Law Commons^™

Perverse Incentives: Risk Taking And Reform, Aaron J. Unterman

Aaron J. Unterman

The common theme that ties the financial crisis (and this article) together is one of misguided incentives that pervaded the finance industry and perverted the actions of individuals and institutions resulting in a global crisis with severely deleterious social effects. In the world of finance, the greatest way to achieve a dramatic increase in wealth is to take large risks, of course, this is also the easiest way to lose it. A great deal of the so-called financial innovation that we experienced preceding the crisis was devoted to finding ways to take on as much risk as possible. The rise …

The Milgram Universe Of Credit Derivatives: A Regulatory Proposal, Grace Chong

Grace Chong

Much work in social psychology suggests that in compressed and interactively complex systems, subjects surrender responsibility for their actions in full faith of the system. The leading experiment on obedience, the Milgram experiment, was originally devised by Stanley Milgram to test the willingness of subjects to comply with acts against their conscience under the instruction of authority. However, his later findings, and further research by other academics have expanded the scope of his previous conception of ‘authority’ to hospital studies , aviation , and business contexts. No research has yet been conducted as to the relation between Milgram’s theory and …

Et Tu, Brute? The Downfall Of Wachovia Bank And The Proper Roll Of The Federal Deposit Insurance Corporation In Providing Open Bank Assistance, Angelo M. Metaxatos

Angelo Metaxatos

In the autumn of 2008, our country’s banking system, crippled by risky lending practices and over-leveraging, was teetering on the precipice of widespread failure. During this period, the Federal Deposit Insurance Corporation (FDIC) played a crucial role in assisting some banks, and acting as a receiver with others. When Wachovia Bank, one of our country’s largest financial institutions, was in danger of failing at the peak of the crisis, the FDIC concluded they were “too big to fail” and took the extraordinary step of providing open bank assistance. When, as a result of this assistance, Citigroup offered to purchase Wachovia …

Toxic Assets: Untangling The Web, Margarita S. Brose, Bill Nichols

Margarita S Brose

No abstract provided.

Securitization And Systemic Risk Amid Deregulation And Regulatory Failure

Patricia A. McCoy

During the recent housing boom, private-label securitization without regulation was unsustainable. Without regulation, securitization allowed mortgage industry actors to gain fees and to put off risks. The ability to pass off risk allowed lenders and securitizers to compete for market share by lowering their lending standards, which activated more borrowing. Lenders who did not join in the easing of lending standards were crowded out of the market. Meanwhile, the mortgages underlying securities became more exposed to growing default risk, but investors did not receive higher rates of return. Artificially low risk premia caused the asset price of houses to go …

Should The Hvcc Settlement Be Treated As An Agency Rulemaking?, Ted C. Koshiol

Ted C. Koshiol

Abstract On March 3, 2008, the New York Attorney General’s reached an important settlement with Fannie Mae, Freddie Mac, and the Office of Federal Housing Enterprise Oversight. Under the terms of the agreement, Fannie and Freddie agreed to only purchase mortgages from banks that would abide by a new set of appraisal standards. Observers immediately recognized that the impact of the agreement would be widespread, effectively imposing new rules on every mortgage lender in America. The scenario raises a novel legal issue: is a settlement agreement always an adjudicatory action, or are there instances where it should be required to …

Banking Supervision And Its Regulations — Comparative Study Between U.S. And China, Han Deng

Cornell Law School Inter-University Graduate Student Conference Papers

The health of the economy and the effectiveness of monetary policy depend on a sound financial system. A smoothly functioning banking supervision regime is one of the cornerstones of any financial system. Only a stable financial system, which is one of the key aims of state regulation and oversight, can optimally fulfill its macroeconomic function of efficient and low-cost transformation and provision of financial resources. A global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The primary goals of supervision and regulations include protecting depositors' funds, maintaining a stable monetary system, promoting an efficient …

Do Individual Investors Affect Share Price Accuracy? Some Preliminary Evidence, Alicia Davis Evans

Law & Economics Working Papers Archive: 2003-2009

A common belief is that individual investors are noise traders that distort stock prices. Because accurate share prices are important for economic functioning, the market effect of retail investors has significant regulatory implications. This paper, employing a new NYSE retail trading data set and the R2 metric of share price informedness, contributes to the debate by demonstrating that as the proportion of trading by individual investors increases, the R2 of firms decreases. Adherents of the R2 methodology hold that lower R2's imply more accurate stock prices. The results of an instrumental variable estimation suggest that this relationship is a causal …

Macroeconomics & The Modern Corporation, Richard Shamos

Richard Shamos

This paper examines the intellectual basis of corporate law in order to develop a theory of the firm—metering theory—that is rooted in team production and institutional economics. This reconceptualization is distinct from the pure free market approach promoted by agency theory, which emphasizes the role of incentive effects on microeconomic actors. The main limitation of the agency analysis is its reliance on property law to analyze the modern corporation, which is instead driven by entity law. The crux of the economic analysis lies in the application of the macroeconomic model for the flow of goods and money in the economy …

The Coming Demise Of Deregulation Ii, Richard D. Cudahy

Richard D. Cudahy

An article that I had written in 1993, which forecast the "coming demise of deregulation," might at last be vindicated by the fallout from the banking and credit crisis. This article discuses recent developments in the banking and financial services industry, and anticipates a resurgence of regulation.

On The Use And Abuse Of Standards For Law: Global Governance And Offshore Financial Centers, Richard K. Gordon

Richard K Gordon

Current trends in international legal scholarship have shifted from a paradigm of state actors working within recognized sources of international law to one that includes transnational regulatory networks working within generally accepted standards. The new paradigm can be seen in operation in the efforts by onshore countries to restrict the activities of offshore financial centers. Onshore countries have attempted to use regulatory networks to advance new standards for income taxation, prudential regulation, and money laundering. In part because of the way in which the IMF participated in the process, onshore centers have largely succeeded in securing compliance with financial regulatory …

Why Not Tell The Truth?: Deceptive Practices And The Economic Meltdown, Charles W. Murdock

Charles W. Murdock

Today we are witnessing a crisis caused by economic formulae developed without a responsible exercise of judgment and, in many instances, with a shocking disregard for the truth. The virtue of truthfulness is not just some abstract moral principle. Rather, it is a critical component of a well functioning society. As the current situation demonstrates, the lack of regard for truthfulness can have disastrous consequences, not just for our own country, but around the world.

This article will first examine how broadly truth is devalued throughout our society. Second, it will focus on the lack of truthfulness in politics and …

Why We Need A Superfund For Hedge Funds, Dale B. Thompson

Dale Thompson

The current financial crisis has led to numerous calls for regulation of hedge funds. This article argues that the appropriate response is a combination of mechanisms: establishment of a Superfund financed by a tax on hedge funds, whose revenues are then used to conduct market purchases of “toxic” financial assets, along with supporting regulations. This article develops this solution by focusing on the market failures caused by hedge funds, namely the externalities posed by liquidity risks, and the inability of market prices to provide information about the valuation of financial securities. It then considers possible solutions through the prism of …

Why We Need A Superfund For Hedge Funds, Dale B. Thompson

Dale Thompson

The current financial crisis has led to numerous calls for regulation of hedge funds. This article argues that the appropriate response is a combination of mechanisms: establishment of a Superfund financed by a tax on hedge funds, whose revenues are then used to conduct market purchases of “toxic” financial assets, along with supporting regulations. This article develops this solution by focusing on the market failures caused by hedge funds, namely the externalities posed by liquidity risks, and the inability of market prices to provide information about the valuation of financial securities. It then considers possible solutions through the prism of …

The New Regulation: From Command To Coordination In The Modern Administrative State, Robert B. Ahdieh

Robert B. Ahdieh

The New Regulation: From Command To Coordination In The Modern Administrative State, Robert B. Ahdieh

Robert B. Ahdieh

The New Regulation: From Command To Coordination In The Modern Administrative State, Robert B. Ahdieh

Robert B. Ahdieh

The New Regulation: From Command To Coordination In The Modern Administrative State, Robert B. Ahdieh

Robert B. Ahdieh

The New Regulation: From Command To Coordination In The Modern Administrative State, Robert B. Ahdieh

Robert B. Ahdieh

The Environmental Deficit: Applying Lessons From The Economic Recession, Christine Klein

Christine A. Klein

In 2007, the nation entered a financial downturn unprecedented since the Great Depression of the 1930s. A period of national introspection followed, including memorable moments such as Federal Chairman Alan Greenspan’s gut-wrenching admission that his “whole intellectual edifice” had collapsed during the summer of 2007. Although prescriptions for financial rescue varied widely in the details, a surprisingly-broad consensus began to emerge as to the underlying pathology of the crisis. This Essay focuses on three underlying errors: rejecting rules through deregulation, trivializing risk through overly-optimistic analyses, and recklessly borrowing and lending money. Those powerful lessons, accepted by a stunned nation in …

What Will It Take To Label Participation In A Deceptive Scheme To Defraud Buyers Of Securities A Violation Of Section 10(B)? The Disastrous Result And Reasoning Of Stoneridge, Mark S. Klock

Mark S Klock

In 2008 the Supreme Court ruled in a 5 to 3 decision that participants to a sham transaction in the product market designed to fraudulently inflate revenue could not be liable in a private action to recover under Section 10(b) of the Securities and Exchange Act because the participants had not communicated directly with the shareholders and therefore the public could not have relied on the misrepresentations. Early commentary has been critical of the majority’s legal reasoning. I bring additional economic theory to the criticism of the majority in light of the subsequent financial sector and macroeconomic collapse and the …

Fannie Mae And Freddie Mac And The Future Of Federal Housing Finance Policy: A Study Of Regulatory Privilege, David J. Reiss

David J Reiss

The federal government recently placed Fannie Mae and Freddie Mac, the government-chartered, privately owned mortgage finance companies, in conservatorship. These two massive companies are profit-driven, but as government-sponsored enterprises they also have a government-mandated mission to provide liquidity and stability to the United States mortgage market and to achieve certain affordable housing goals. How the two companies should exit their conservatorship has implications that reach throughout the global financial markets and are of key importance to the future of American housing finance policy.

While the American taxpayer will be required to fund a bailout of the two companies that will …

Federally-Insured Money Market Funds And Narrow Banks: The Path Of Least Insurance, Mercer E. Bullard

Mercer E Bullard

In September 2008, the Treasury created a temporary insurance program for money market funds (“MMFs”), which had never previously been covered by government insurance. This essay argues that this program should be made permanent. To the extent that deposit insurance is intended to protect cash accounts that provide a stable foundation for our payments system, similar insurance should be made available to MMFs, which serve this function while presenting less risk than bank deposits. The argument that only bank accounts should be insured because the liquidity they create for long-term ventures otherwise would dry up might once have made sense, …

'Wishin And Hopin And Thinkin And Prayin, Plannin And Dreamin:' The Narrative Theor[Ies] Of Predatory Lending, Carolyn Grose

carolyn grose

This is an article that uses a predatory lending case as a vehicle to examine the metaphor of the lawyer as storyteller. For many years and in many law reviews now, we have been reading and writing about the relationship between narrative and story and the law. I add my voice once again to this discussion by examining more closely this idea that as representors of clients, lawyers are constructors and tellers of stories. Specifically, I examine the process lawyers go through and the choices lawyers make in figuring out what stories to tell and how to tell them.

The …

Tainted Loans: Towards A Mass Torts Approach To Subprime Mortgage Litigation, Raymond H. Brescia

Raymond H Brescia

A poison has entered the financial bloodstream. The subprime mortgage crisis and the wider financial crisis it has spawned have caused the erosion of trillions of dollars in wealth, destroyed whole communities and the dislocation of millions of homeowners. Yet, unlike in other situations where toxic products have caused widespread harm, to date, we have not seen an avalanche of litigation, large jury awards, massive settlements compensating victims and financial ruin for the distributors of those products. Some of this is changing, however. Litigation arising out of the present financial crisis is hitting the courts, including suits alleging discrimination in …

Gingerly Stepping Between And Law And Practice: Implications Of The Real Rights Law Of China 2007 On The Alternatives Of Shipbuilding Refund Guarantee, Jiang Lin

Jiang LIN

The Real Rights Law of China 2007 is a one-step further made by China towards the commercial reality. However, the new legislation may have many far-reaching effects in practice beyond the step-by-step contemplation of the legislators. This article studies the possible effects of the new legislation on the shipbuilding refund guarantee, which is essential for the survival and development of Chinese shipbuilding industry - the second largest in the world. The study shows that the new legislation could realise the ship construction mortgage by way of charging semi-finished product or “floating asset”. Moreover, it could perfect the title transferred under …

Star Creation: The Manipulation Of Mutual Fund Performance Through Incubation, Ahmed E. Taha, Alan R. Palmiter

Ahmed E Taha

This article reveals how mutual fund companies mislead investors by marketing new funds with artificially high returns. Fund companies create a number of small, new funds (“incubator funds”) that initially operate out of public view. After a period of incubation, the strong performers are actively marketed to the public while the weak performers are quietly terminated. By highlighting the successful incubator funds and hiding the unsuccessful ones, funds companies create the illusion that that the successful funds’ returns were the result of skill rather than luck. In addition, fund companies often subsidize their incubator funds to further artificially boost their …

Secret Liens And The Financial Crisis Of 2008, Michael N. Simkovic

Michael N Simkovic

This article explains the roots of financial crises in one of the oldest and most fundamental problems of commercial law: hidden leverage. Common law courts wrestled with this problem for centuries and developed a time-tested solution: the doctrine of secret liens. If the debtor becomes insolvent, the doctrine of secret liens punishes secret lien holders by subordinating their claims to those of other creditors. In other words, by overriding privately negotiated payment priorities, the doctrine of secret liens creates incentives for transparency. This article argues that legal changes over the last 80 years eroded the doctrine of secret liens, and …

Complexity As A Catalyst Of Market Failure', Steven L. Schwarcz

Steven L Schwarcz

This article examines how the complexities of modern financial markets and investment securities can trigger market failure. The article also analyzes what steps, including possible regulation, should be taken to reduce the potential for failure. Because market complexities and failures are characteristic of complexities and failures in engineering systems with nonlinear feedback, the article employs a law and engineering analysis, drawing on the literature analyzing those systems.

Complexity As A Catalyst Of Market Failure, Steven L. Schwarcz

Steven L Schwarcz

This article examines how the complexities of modern financial markets and investment securities can trigger market failure. The article also analyzes what steps, including possible regulation, should be taken to reduce the potential for failure. Because market complexities and failures are characteristic of complexities and failures in engineering systems with nonlinear feedback, the analysis draws on the literature analyzing those systems.