Archive | Finance

The Trillion Dollar Coin and the Problem of Circulation

Everyone loves money. That is why they call it MONEY.” – David Mamet.

The trillion-dollar coin is a proposal to avoid the debt ceiling through a loophole in a federal statute that authorizes the U.S. Mint to coin platinum in any denomination. Platinum is reserved for commemorative issues, and the obscure statutory provision was certainly not intended by Congress to authorize the effective borrowing of a trillion dollars, but as a statutory matter, the trillion dollar coin may work.

I have not examined the matter too closely, but at least one constitutional question pops up here.

Congress is authorized to “coin money.” The proposed trillion-dollar coin is certainly a coin – but is it money? Money is created for circulation. As Justice Story put it in his Commentary on the constitution, the power to coin money is designed to “preserve a proper circulation of good coin of a known value.” Vol. 2, § 1118. That is why it is put into the convenient form of coins or bills. Specie never intended for circulation, one might argue, is simply not money.

The link between circulation and coinage has been noted by courts, though obviously nothing has been decided, at least as far as my brief inquiry revealed. Veazie Bank v. Fenno, 75 U.S. 533 (1869) (“It cannot be doubted that under the constitution the power to provide a circulation of coin is given to congress.”)

Let us turn to the dictionaries. “Money” is “metal coined for public use,” according to the 1788 edition of William Perry’s The royal standard English dictionary. This may lead to a debate about what a “public use” is, reminscent of the “general welfare” question in the Spending power. I would guess it means “use by the public,” a view supported by “Metal coined [...]

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Adam Levitin on the New Massachusetts Court Foreclosure Decision

(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

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David Skeel’s Excellent Book, and Comparing Discretion in the Financial Crisis and National Security

(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 [...]

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Law and Regulation of Central Banking?

I am curious as to whether any law school offers a (seminar?) course on the law and regulation of central banking, either specifically on the Fed in US domestic law or else something like “comparative central banking” in the transnational law curriculum.  I’d be interested in responses as to courses, syllabi, reading, and course topics.  Serious responses please; no rants or off topic responses.  (Let me add that I don’t mean exactly what typically features in the banking course, which is, in my experience, less about the law governing central banking than the legal mechanisms by which the central bank interacts with the rest of the banking and financial services sector.  They are not quite the same thing.)

The legal powers of the Fed – and their limits, regulatory, statutory, and Constitutional – are obviously a question of importance today.  The financial crisis, the response, and the continuing unemployment rate make the question of the Fed’s mandate, independence, and limits germane in a way that has only rarely been true in the economic history of the US since creation of the Federal Reserve.  Consider one of the latest arguments – will the Fed move to monetize the fisc, meaning the fiscal deficits of states and municipalities, as a source of – not liquidity of last resort – but instead as a provider of solvency?  A George Will column expressed the concern, set against public pension issues, this way:

People seeking backdoor bailouts hope that the fourth branch of government, a.k.a. Ben Bernanke, will declare an emergency power for the Federal Reserve to buy municipal bonds to lower localities’ borrowing costs. This political act might mitigate one crisis by creating a larger one – the Fed’s forfeiture of its independence.

Will obviously has a side in this debate, but that [...]

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The Conglomerate Book Club on ‘All the Devils Are Here’

Over at the business law professor blog, The Conglomerate, the book club has been reading Bethany McLean and Joe Nocera’s book on the run-up to the financial crisis, All the Devils Are Here: The Hidden History of the Financial Crisis.  David Zaring introduces the book, his brief take, and the book club discussion here – then scroll up for the other mini-reviews and comments.  The Conglomerators think the book is worth reading, and I’ve just ordered it.  (For my own part, I have just finished a second, closer read of David Skeel’s The New Financial Deal, which is outstanding, and on which I’ll post a short review later.) [...]

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Derivatives Clearing Houses

Although I have a few reservations about the tone of the article being just slightly conspiratorial, Louise Story’s front page NYT story today on the evolution of derivatives clearinghouses is highly informative and very well done.  The graphics showing how the bilateral trades would turn into centralized clearing are quite good and would be useful with a class.  On balance,  I think the overall shift to centralized clearing is a good move.  But I also have a bad, bad feeling about this in the context of Dodd-Frank and future expectations.  As I have said in past posts, in a future of financial regulation in which the central question of systemic risk and moral hazard has not been addressed, the result of what is otherwise a sensible move (yes, yes I’m skipping over all the concerns about end-users and Main Street, etc.) could turn out to create not so much a central clearing house but instead … a central address for depositing unwanted risk.

After all, why should any of these leading market participants believe at this point that the government would allow the central clearinghouse to burn down in a crisis?  And if they don’t believe that, then what is their incentive to set terms that will adequately address the risk as a matter of private ordering of fees, margin, whatever form of insurance the central risk-clearer needs? Having a central clearing counterparty is a great idea – if it and the actors that run and control it have the private incentives to make sure it is not a mechanism for accumulating and compounding risks.

Presumably the answer is that government regulators will set those requirements and solve the problem.  But the general theory of financial regulation used to be that systems would be monitored for risk-taking, after private parties [...]

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My One Paragraph Assessment of Dodd-Frank

While I wait for David Skeel and William Cowan’s new book on the Dodd-Frank financial reform bill to appear next month (The New Financial Deal), I have tried to make my own assessment of what the bill means in the aggregate.  In order to do this, I have read the bill in its entirety twice.  The first time was when the bill was first passed, and this was in order to see if anything in it took me by total surprise.  That amounts to a search for particular nuggets that jump out at you, not the “totality” of the bill.  I’ll add that he experience of reading the entire thing as a “thing” made clear to me why “reading” bills before you pass them, if it is a good idea, needs to mean “reading” in a really different way.  You have to read the bill with all the cross references to other legislation being amended to hand in advance, and a staff of experienced people to make sure that you know the context into which this change or that fits.  One hopes, of course, that this was also part of the drafting of the bill … but let’s pass over that detail.  (Update:  I just ordered Skeel-Cowan from Amazon.)

The second time around reading it was not for nuggets, but instead to try and understand the whole thing, as a comprehensive thing.  I realize that this makes little sense given that it is not a “thing” but an agglomeration of many things, some of which fit together and some of which don’t.  But this second time, I read it with some research help, and more importantly with the several hundred page bill summary to hand.  This was partly to understand the bill, but partly to get a reality [...]

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David Skeel on Bankruptcy for States


UPenn law professor and corporate finance and bankruptcy specialist David Skeel has an important article in this week’s Weekly Standard talking about the possibility and utility of bankruptcy for states.  The article argues first that a new chapter for states in the Federal bankruptcy statute would be constitutional, and then turns to argue, second, that the benefits to the public would be considerable:

When taxpayer-funded bailouts are inserted into the equation, the case for a new bankruptcy chapter becomes overwhelming. And it’s a case for Congress to move now on the creation of a state bankruptcy law.

With the presidential election just two years away, the pressure to bail out California, Illinois, and perhaps other states is about to become irresistible. As we learned in 2008 and 2009, it is impossible to stop a bailout once the government decides to go this route. The rescue of Bear -Stearns in 2008 was achieved through a “lockup” of its sale to JPMorgan Chase that flagrantly violated corporate merger law. To bail out Chrysler and General Motors, the government used funds that were only authorized for “financial institutions,” and illegally commandeered the bankruptcy process to give the car companies a helping hand. There is, in short, no law that will stop the federal government from bailing out profligate state governments like those in California or Illinois if it chooses to do so.

The appeal of bankruptcy-for-states is that it would give the federal government a compelling reason to resist the bailout urge.

This is an important piece of public advocacy by a leading scholar, agree or disagree with its two main contentions, and repays close reading.  (The illustration above is a thumbnail from the WS.)

Update:  Thanks, Glenn, for the Instalanche – but also for the very interesting updates at Insta [...]

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Microfinance as Subprime

Having done a fair amount of work in microfinance and closely related areas (development finance involving business clients with larger-than-microfinance loans) in the developing world, I am overall a big fan.  As many people are.  The question that has long loomed, however, is whether it can or should scale upwards to become a full-fledged part of the global capital markets, or whether it should remain a highly subsidized development activity for very poor people or, most plausibly, some of both.  I wrote about this problem in an article in 2002 – asking whether sufficient attention had been given in the conceptualization of microfinance to the question of whether it was supposed to serve as:

  • a genuinely economic connection between very poor people and the capital markets, or instead
  • a kind of “faux-market” in which the tools of the market were deployed as a form of artificially sustained discipline over the efficient use of resource, but nonetheless massively subsidized and, in that sense, never genuinely part of the global capital markets but instead always some sort of philanthropy.

I, like everyone else I have known in this field, have wanted to see some of the first, some of the second and, most crucially, some kind of “venture philanthropy” merger of the two that would somehow combine:

  • the discipline of genuine capital markets to induce efficient use of capital to promote geniune economic growth;
  • access to much larger pools of capital than are available to government aidagencies or NGOs, through the commercial capital markets;
  • subsidies or guarantees to facilitate the entry of for-profit entities into the sector, in order to help them gain experience with loan-making, monitoring, default, and other costs of microfinance, and to overcome the problem of microfinance’s problematic diseconomies of scale compared to other commercial lending;
  • the many social
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GM Benefits from Tax Law Ruling

In the terrific conference on the Constitution in the Financial Crisis that Co-Conspirator Todd and I were privileged to attend last week at Stanford Law School, one of the panelists (this was a panel looking at the peculiar incentives and disincentives created for corporate governance by having government as a controlling shareholder, as in GM) pointed out something I had completely missed and apparently a number of other people in that highly expert audience, too.  A WSJ article of November 3, 2010, by Randall Smith and Sharon Terlep, points to a little-noticed IRS ruling on GM’s tax-loss carryforwards from years prior to the bailout.  The amount at issue is potentially $45 billion.   (Thanks to commenters for links to ruling.)

Although ordinarily a company in the midst of major restructuring would have limits on its ability to use the carryforwards – and ordinarily the Treasury’s 61% stake would trigger such limitations – the IRS has ruled that companies receiving TARP bailout funds will not be subject to the restructuring limits.  (Someone can correct me, since is from memory (one of my first assignments in practice back when I started as a tax lawyer was on this very question, but I have long since dropped out of corporate tax), but I believe this is a classic section 382 problem (corrected per comment).)  The WSJ story puts the argument and counter-argument over the ruling this way:

But the federal government, in a little-noticed ruling last year, decided that companies that received U.S. bailout money under the Troubled Asset Relief Program won’t fall under that rule.

“The Internal Revenue Service has decided that the government’s involvement with these companies, both its acquisitions plus its disposals of their stock, means they should be exempt” from the rule, said Robert Willens, a New York

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The NYT’s Room for Debate Blog on Investing/Lending to Finance Lawsuits

The often very interesting Room for Debate blog at the New York Times has a new discussion on the question of whether it is good policy to allow outsiders to invest in someone else’s lawsuit.  Here’s the opening to how the question is framed:

With litigation costs rising, many plaintiffs and their lawyers do not have the money to hire expensive experts or pay for years of trial preparation. To fill this need,specialized litigation lenders are stepping in to bankroll lawsuits — often providing millions of dollars at very high interest rates because conventional banks typically do not offer such loans.

Richard Epstein, Anthony Sebok, Paul Rubin, Laurel Terry, and Susan Lorde Martin take part.

My overall take is that this creates yet another system of side bet financing, in which there are the typical problems of not having an insurable interest.  The counterargument is that the liquidity provided allows for more socially efficient litigation to take place; the response is that a liquid but also disconnected system of derivatives creates downstream bad incentives.  One does not have to reach to the financial crisis to find examples; the tobacco settlements – pathbreaking achievements in their way in structured finance – solve some problems but create some new ones. [...]

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Divorce Insurance

The New York Times Bucks Blog (of August 6, 2010) has a fascinating article by Jennifer Saranow Schultz on the first-ever offering in the United States of divorce insurance, the WedLock policy issued by a start up insurance company in North Carolina, Safeguard Guaranty Corp.  Markets in everything, etc.

The casualty insurance is designed to provide financial assistance in the form of cash to cover the costs of a divorce, such as legal proceedings or setting up a new apartment or house. It is sold in “units of protection.” Each unit costs $15.99 per month and provides $1,250 in coverage. So, if you bought 10 units, your initial coverage would be $12,500 and you’d be paying $15.99 per month for each of those units. In addition, every year, the company adds $250 in coverage for each unit.

Then, if you get divorced and your policy has matured (see below for the maturation rules), you would send WedLock proof of your divorce. In return, you’d receive a lump sum of cash equivalent to the amount of coverage you had purchased.

There are a couple of classic insurance questions explored in the NYT article.  One is how to prevent people who know they are going to get divorced from signing up; the key element is a maturation clause (a little bit like suicide riders in life insurance policies) that requires 48 months (reducible to 36 if you buy an additional rider) before the policy will pay off.  A second is how the company sets its rates – it does so based around the factors summarized,  more or less, in its “divorce probability calculator,” for which it claims a 13% margin of error (curiously, I thought, it does not ask how many years a married person has already been married, but maybe [...]

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Incompatible Trilemma Arguments

I have always appreciated the structure of the classic “problem of evil” argument – appreciated it on aesthetic and elegance grounds.  You perhaps recall the general formulation: all powerful, all knowing, and all good.  Any two are compatible with the existence of evil; not all three.  There are many forms of argument roughly set up in this way; this one says that the three taken together are incompatible with an additional condition, the existence of evil.

Another related structure of argument is that any two conditions are compatible, but not the third, as among the three of them (even without reference to a fourth condition).  And so on.  So, just on elegance of structure alone, I appreciated Professor Mankiw’s NYT column from yesterday, setting out the classic argument over incompatible policy goals in international economics, The Trilemma of International Finance:

What is the trilemma in international finance? It stems from the fact that, in most nations, economic policy makers would like to achieve these three goals:

  • Make the country’s economy open to international flows of capital. Capital mobility lets a nation’s citizens diversify their holdings by investing abroad. It also encourages foreign investors to bring their resources and expertise into the country.
  • Use monetary policy as a tool to help stabilize the economy. The central bank can then increase the money supply and reduce interest rates when the economy is depressed, and reduce money growth and raise interest rates when it is overheated.
  • Maintain stability in the currency exchange rate. A volatile exchange rate, at times driven by speculation, can be a source of broader economic volatility. Moreover, a stable rate makes it easier for households and businesses to engage in the world economy and plan for the future.

But here’s the rub: You can’t get all three. If

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Death Incentives

Mean Professor Anderson made his first year law and economics class memorize Greg Mankiw’s ten basic principles of economics, including … incentives matter.  Also, people make decisions at the margin.  One of the interesting questions – more than interesting, genuinely crucial to how one understands and interacts with other people – is when those heuristics don’t apply, however.  Spheres of social, interpersonal, intimate, familial, etc., life in which one eschews making decisions at the rationality margins, and instead goes with relational and affective values that are not “scalable” in the sense that marginal decision-making requires.

And then there is the vexed question of when one might think in terms of one, or the other, or both … which brings us to the question of the estate tax, as this Wall Street Journal article observes.  Last year, people had an incentive to stay alive, and their heirs had an incentive to keep them alive, until January 1, 2010, in order to avoid the estate tax.  It will go into reverse, however, at the end of the year:

When the Senate allowed the estate tax to lapse at the end of last year, it encouraged wealthy people near death’s door to stay alive until Jan. 1 so they could spare their heirs a 45% tax hit.  Now the situation has reversed: If Congress doesn’t change the law soon—and many experts think it won’t—the estate tax will come roaring back in 2011.  Not only will the top rate jump to 55%, but the exemption will shrink from $3.5 million per individual in 2009 to just $1 million in 2011, potentially affecting eight times as many taxpayers.  The math is ugly: On a $5 million estate, the tax consequence of dying a minute after midnight on Jan. 1, 2011 rather than two minutes

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