBA is telling us. CBA is basically guesswork, and does not yield a reasonably specific answer when substantial uncertainties exist. Read More

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Now What? Applying the Economic Dynamic Approach to Financial Reform

Echoing the earlier commentators, I commend Professor David Driesen on his important contribution to legal scholarship and public policy with The Economic Dynamics of Law. I am hopeful that the economic dynamic approach can be used in the academy and on the front lines of financial reform.

As Driesen observes, the centerpiece of financial reform in the U.S., the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) “mandates only minimal structural reform.” Moreover, efforts persist to rollback, dilute and delay the modest improvements accomplished through Dodd-Frank. The result has been to emphasize bank-collapse intervention tools without sufficient focus on prevention. Consider that this modest reform effort began while the 2008 crisis was still fresh in mind. As memories fade and passions cool, the ability to enact structural reform diminishes.

And, this is exactly where use of an economic dynamic analysis is needed. Let me present just one real-life fact pattern. This coming Tuesday morning, the U.S. House of Representatives Committee on Financial Services has scheduled a hearing entitled, “Who’s In Your Wallet: Examining How Washington Red Tape Impairs Economic Freedom.” The invited witnesses are the general counsels of five federal financial agencies, including the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Federal Reserve Board, the National Credit Union Association, and the Office of the Comptroller of the Currency. In the memo announcing the hearing the following agenda is described:

“Among other things, the hearing will examine how federal financial regulatory agencies evaluate the costs and benefits to consumers of their regulatory, enforcement, and supervisory actions. The Committee will explore whether products or services are no longer being offered to consumers because of agency actions and the steps federal regulators take to measure the impact on consumers if they no longer have access to specific products or services as a result of regulatory action. The Committee will also consider the procedures or standards agencies follow in determining whether to engage in formal rulemaking under the Administrative Procedures Act.”

The intent appears to be to treat as a cost the potential failure to satisfy individual preferences in the present without considering broader costs and harms that particular financial products can create for individuals and the system at large. As Driesen describes in Chapter 2, by emphasizing allocative efficiency, “the law of financial regulation ceases to function as a means of avoiding a depression, and instead becomes thought of as a product of balancing a proposed regulation’s benefits against its costs.”

Consumers may have had preferences for very low-money-down, negatively amortizing mortgages for which there would or could be a payment shock upon recast.  And many did show those preferences (even when the bank in-house marketing studies showed the product had to be pushed on them with minimal disclosure). However such toxic products and others led to millions of foreclosures and bank safety and soundness problems, and ultimately a global financial meltdown.

It will be interesting to see whether the witnesses on Tuesday reject the assumptions underlying how the hearing has been framed and instead apply an economic dynamics approach to their testimony and answers.

 

 

 

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On Norms and Analysis

            Michael Livermore views my book as either challenging the normative foundations of law and economics or as offering a set of proposals to improve cost-benefit analysis (CBA). The book advocates goals, namely systemic risk avoidance and opportunity creation, and a focus on the shape over change over time that challenge the normative foundations of law and economics, i.e. static allocative efficiency. It also commends an analytical technique, economic dynamic analysis, to improve the economic analysis of law, but intends this technique to improve all economic analysis of law, not primarily CBA. By conflating analytical and normative questions and reducing all economic analysis to CBA, Michael makes it hard to properly understand either the normative or the analytical debate.

The question of whether avoidance of systemic risk and keeping open a reasonably robust set of economic opportunities constitutes a more important goal for society than allocative efficiency requires a normative discussion not focused on questions of technique. (See Martha McCluskey’s post in this symposium). The only glimmer of normative discussion that Michael offers casts doubt on his apparent preference for efficiency as a goal. He agrees with me that government should not be viewed as a master allocator of resources. But the goal of achieving allocative efficiency flows from viewing government as a master allocator of resources. And it is this goal that motivates proposals for use of CBA as an analytical technique. This is, reducing all costs and benefits to dollar terms in order to compare them on a single metric, however morally dubious and technically difficult, does serve the goal of optimal resource allocation. It’s a lot of wasted effort for many other kinds of goals. Read More

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Where Have All of the Storefronts Gone?

Have you noticed the number of empty storefronts around? (For a list of recent store closings, see here.) Business failure unfortunately is part of an economic recession, but it also follows changes in consumer patterns and market demands. Although studies debate the advantages of online versus brick and mortar stores (see herehere and here), consumers are increasingly more comfortable shopping online. Increased security and user-friendly return policies (not to mention all of those free shipping deals) appear to be fostering that trend.

Online or virtual stores also have a very different business model and cost structure (see, e.g., here). A small workforce in one location can service all of a company’s online customers. Compare that model with the brick and mortar model where a company operating in more than one location needs, at a minimum, to own or lease property in each location, pay maintenance and taxes for each facility, retain employees at each facility and comply with the law of each jurisdiction.  (For interesting comparisons, see here, here and here.) Accordingly, brick and mortar stores are relying to some extent on certain intangibles—e.g., consumers wanting to touch and see what they are buying, wanting personal service, etc.—to offset these additional costs.

So is it the economy, the changing market or (as is likely) some combination of factors causing companies like Blockbuster, Borders and Harry and David’s to struggle? (For my prior post related to Borders’ financial challenges, see here.) And if it is the latter, will traditional brick and mortar retail stores make a strong comeback when the economy recovers? I am not so sure. I think we may see more retail bankruptcies end like Circuit City’s case—i.e., Circuit City’s core business continues, as does the use of its name, but only in an online form (and under new ownership; see here). Although I appreciate the efficiencies of this model for both the company and the consumer, I do not think it is necessarily the best trend for us as communities and neighbors. As the commercial says, having a face-to-face conversation with a salesperson about your product questions: “priceless.”

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Gearing Up for a Let Down?

There currently is a lot of activity surrounding implementation of the Dodd-Frank Act. The various agencies are proposing rules, numerous organizations are filing responsive comments and many rules have become final. (For useful resources to help track rulemaking and developments, see here and here.) Major portions of the Act are taking shape (see, e.g., here, here and here); the new Consumer Financial Protection Bureau even has its website up and running.

But there are problems. Although progress is being made, agencies are behind schedule in meeting certain benchmarks, with the first anniversary of the Act quickly approaching. Opposition lobbies continue to form and are gaining strength (see, e.g., here and here), and funding for the Act’s initiatives remains in question (see here, here and here). I can’t help but wonder about the endgame. Can our already understaffed and underfunded agencies enforce these new rules? Are rules on the books without any meaningful enforcement mechanisms effective? If the answer to both of these questions is no, where exactly are we headed?

I am not the first, and certainly will not be the last, to raise these types of questions. Nevertheless, I raise them to consider the alternatives. If the risk management, corporate governance and consumer protection issues highlighted by the recent recession can’t be fixed effectively through the regulatory process, what might work? The obvious alternatives—market discipline and industry self-regulation—have their own problems, which might be as challenging to overcome as the resource issues facing the government.  (For interesting perspectives on these alternatives, see, e.g., here and here.) But I think we should continue to try; we should consider innovative ways to enhance the efficiency of these and other monitoring/disciplining tools that could complement whatever comes out of the regulatory initiatives. The economic problems we face are too big for us to fail.

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Volunteering in a Recession

I heard an interview today with a representative of a nonprofit organization that matches volunteers with organizations in need—a sort of match-maker in the volunteer context. Interestingly, the representative reported an increase in the number of available volunteers during the recession (see also here and here). She attributed this trend to two things: people who had lost their jobs wanting to keep up their skills while searching for new employment and people generally wanting to help others in need.

The report piqued my interest regarding whether the recession was having a similar, positive effect on the provision of pro bono legal services. I suspected that more people were in greater need of legal assistance as a result of the recession, which in fact turns out to be the case (see here and here). I did not know, however, whether lawyers were meeting this increased demand. I like to think we are, but the profession’s record on this point is not necessarily encouraging (see, e.g., here).

The results appear mixed. Some reports suggest that the level of pro bono activity has remained the same or increased slightly in the past few years (but see here). (For interesting perspectives on the recession and the legal profession, including pro bono legal services, see here and here.) Nevertheless, even these increased activity levels fall woefully short of the reported need. So, given high lawyer unemployment rates and the desire to better train new lawyers, why does this gap exist?

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Perhaps a Sign of Things to Come

A Federal Reserve staffer suggested this week that the Fed will defer a key consumer decision to the newly-created Consumer Financial Protection Bureau (CFPB). That decision concerns homeowners’ rights of rescission. The rescission right gives a homeowner a certain period of time (in some cases up to three years) to challenge a mortgage on the grounds of misrepresentation or inadequate disclosure and requires the mortgagor to release its lien on the subject property. As you might guess, the rescission remedy has been invoked extensively in the recent economic downturn.

The mortgage industry has been encouraging the Federal Reserve to address the rescission issue with a sense of urgency, perhaps fearing what might happen to the rule after July 21, 2011—the date that authority on such issues is transferred to the CFPB. The Federal Reserve looked poised to make a move, having proposed a rule in September 2010 that would significantly restrict the circumstances under which a homeowner could seek to rescind a mortgage. The comment period for the proposed rule closed on December 23rd, and, despite opposition by consumer groups, many thought the Federal Reserve would continue to pursue the proposal. 

A decision by the Federal Reserve to defer this particular issue to the CFPB would be consistent with the CFPB’s objective to consolidate the oversight and implementation of consumer protection regulations in a single agency. It may not, however, produce a result consistent with the intent of the Federal Reserve’s proposed rule and the desires of many in the mortgage industry. One of the CFPB’s charges is to oversee the mortgage and credit card industries, including the language and substance of consumer disclosures. Given the CFPB’s preemption provisions (which favor enforcing state consumer protection laws), the CFPB’s proposed partnership with state attorneys general and the robo-signing and related concerns swirling around the mortgage industry, I doubt that weakening consumers’ rescission rights is high on the priority list.

I look forward to seeing how this and other pressing consumer issues play out, particularly after July 21st. The CFPB is starting to take shape (see here and here), and it appears that it will hit the ground running. (For interesting Q&A with Elizabeth Warren on the CFPB, see here and here.) In any event, the agency certainly has its work cut out for it.

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Are You a Winner?

Two lucky people woke up this morning mega millionaires. After yesterday’s lottery ticket buying frenzy, one winning ticket was sold in Idaho and the other in Washington (see here). The winners will share equally the $355 million jackpot.

Sounds like a dream coming true, right? Unfortunately, for many lottery winners, winning the lottery eventually leads to bankruptcy (see here, here and here). Statistics tend to show that a good portion of lottery winners file chapter 7 or chapter 13 personal bankruptcy cases within five years of receiving their jackpots (see here and here). In one sense, the tale of doom attached to big lottery winnings seems similar to the ploy of telling a bride that rain on her wedding day signals good luck—it makes those of us who didn’t win feel a little better. In another sense, however, it highlights a real problem in our approach to financial education.

Yesterday, the American Bankruptcy Institute reported a significant increase in overall personal bankruptcy filings. Undoubtedly, some of those filings are the direct result of the recession, and some filings stem from similar unforeseen changes in circumstances, such as divorce and serious health problems. But many personal bankruptcies involve honest, unsophisticated individuals who simply do not understand or have the skill set to manage their personal finances. Yes, these individuals should take responsibility for their finances, but they also need training and resources to be successful in that endeavor. Studies suggest that many high school graduates do not understand how credit cards and other basic financial instruments work (see herehere and here), yet most carry credit and debit cards in their wallets.

I appreciate the enormous challenges facing the U.S. education system. As we evaluate these challenges, however, we need to consider financial education as part of the core curriculum. We also need to continue working to provide meaningful financial education to adults (for an interesting study concerning financial education and bankruptcy, see here). Although the 2005 amendments to the U.S. Bankruptcy Code incorporate a consumer education component, that requirement has become little more than the potential debtor sitting in front of a computer screen and answering a few questions in order to be able to file her bankruptcy petition (for other perspectives, see here, here and here; for an excellent study regarding the impact of the 2005 amendments on consumer debtors, see here). I hope that as the economy recovers, so too do our financial education initiatives  (see here and here) so that more individuals have a real chance at sustainable financial health.

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Creative Reconstruction

In my opening post, I referenced the slow pace of change and how it can be exceedingly painful for individual consumers. I want to follow up on that concept in the business context, where slow change—or the failure to change at all—can be fatal.

Consider, for example, Borders, which recently announced that it was suspending payments to vendors and trying to refinance its debt obligations (see here and here). Borders, like its competitor Barnes & Noble, is struggling to compete with big box retailers that offer steep discounts on traditional books and the growing popularity of e-Books (see here, here and here). Also like many retailers, Borders was hit hard by the economic recession (see here).

Some may say that Borders is a victim of the recession and creative destruction. And that may, in part, be accurate. (For interesting perspectives on the utility of recessions and creative destruction, see here and here.) But anyone who follows the retail industry or is an avid reader had some sense that this was coming (see here, here and here). So why didn’t Borders’ management? Or rather, why didn’t they react more quickly to the changing market and economy?

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2011: Has that much really changed?

I want to start by wishing everyone a very happy New Year and by thanking my colleague Danielle Citron and all of the permanent authors of Concurring Opinions for inviting me back to guest blog. I truly enjoyed my time as a guest blogger last January, and I look forward to participating on the blog during the next few weeks.

2010 certainly was an active year—we saw Congress pass landmark legislation (see here and here), voters overhaul the political landscape in the mid-term elections (see here and here) and everyone continue to focus on the economic recovery (see here, here and here). But as I reflect on the past year and look forward to 2011, I am not really sure that much has changed.

Yes, we were told that the economic recession officially ended, but people, businesses and countries are still feeling the pain. Domestic unemployment continues to hover around 9.8 percent, and some jobs lost during the recession may not be coming back (see here). The U.S. national debt exceeds $13 trillion, and we have no clear path for reducing it (see here and here). Several European countries continue to struggle with liquidity issues (see here and here) and banks continue to fail.

Nevertheless, some things do appear to be changing—albeit at a very slow pace. For academics, slow change can be good, in that it allows us to analyze critically the causes, developments and potential resolutions in (almost) real time. For others, the slow pace of change can be exceedingly painful. In any case, part of what I hope to do during the next few weeks is explore ongoing changes in the corporate and financial fields, as well as the challenges we continue to face in the legal profession generally. These areas are the primary focus of my teaching and scholarship, and I will endeavor to impart some of my passion, concern and optimism for each through my upcoming posts.