The Volokh Conspiracy

At my suggestion, Intelligence Squared is hosting a debate on the motion: Abolish The Minimum Wage. At a time when President Obama is proposing to increase it, I thought it might be useful to go back to first principles and explore whether the minimum wage is good policy in the first place. The debaters are top-notch, and the program promises to be very lively.

Intelligence Squared debates are usually held in New York City, but this one will be in Washington, DC, at the Burke Theater at the U.S. Navy Memorial, 701 Pennsylvania Avenue, NW. Wednesday, April 3. Reception, 4:30-5:15pm; Debate, 5:30-7:00pm.

More information is available here. Tickets to the live debate can be purchased here. And, on April 10, the podcast will be available here.

From a review in the most recent issue of Reviews in American History:

Like most conservatives, Shlaes assumes a perfectly competitive marketplace in which the government can only make an unwarranted and counterproductive intrusion. This perspective leads Shlaes to discount the role of jobs programs such as the CCC and the WPA that contributed to the decline in unemployment from 22 percent in 1932 to 9 percent in 1937. By setting a standard in which a public program cannot provide real work and must be temporary, she forecloses the possibility that any government program could strengthen the economy. Because Shlaes’ position is roughly equivalent to a cancer researcher who refuses to count remissions from chemotherapy, Hiltzik easily rebuts her.

Outside these parameters, however, Hiltzik has his own problem. The New Deal did reduce unemployment, but it was ultimately World War II and the warfare/welfare state emerging out of it that has kept the rate down ever since. Although Hiltzik briefly acknowledges World War II’s role in reducing unemployment, both he and Shlaes actually suffer from parallel oversights: Hiltzik does not fully account for the military component of the intervention, and Shlaes does not count the welfare.

Now that Eugene has given me the electronic keys to this Conspiracy, I could not resist getting involved in the now-legendary discussion of the ACA...

There is a serious inconsistency between the government’s arguments for the mandate and for the Medicaid expansion. In a nutshell, these arguments make opposite assumptions about the effect of financial duress on states’ ability to execute their policy preferences. Defending the mandate, the government says states are individually incompetent to regulate insurance, because the first state to adopt generous rules would be inundated with the sick, and forced to abandon its policy. This is a basic race to the bottom story and has been around in Commerce Clause cases since the New Deal.

Crucially, the argument takes financial realities as dispositive: states cannot realistically choose to experiment with medical insurance individually because it would be ruinous. The economic effects mean that states do not really have the power to choose individual regulatory regimes.

Yet turning to the Spending power, the government ask us to believe that states can realistically turn down federal medicaid funds, though it would be at least as ruinous if not more. Either the prospect of massive losses makes a states ability to pursue a certain course illusory or it does not. 

Incidentally, these two cases are not equal in that in that in the former, the ruinous consequences are a result of the market, in the latter a result of calculated federal efforts to make the offer unrefusable.

WSJ: “Some economists have argued that a quake could actually lift the economy in the long run, by requiring a surge in rebuilding spending.”

Sure. And instead of sending American aid, let’s follow up the earthquake with a few bombing runs over Tokyo. That will really “lift the economy.” Jeez.

Tyler Cowen has assembled two lists of common mistakes made by economists. The first is of common mistakes made by right-wing/market-oriented economists and the second is of common mistakes made by left-wing economists. They’re both quite interesting.

UPDATE: I’m not endorsing every item on each list, but I think they both provide much to consider and ample grist for discussion.

SECOND UPDATE: Ezra Klein comments.

MORE: David Leonhardt posts his own lists.

Greg Mankiw points to recommended reading by Robert Shiller (and, apparently, Karl Rove).  The book?  Adam Smith’s The Theory of Moral Sentiments.

The book’s resurgence does not surprise me.  Certainly not from Shiller who, with George Akerloff, gave us the intriguing book Animal Spirits.  Shiller is of course not indifferent to the core point raised by TMS as well as the famous reference to Keynes, which is that “affect” matters in economics.  From Karl Rove, I’m not quite sure.  I’m curious as to what relevance, if any, Professor Mankiw thinks that TMS has today.

I’ve written about the importance of TMS before here at Volokh.  Smith himself believed that you could not really understand, or for that matter hope to see in action, the market operations and effects of The Wealth of Nations without a concomitant “moral psychology” of human beings.  The constitutive moral psychology of sociability was, for Smith, a predicate for the social institutions of the market that make up The Wealth of Nations.  He believed that the two books, and the two accounts of human affective traits and market institutions based around the commodification of affections within a marketplace were what made market institutions possible, or at least stable.

The commitment to a psychology of market-making human beings that is more than simply “thin” rational self-interest is not the same as urging that markets need morally “better” people, which, come to that, we are not likely to get.  The point of TMS or what I would hope is a turn toward economic foundationalism that takes affect and moral psychology seriously is not exhortation, windy or otherwise.  It is not prescriptive; it is, rather, descriptive in its assertion that stable and successful market institutions are constituted around social practices – legal, personal, affective, sociable – that presume not thin rationalism but instead a much thicker affective parts.

The term “moral psychology” here is a term of art; it refers not to morality in the right and wrong sense, but instead to the affections that invite to sociability.  Shiller, in the discussion linked by Professor Mankiw, refers to “empathy” as being the general quality that Smith means.  He notes that the term had not yet entered the English language.  But that is probably not quite it, not in our modern use of the word.  Smith version of social virtues is not precisely the ability to feel as another feels, but to put oneself in the reciprocal condition and make judgments, including moral judgments of how to behave, on the basis of reciprocal fellow-feeling.  I don’t think that is precisely the emphasis on “feeling” straight-up that we normally associate with our modern use of empathy.  It is less a question of emotion and more a question of judgment.

Yet the preceding paragraph, while one that would not discomfit Smith, is one that must likely discomfit the economists who walk among us.  It is attentive, after all, to all the contingent if not irrelevant things, affect rather than rationality, and the nuances of how we use words by seeking to apply a certain analytic sense to matters of sensibility.  It is not, to say the least, social science.  Nevertheless, it would not be beyond Adam Smith to channel Marx and even Freud and suggest that perhaps the insistence upon so much ahistorical social science has a certain amount of “veil of ideology” attached to it  Or, if you prefer, the return of the repressed.

This is not wild-eyed revisionism and the belief (one that arises in manias and panics  when Things Fall Apart) that somehow economic theory is up for grabs.  Even if it lends itself to the sort of thing that justly causes the professional economists to roll their eyes, of course it’s not, or not necessarily that.  Professor Mankiw’s texts should continue to sell as well as ever and may we all study them, including law students.  But it is not beyond the pale to suggest that, for example, at some crucial points economic theory crossed from the empirical description of efficient markets in particular markets under particular conditions to a panglossian, deductive assumption about the nature of necessity and a necessity of nature.

The economic theorists I know seem to believe that the solution for the difficulties of rationalist economics is to introduce behavioralism.  It is of course profoundly important.  But it is also insufficient.  Smith’s point, after all, is that intentions matter beyond mere behavior.  If rationalism is too thin a conception of human beings in markets as social systems, so is behaviorism; it is thin in a different way, the one that says that one can read everything off the surface.  The biggest divide that ought to preoccupy economics as a methodological question, it seems to me, is not between rationality and actual behavior, but instead between methods that are deliberately minimal, thin, and superficial as to human beings, and those that presume – as Smith does – that what we see as markets takes as foundational a thicker view of humans.

And a thicker view in two distinct senses, giving rise to two additional methodological lenses:  moral psychology, the psychology of intention, on the one hand, and the social theory of legitimacy of institutions, whether of Weber or Durkheim or Marx or others, on the other.  The reductionism of both rationalism and behaviorism – reading off the surface – has its point and far from me to deny its value.  But the point of TMS, and presumably why it is resurgent among dissatisfied congniscenti, is that the observed social institutions that we call markets do involve thicker human beings than that, and necessarily so.

There is a problem in the foundations, I take Shiller to say, and as things stand, the foundations matter today rather more than they did.  There is therefore a contribution, and a major intellectual one, to be made to the foundations of economics by the humanities, the philosophy of value and valuation, and moral psychology.  The recovery of intellectual history that would re-locate economics within a larger tradition of social theory and philosophy, for example.

Problem is, outside of philosophy and particularly the philosophers of value – Elizabeth Anderson, for example – or certain social theorists – Zygmunt Bauman, for another – the remainder of the humanities does not have much to offer here.  It should, but it doesn’t.  As Bauman once put it in a superb essay, it has sawed off intellectual branch it was sitting on and, as I would put it, lost the ability to apply analytic sense to sensibility.  It won’t recover it any time soon.  It’s a pity for the humanities, of course – but also a pity for economics.

(ps. Law has something of its own to contribute.  We are used to re-thinking law in terms of economics.  It seems frankly strange in today’s intellectual environment to think that there might be something methodological the other way around.  I mean as method, not as the substantive fact that markets depend upon legal assignments of rights, property, liability, etc. – I mean method and concepts in law that can be used to inform economics as a discipline in the way that law and economics as a subject takes economics to inform law.

An example of this would be agency and particularly the notion of a fiduciary.  The notion of a fiduciary as a status that a person holds can be explained, if one likes, in reductionist economic terms of obligations to behave in the following ways or incur liability.  What the law tells us, however, is that this is frankly insufficient to describe what we mean by the word itself.  The term cannot be reduced, without leaving out a crucial part of its content, into purely act-consequence formulations; the internalization of a certain status, leading to a certain form of judgment, is part of what the law of agency means by fiduciary.  It is a thicker description of an agent than is built into the territory of what it means to be a fiduciary, and that is so even when people fail in their duties and incur sanctions.)

The Manhattan Institute’s EJ McMahon argues for alternatives to state bankruptcy in the Wall Street Journal today.  The article is not framed as an argument for the sustainability of the state debt obligations – i.e., raise taxes to the level necessary to cover the promises made – but instead argues that governors and state legislatures have the tools necessary to deal with the public employee unions.  Perhaps most tellingly, it asks why a state would voluntarily enter into bankruptcy if it already lacked the political will to deal with the public employee unions.

For constitutional reasons, any federal law enabling state bankruptcy would have to be voluntary, meaning states would have to invite federal judges to play tough with their unions. But if Gov. Jerry Brown and the California legislature are unwilling to rewrite their collective bargaining rules—signed into law by Mr. Brown himself, 33 years ago—why assume they would plead with a federal judge to do it for them?

It’s more likely that a state like California would pursue bankruptcy if powerful unions and other budget-dependent interest groups saw this as a way to deflect some of the pain to bondholders. California is one of the states that constitutionally guarantees its general obligation debt, and whose bondholders are now seemingly untouchable. That could change with a bankruptcy option.

It’s a good piece, and worth reading closely, although I think it is somewhat arguing past Skeel’s argument.  It’s even better read in conjunction with historian Fred Siegel’s account of how New York’s mayor Robert F. Wagner first saw the opportunity presented by public employee unions, and how politicians and the unions found the way to collude to internalize benefits to themselves and externalize costs onto taxpayers.  It is a textbook example of public choice theory in operation, and Siegel gives the historical context.

Liberals were once skeptical of public-sector unionism. In the 1930s, New York Mayor Fiorello LaGuardia warned against it as an infringement on democratic freedoms that threatened the ability of government to represent the broad needs of the citizenry. And in a 1937 letter to the head of an organization of federal workers, FDR noted that “a strike of public employees manifests nothing less than an intent on their part to prevent or obstruct the operations of Government until their demands are satisfied. Such action, looking toward the paralysis of Government by those who have sworn to support it, is unthinkable and intolerable.”

Private-sector union leaders were also divided. George Meany, the president of the AFL-CIO from 1955-1979 who came out of the building trades, argued that it was “impossible to bargain collectively with the government.” Private unionists more generally worried that rather than winning a greater share of profits, public-sector labor would be extracting taxes from a public that included their own workers. But in the late 1950s, with the failure of the labor movement’s organizing campaign in the South, Meany’s own executive council insisted on the necessity of winning the right to organize public employees.

The first to seize on the political potential of government workers was New York City Mayor Robert F. Wagner .... Running for re-election in 1961, Mayor Wagner was opposed by the old-line party bosses of all five boroughs. He turned to a new force, the public-sector unions, as his political machine ...  Ten weeks after Wagner’s victory, Kennedy looked to mobilize public-sector workers as a new source of Democratic Party political support. In mid-January 1962, he issued Executive Order 10988, which gave federal workers the right to organize in unions.

Siegel then traces through the political organizing down through the 1970s and 80s.  He is not arguing for state bankruptcy, but instead for reversing the source of the public choice conundrum, going back to FDR’s original concern.  I share Siegel’s view of the underlying problem.

The New York Times ran a front page story today on an issue discussed off and on here at VC, the possibility of creating a bankruptcy chapter for states.  It quotes David Skeel, who has been the leading intellectual mover of this idea, along with a number of other people, including various public employee union officials dismayed by the very concept.  It was not a long article, but decent straight-up reporting.  As I have mentioned in earlier posts, one of the most persuasive parts of the proposal to me is that bankruptcy allows judges a great deal of discretion – but that discretion is cabined within a highly specified range.  That seems to me of great importance in addressing financial shocks and crises. 

In the case of national security, in which government seeks to confront enemies, strategic ambiguity as to how crazy you might get – to reference the classic nuclear standoff debates – can serve a useful purpose.  Unbounded discretion in that situation, and ambiguity about scope, circumstance, and range of response can be of immense value in confronting true enemies.  In the case of financial crisis, one is not confronting enemies, but seeking to channel and contain and regulate the activities of those who are, in a word, friends.  Members of our political and social and economic communities, with whom we seek to find ways in which competition within the rules can create a whole that is greater than the mere sum of the parts.  In that case, strategic ambiguity, represented here by discretion without apparent boundaries or constraints, works in exactly the wrong way.  The effect is to ratchet up uncertainty and make planning for the future harder, and forces parties to seek to insure against the discretionary regulatory moves made by government.  Clear rules imposing clear moral hazard is more efficient for everyone.  That is what makes bankruptcy regimes – rule of law regime allowing for exercises of discretion within particular issues and ranges – attractive.  That is also true in a new bankruptcy chapter for states, though inevitably a new chapter in the code would leave many questions unanswered.

There is a risk, however, which should also be addressed.  Actors chosen for an extended role – bankruptcy judges drawn from private bankruptcy, at most municipal bankruptcy, now pressed into a new chapter of state bankruptcy – risk becoming transformed by the role itself.  We asked a certain kind of actor to take on a certain role because we had a good idea how the actor behaved in the old one, and we liked it.  We figured that the new role wouldn’t change the behavior of the actor.  But in many situations that is not the case. 

 Consider a comparison, once again, with national security law.  One reason to be leery of tasking district court judges with the role of directly supervising the military in national security missions abroad – who can be detained, who can be targeted with a missile, etc. – is that to be a federal district court judge is to be formed by a practice, and a practice designed for a specific social setting – domestic, within territorial borders controlled by the sovereign and its police, situations where the stakes are law enforcement mostly concerning individual crimes and their consequences for particular individuals, etc.  The court rules of procedure, evidence, testimony, etc., were not designed nor did they evolve with these vastly different situations in mind.  But federal judges are a product as much of those rules and their contraining force as of anything; their personal probity is not at issue, but the consistent application of the rule of law is, because that consistency depends upon adherence by judges generally to those shaping and constraining forces.  Confronted with a wholly new kind of task – decide to issue or not a “death warrant” to allow a drone missile strike against someone in Pakistan or Yemen, in advance – one of two things will happen.  Either the structure of rules takes front rank – the judge demands evidence in all the complexity of rules for domestic trials, for example, in which case the standard can never be met; this will presumably survive until enough people have been killed through failure to act.  Or else, faced with national security reality, the judge relaxes the various procedural constraints, reasoning quite correctly that they evolved for a different social ecology and cannot hold. 

But in so relaxing them, the judge has essentially altered his or her nature and role.  We no longer have a judge in whom we have faith because he or she is a person of integrity and probity, who reaches results based on good faith interpretation of existing rules; instead we have a judge whom we have entrusted with these tasks fundamentally because we think he or she is a person of integrity and probity.  That’s nothing to sneer at – quite the contrary – but the meaning of a federal judge in a constitutional system is more than that.  There’s a category mistake in running the two circumstances together – and the effort to extend one to the other is quite likely to alter the nature of the judging enterprise.  Not because the judge is less good or competent or anything – but because the nature of the thing to be judged is different, as a matter of social fact.

I have framed this in national security terms as an example.  It seems to me important in proposing something that has elements of a different “social fact” in proposing to extend the concepts of bankruptcy from traditional private bankruptcy plus municipalities, to states.  However “political” and politically fraught even a large-scale private bankruptcy is, to reconfigure the debtor-creditor relationships of a whole state, particularly a large one, inevitably involves large-scale social engineering.  It seems to me a political and social fact of the matter.  The risk might be that we ask bankruptcy judges to take on too much as a single task, because we task them with the state in toto.  It might begin to remind one uncomfortably of the 1970s and the move to task district courts with re-engineering other large public entities in the name of desegregation through busing.  It did not work out so well; the numbers of people involved, their opposed interests, their moves to alternatives to those envisioned by the courts and their planners ... a whole raft of unintended consequences that propelled domestic neo-conservative (in its original domestic, not foreign policy, sense) skepticism aboutmassive social engineering for at least a generation. 

My initial, but revisable, conclusion is that even taking this caution into account, bankruptcy judges are best situated for the task.  Because the task is not going to go away – what can’t go on, won’t, in the famous expression – and bankruptcy judges dealing with a whole state is likely a far better outcome than piecemeal approaches, or political bailouts from Congress that cannot possibly bail out the existing promises, let alone provide any check on future unsustainable promises.  Someone will have to address something somehow.  But in designing how a system might work, anxious consideration of what might go wrong if this were considered not merely as bankruptcy, but in light of other social engineering projects involving public institutions – school desegregation or mental health deinstitutionalization or prison reform, etc. – from past decades would be a salutary exercise.  This is not a reason not to go forward – and please do not take me as saying that - but it is a reason not to be overly sanguine in saying that a state is just like a really, really, really giant corporation, or a really big municipality.  It’s not.

Bankruptcy law professor David Skeel, whose new book The New Financial Deal is one I admire a great deal, has a new op-ed in the Wall Street Journal today urging a bankruptcy regime for the states.  Among his most important points is that bankruptcy for states offers the most likely means that states can address the arguably most important long-term problem – the deals set with public employee unions for retirement benefits that are already crowding out the provision of services to the public.  States cannot afford to maintain current staff – teachers or whatever job category – given the obligations to retired employees, even if one assumes that those services, requiring whatever levels of staffing, at whatever levels of current pay, are prudent.  As he says:

[S]tate bankruptcy could even permit a restructuring of the Cadillac pension benefits that states have promised to public employees. These are often “vested” under state law, and in some states, like California, are protected by the state constitution. Under state law, little can be done to adjust them to more reasonable amounts.

Although the law is somewhat murky, there is a strong argument that bankruptcy could provide for an adjustment of these obligations. Unless the state’s “guarantees” were construed as a property right protected by the Takings Clause of the Constitution (which is doubtful if there is no collateral or other indicia of a property right), the federal bankruptcy law would trump contrary state law under the Constitution’s Supremacy Clause.

A central feature of these promises in many states and municipalities is the capture of both sides of the bargaining table by public employee unions.  It is a classic process described by public choice theory, through which the campaign contributions of a highly motivated subset of voters capture the political offices that negotiate economic terms with that same set of voters-as-employees.  I have sometimes wondered whether a legal theory – far fetched in court, of course, but not so very far from the situation in economic terms – of fraudulent conveyance could be raised against these kinds of negotiations, as a basis for being overturned in bankruptcy.

But of course Skeel’s basic point is that you don’t need recourse to a legal rationale like this if you have an explicit bankruptcy-for-states regime.  Conceptually, though not as a doctrinal legal matter, I think that capture of both sides of the bargaining table is pretty well described as conceptually fraudulent conveyance.  Skeel, to be clear, is not making anything like this argument and as a bona fide bankruptcy expert might easily say it is not even plausible as pure concept.

But for my part, query whether the US needs to evolve legal doctrines that would address the problem of the capture of political office by representatives of those who will ostensibly bargain at arms length.  Of course, the simplest answer would be to get public employee unions out of the campaign contributions business, if not out of the striking business and, perhaps, go all the back to FDR’s original, negative view of public employee unions being established at all.

Update: A last question, to Co-Conspirator Todd or other bankruptcy law specialists ... does the Anna Nicole Smith case have any bearing on this?  Not my field, so I wouldn’t venture a guess (well, venturing one anyway, probably not), but am curious after reading the post below.

Particularly since the European sovereign debt crisis put the question of sovereign debt ratings squarely on the table, and even more in the last few days since the rating agencies have downgraded Greek debt to junk status, I have to wonder what insulates Moody’s, Standard & Poors, and Fitch against pressures direct and indirect, subtle and not so subtle, by interested sovereigns.  The New York Times business pages ran a story on Friday (January 14, 2011, Graham Bowley) reporting that Moody’s and the S&P warned the United States that its outlook might conceivably put its AAA status at risk.  In Europe, it’s not just Greek bonds that are finally in question, it’s the debt of much bigger states as well – and the fact that the rating of sovereign debt even of Greece matters quite a lot to Germany or France for many reasons, not the least of which is that so much of it is held by their banks.

Standard public choice theory seeks to account for the essentially political forces that “supply” law and regulation to its economic “consumers” (voluntary or not!) in the marketplace.  It fills in a crucial gap in the account of law and economics, which tends to start with the laws and regulations and their creation as a given for structuring the incentives and disincentives of markets.  It connects law and markets, politics and markets, politicians and market-makers.  Sovereign debt, for its part, is a commodity in the markets that depends in very special ways on political and governmental forces, in part acting as market players, but in part acting as rule-creating sovereigns.  All of which is a roundabout way of saying that sovereign issuers of sovereign debt have large incentives to use their rule-influencing, regulatory, and law-creating powers, their political will, to influence market outcomes.  Rating agencies, one would have thought, would be particularly susceptible.

The model of rating agencies is built around private actors assessing other private actors.  Regulators act to ensure that the agencies not fraudulently sell their ratings for other private actors.  But we all know the ways in which that model departs from the ideal, starting with who pays for the rating, and all the other ways in which rating agencies failed to deliver objective, reliable assessments.  Government, in seeking to reform financial regulation, has many reasons to investigate, reform the rules, and perhaps hold agencies accountable for departures from the rules in the past.  But that, of course, presents many opportunities for governments to pressure rating agency behavior down the road, with respect to a given government’s sovereign debt.

That’s just one example; one could look to others.  US regulations still mandate in various ways that ratings from the established agencies be used for many purposes; a lively debate has ensued over whether those requirements are prudent, whether they cartelize the agencies and reduce competition or – as David Skeel notes in his new book, The New Financial Deal – can create competition among rating agencies leading to a “race to the bottom.”  Those regulations provide both a great deal of automatic business to the rating agencies and protection against competition.  They are therefore a potential source of pressure on the rating agencies for other purposes of sovereign borrowers.

Curiously, I have not so far seen evidence that leading sovereigns are putting political pressure on the rating agencies.  (If I have missed something about this, please advise in the comments; I’m interested in the US as well as other leading sovereigns in Europe and elsewhere.)  Standard public choice theory would say, however, that especially in an economic activity so crucial to the state, and where the private actor is already part of regulatory structures for other reasons, the internal wall that separate sovereign politics from the sovereign as mere market actor has to come under pressure, at least as the political pressures rise.  And surely the political pressures are rising.

Is that happening now and I have missed something?  If not now, why not?  Why would this not happen as standard incentives theory would predict?  What form is it likely to take in the future?  Does it matter?

(PS.  Steve Schwarcz has written extensively about rating agencies; see his faculty bibliography page for various articles.  I would also be curious as to what my colleague Anna Gelpern and her occasional co-author Mitu Gulati, both leading academic experts on sovereign debt, would say – is this an issue in the larger world of sovereign debt?)

In conversation with someone who, as a senior NGO executive in international development and food aid, is well situated to respond on the question of rising commodity prices for food globally.  I asked specifically about the Wall Street Journal news story a few days ago on this topic, which reported:

Prices of corn and soybeans leapt 4% Wednesday and wheat gained 1%, continuing the broad rally in commodity prices that began in June. With yesterday’s gains, prices of corn futures contracts are now up 94% from their June lows; soybeans are up 51% and wheat is up 80%.

The USDA’s revisions reflect the impact of dry weather in South America and floods in Australia, which have compounded supply constraints that first started to emerge in the middle of last year, when a drought in Russia ravaged that country’s wheat fields. The agency also cut estimates for U.S. harvests of corn and soybeans.

At the same time, demand is increasing. The USDA said ethanol producers likely will increase their use of corn, and consumption by emerging market countries continues to be strong.

Prices of many agricultural commodities are still below the levels that sparked food riots in poor countries around the world in 2008. But economists see few signs that prices for grain, livestock and cotton will cool significantly anytime soon, signaling potential headaches for consumers and food companies.

I was told that, if anything, this article understated the problem, at least if consumers in poor countries were taken into account and that food riots akin to those of 2008 would be unsurprising.  I was asked in turn why the US continues to subsidize ethanol, for which I had no good answer.

(See also this story, HT Insta, and commenters are correct to note the Tunisian food riots.)

Update:  This blistering but, in my view, persuasive opinion piece in the Asia Times by Hossein Askari and Noureddine Krichene lays out the case that the rise in food prices can be squarely laid at the feet of the Fed.  This is an important piece and bears close reading.

In contrast to their counterparts in many leading countries, US policymakers do not appear alarmed by energy and food price inflation; in fact, it has hardly made it onto their agenda. Even though prices of sugar, wheat, corn, coffee, soybeans, and many other basic food, such as onions and cooking oil, rose at rates ranging between 60%-80% in 2010, this inflation seems to have been of little concern to the Federal Reserve.

(Update.  Megan McArdle has a number of interesting comments and posts on foreclosure, modification, the effect of securitization, and the processes for recording title and other things.  This blog post has very interesting comments as well.)

Adam Levitin writes at the ForeclosureBlues blog about the Ibanez decision in the Supreme Judicial Court of Massachusetts (pdf via Creditslips blog), handed down last Friday.  (Actually, I think Adam’s post originated at CreditSlips.) This is an important decision in addressing the exceedingly vexed and, as Megan McArdle notes, highly technical legal questions surrounding the property issues – chain of title, etc. – in foreclosures on mortgages that have been securitized.  Levitin offers this assessment of the holding in Ibanez (I recommend also his article with Anna Gelpern, Rewriting Frankenstein Contracts):

The Ibanez case itself is actually very simple. The issue before the court was whether the two securitization trusts could prove a chain of title for the mortgages they were attempting to foreclose on.

There’s broad agreement that absent such a chain of title, they don’t have the right to foreclose–they’d have as much standing as I do relative to the homeowners. The trusts claimed three alternative bases for chain of title:

(1) that the mortgages were transferred via the pooling and servicing agreement (PSA)–basically a contract of sale of the mortgages

(2) that the mortgages were transferred via assignments in blank.

(3) that the mortgages follow the note and transferred via the transfers of the notes.

The Supreme Judicial Court (SJC) held that arguments #2 and #3 simply don’t work in Massachusetts. The reasoning here was heavily derived from Massachusetts being a title theory state, but I think a court in a lien theory state could easily reach the same result. It’s hard to predict if other states will adopt the SJC’s reasoning, but it is a unanimous verdict (with an even sharper concurrence) by one of the most highly regarded state courts in the country. The opinion is quite lucid and persuasive, particularly the point that if the wrong plaintiff is named is the foreclosure notice, the homeowner hasn’t received proper notice of the foreclosure.

Regarding #1, the SJC held that a PSA might suffice as a valid assignment of the mortgages, if the PSA is executed and contains a schedule that sufficiently identifies the mortgage in question, and if there is proof that the assignor in the PSA itself held the mortgage. (This last point is nothing more than the old rule of nemo dat–you can’t give what you don’t have. It shows that there has to be a complete chain of title going back to origination.)

I don’t think it is too much to ask the financial services industry to follow the rules on title and transfer.  I have been surprised by how many people, including lawyers, have simply said that intentions were clear even if the requirements of transfer were not followed.  I don’t think that’s good enough, not for the past and less so going forward.  There are reasons why we treat transfer of property, and real property and associated rights, differently than contract.  I have no doubt that things are much more complicated than I imagine, but with computerization and technology, on a regulatory reform basis, shouldn’t we be able to do a whole lot better than this?

What would a rational, going forward system of title and transfer look like – tell me in ways that take advantage of technology as it is, not some imagined possible world, and tell me ways that match up to things already being done in the securities industry.

While everyone is at it, tell me how we should address the Frankenstein hangover of the past.

Probably many readers have seen this New York Times article, offering a lengthy and well-reported analysis in the Business Pages by David Segal of whether law school is a worthwhile investment.  The analysis points to a couple of different factors, including:

• supply of lawyers outstripping demand, now and into the future;
• cost of legal education outstripping the ability to repay on most lawyers’ salaries;
• oversupply of law schools (leading to oversupply of lawyers, but in fact contributing its own frictions in bringing supply and demand to clear);
• huge information gaps making it difficult at best for would-be students to make a decision;
• inaccurate and gamed information supplied by law schools on employment and salaries of graduates.

The article traces through several law grads, with a particular focus on a graduate of Thomas Jefferson law school in San Diego, who has racked up several hundred thousand dollars in debt – if he were paying the monthly payments, they would be around $3,000 a month, if I recall the article correctly.  He himself says that he’s not so good at keeping track of that sort of thing.  The debt is not dischargeable in bankruptcy, so he and his girlfriend have simply gone off the employment or any other kind of income grid, pretty much.

A lot of readers of the article will be unimpressed with the young man’s cavalier attitude both to running up the debt – including on remarkably idiotic things, like trips abroad – and to repayment at all.  But while we all should take a lesson – I for one take a deep breath and hope that my own kid would not make these kinds of mistakes – there’s also a fact that it was only in the last two years or so that the vast majority of middle class people would have had any real question either about the ability to repay the debt or, more fundamentally, that more education was automatically a good thing.  More human capital investment, good, and professional education like law, better still.  It is only in the last two years, frankly, that very many of us – I include myself – have been thinking about higher education ROI.  I’m not at all sure that we can hang it on some admittedly not so bright kid for going with the assumptions that all the rest of us have gone with.

As I’ve noted in some earlier posts about 21st century jobs, there’s also something quite dismaying in the fact that, for the first time I can remember in my adult life, we seem to be concluding that investment in human capital is not worth it.  That might be true because the training is idiotic and not really “human capital investment” at all, but more like summer camp.

But the much more worrying possibility is that structural problems in the US economy mean that there isn’t a need for professionally skilled labor, because the economy can’t deploy people to these higher skilled tasks.  In the case of lawyers, or people who might have become lawyers, that might be because capital has been wasted in pointless things that didn’t pay off, and now there isn’t enough capital to invest in new things for which lawyers – yes, even lawyers – would be useful in making happen.  It can, and certainly has, happened to engineers, too, over the past fifty years.

To the extent that is a structural, rather than cyclical, new normal for the economy, that is dismaying and disheartening.  One can say that in that case, deploying would-be lawyers or, for that matter, engineers, into subsistence farming is, under those conditions, the most efficient available deployment of their labor.  But of course that would be true by definition.  The wastage compared to a better organized economy is enormous and finally tragic.

That is true, by the way, of the young man featured in the story.  He might be a genial idiot, when it comes to practicalities, but it does seem unlikely that even his talents, impressive or meager as they might be, are best deployed in our economy trying to avoid doing anything that earns any money, because of an unsustainable debt load.  From a social welfare perspective, his human capital is mis-deployed – while also being true that the moral hazard of a massive bailout of misplaced expectations of student loans is disastrous, quite apart from the cost.  It’s striking in the article that waiting for a political fix to his problems seems to be his overall strategy.  That’s scary all by itself.

However, it was finally this comment that attracted my attention from the standpoint of teaching law and economics to law students: consider the ways in which this statement is not quite right:

“Law school might not be worth it for another 10 or 15 years,” he says, “but the riskier approach always has the bigger payoff.”

Critique the last half of that statement.

(Note: I was writing this on the plane without quite being able to see the computer screen, so I’ve gone back and corrected some grammar and spelling, and tried to make a couple of things clearer.  I’ll post separately as well on the topic of national security and the financial crisis, and the role of executive discretion in responding.  But I also wanted to note that over at The Conglomerate, the compadres there are also having a discussion of Professor Skeel’s book, including my friend David Zaring, who, along with the redoubtable Steven Davidoff, was responsible for a seminal article and concept in this question of discretionary regulation, “Regulation by Deal.”)

Flying to and from meetings this week at the Hoover Institution, I re-read David Skeel’s brand-new book, The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences (Wiley 2011), for a second time. I am even more impressed with this book the second time around, and I believe that it is one of the short list of essential books on the financial crisis and the regulatory aftermath. If you have any interest at all in these topics, this is a book to give serious consideration to reading.

The New Financial Deal is very far from being a dense, specialist book readable only by a lawyer, or law professor, or bankruptcy or finance expert. You might guess from the title that the book is a technically useful, but, for the general reader, impenetrable commentary on the Dodd-Frank bill. After all, the bill itself runs several thousand pages of impenetrable legislative language and Skeel himself one of the country’s leading bankruptcy scholars. It might seem from the title that it is simply an unpacking – at the technical level – of what Dodd-Frank says. Technical experts can benefit enormously from such unpacking, but not so much the policy person or general reader.

But it’s not that. On the contrary, Skeel’s considerable achievement in this book is to write accessibly and persuasively about the Dodd-Frank bill. Skeel is an an admirably clear and graceful writer on very difficult topics; it shows in the sentence by sentence prose, but equally in the overall organization and selection of topics for discussion. It doesn’t seek encyclopedic analysis of the zillions of legislative provisions, but instead makes a judicious and profoundly informed selection of the main achievements (and lack thereof) of the legislation. It then succeeds better than anything I’ve read on the topic of financial regulatory reform at placing this in the context of “political economy.”  I don’t mean politics in the day to day sense, but instead the interaction of these financial rules with the political process and the intended and unintended consequences.

II

Corporatism and Brandeis-ism, and the New Resolution Authority

The fundamental reform measures of the Dodd-Frank bill correspond roughly to financial institutions and financial markets. As to institutions, Skeel examines the new mechanisms designed to address systemic risk and the mechanisms created to address supervision of those institutions both before a crisis and after the effective failure of an institution.

The political economy of this institutional supervision is given as two alternative tendencies in American economic regulation. One is the “corporatist” tendency to create a quasi-partnership between government and the largest corporations, so that government is able to exercise in some respects closer control over those corporations but also bending them to its political will – but losing the distance between regulator and regulated that usually makes regulation more effective and more importantly ensuring that those privileged institutions will not be allowed to fail, at least if they play political ball.

The other is what Skeel astutely calls the “Brandeisian” tendency to break up the largest financial institutions so that they cannot become too big, or too interconnected, to fail. He notes – this might surprise some readers – that the New Deal, however empowering government in many matters, was essentially Brandeisian on the treatment of banks, insisting on confining them in function (Glass Steagall, etc.) and in many other ways.

The tendency adopted by both the Bush and Obama administrations has been firmly corporatist. It is evident in the definitions in the Dodd-Frank bill of institutions formally designated as systemically important, but also thereby too big to fail. The corporatist tendency is also a founding feature of Freddie and Fannie, and the extraordinarily politicized activities of both firms as integral to their business models – both buying off Congress and yet chanelling the political will of administrations and bureaucracies – is what Skeel suggests will result from the corporatist model, quite apart from the problem of a lack of moral hazard leading to a regime of permanent bailouts.  (Too big to fail is sometimes correctly criticized as really meaning “too systemically interconnected to fail.”  This is right, but that translates to systemically interconnected firms that, with respect to this feature of risk, are “cartelized” as though they were a gigantic, if loosely, connected enterprise.)

Skeel’s other fundamental point concerning institutions is that the nature of regulatory authority is essentially unconstrained discretion. It is not discretion of the kind exercised by a bankruptcy judge – gap filling and interpretive and discretion existing only for defined issues, existing yes, but within a tightly bound box. It is, instead, one single non-discretionary norm – that certain institutions are too big to fail – but that everything else is discretionary (I exaggerate some, but it helps illustrate the point). It is discretion not as filling in the inevitable gaps, but instead deliberately widening discretion to cover as much as possible. Though Skeel does not frame it this way, I would describe it as “discretion as strategic ambiguity” in which the rule of law is set aside for the purpose of making it impossible to know how you will be treated: allowed to fail in some cases, taken over in others, not allowed to fail and not taken over, with no standards for knowing what results in what. This is the criticism that Skeel makes of the new “resolution authority” for institutions.

Skeel’s deepest normative point, however, is that the regulatory model deliberately undermines the rule of law – particularly the careful establishment of judicial discretion contained with bankruptcy’s special rules of law. Instead, the Dodd-Frank model finds predictable rule-based regulation inapposite to the task at hand and seeks to displace it by deliberate uncertainty, on the one hand, infused with government’s political preferences, on the other. The political preferences are analyzed against one of the most provocative but also, to my mind, persuasive turns of Skeel’s argument: to show how the auto bailouts are the template for the future bailout regime of the financial institutions. The short, accessible yet expert discussion of the treatment of senior creditors in the auto bailouts is outstanding – but most important is how Skeel shows that this, rather than the earlier bailouts in the financial services industry, is the template for future behavior under Dodd-Frank. That, and Fannie and Freddie. Continue reading ‘David Skeel’s Excellent Book, and Comparing Discretion in the Financial Crisis and National Security’ »

Death-bet insurance involves a person taking out life insurance, and then turning around and selling the policy to a stranger – a hedge fund, for example, via intermediaries – who pays the premiums and collects after the insured’s death.  Growing in popularity as a system of side-bets on the insurance markets, it has also been controversial particularly as it raises questions about whether it violates the rule of having an insurable interest.  On the other hand, it puts a bundle of immediate cash into the old person’s hands.  The overall investor problem is that if the insured person does not die on schedule, then the investor has the double-whammy of having to wait for payout and pay premiums in the meantime or lose the payout.

Insurance companies have been suing the third party investors, the investors have been countersuing the insurance companies, and in some cases, relatives of the deceased insured have been suing to claim that the insurance proceeds really belong to them.  There have been several articles in the WSJ and elsewhere describing the contests that have arisen particularly as the business model has been under pressure on account of bad actuarial assumptions about how long the insureds would live.  There is a good piece on the whole litigation mess in today’s WSJ:

The life-policy secondary market was one of many sent reeling by the global financial crisis of 2008-09, but it also has been hurt by revised actuarial tables, which show older people living longer, and the mounting litigation.

Apart from several hundred suits that have been filed by insurers, suits also have been filed by relatives of some of the deceased elderly, alleging that death benefits belong to the family members.

With much of the litigation in early stages, legal experts say it is unclear how effective investors’ new counterattacks will be. Investors could face big losses if policies in their portfolios are canceled, leaving them with nothing to show for their expenditures.

I’m unclear whether this was a side bet industry that depended upon easy money in the bubble or whether it is something that, with a sufficiently revised actuarial model, could survive as a means by which elderly people could cash out while still alive.

What about the insurable interest requirement?  I suppose one could say it’s irrelevant, so long as the stranger-investors have no way to affect the insured’s life and health, and allowing stranger-insurance adds liquidity to the insurance pool.  But I suppose one could also say that there can be peculiarly unanticipated consequences of giving significant groups of stranger-investors interests in one event only ... the death of the insured.

But I’d be curious what others think.  Don’t just tell me about freedom of contract and all – what might be the unanticipated consequences of relaxing an apparently irrelevant insurable interest rule?