The Quest for Better Bankers, Better Banks Requires Better Economists, by William K. Black

In Better Bankers, Better Banks, Claire Hill and Richard Painter of the University of Minnesota Law School signal their approach in the subtitle:  “Promoting Good Business through Contractual Commitment.”  This review explains why their thesis is so timely in terms of the most important theoretical debates boiling in economics and banking regulatory policy and the severe degradation of bankers and banks over the last 30 years.  Contractual commitment was, of course, the heart of Dr. Oliver Williamson’s approach to explaining modern capitalism.  Williamson, in work that led to being made a Nobel Laureate in Economics, argued that corporations were not simply a “nexus of contracts,” but also that these contracts had evolved to suppress the enormous danger to commerce posed by the powerful incentive of profit-maximizing actors to engage in “opportunistic behavior” whenever “information” was “asymmetrical.”  In The Economics Institutions of Capitalism, Williamson defined opportunistic behavior broadly and starkly as “self-interest seeking with guile.”

“This includes but is scarcely limited to more blatant forms, such as lying, stealing, and cheating…More generally, opportunism refers to the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse” (Williamson, 1985, p. 47)

“Opportunism” is obviously a severe problem for a neoclassical microeconomist, but neoclassical macroeconomists, particularly from the so-called “freshwater” school of thought (of which the University of Minnesota is one of the principal leaders) are now writing that fraud (though they refuse to use the “f” word) is the key to the failure of their models to explain or predict finance – precisely the field that Hill and Painter also identify as a field in which things have gone horribly wrong.  Kartik Athreya, the Richmond Fed’s Research Director, makes the point for a general audience in Big Ideas in Macroeconomis: A Nontechnical View (2013).  Artheya says finance has fewer “spot” transactions and more transactions that involve performance over long time periods.  He argues that spot markets are far less vulnerable to abuse, so finance is the area where we would expect the neoclassical assumptions of general equilibrium and Pareto efficiency to go wrong.

Athreya says that the two key conceptual problems in finance are “moral hazard” and “commitment” problems.  Commitment problems prevent “complete markets” and can produce severe inefficiency.  Commitment problems occur when contracting is a poor solution, typically because no cost-effective enforcement can be assured.  Commitment problems and moral hazard interact in finance because one or more of the parties to the transaction have what can be powerful incentives to breach in precisely the circumstances where contract formation and enforcement is most expensive and least reliable.  In sum, motive and opportunity to breach are both present in many finance transactions.  The subtitle of Hill and Painter’s book shows that they have knowingly and correctly situated their work at the heart of the most troubling issue for the prevailing neoclassical models.

Athreya begins his book by explaining how neoclassical macroeconomists approach their field.

“In sum, if there’s one rule we play by, it is this: it takes a model to beat a model.  One measure of the difficulty of achieving this can be seen in the high payoff to succeeding; it is what essentially all of the profession’s biggest names, such as Paul Krugman, Edward Prescott, and George Akerlof, each did at some point.”

Athreya returns later to explain the significance of Akerlof’s model and why it “beat” the prior neoclassical model.

“[A]symmetric information could throw a wrench into the efficiency of decentralized trade.  In fact, the seminal paper of Akerlof (1970) first helped economists recognize the potential effects of what we have come to call adverse selection, whereby the quality of goods available for sale falls with price it is expected by sellers to fetch—sometimes to the point of driving all sellers of high-quality goods out of the market.  Akerlof’s work suggested this possibility in the context of the spot market for used cars.  Akerlof’s work showed that economists that linear prices could not be presumed to work efficiently.”

Note that Akerlof’s work was so troubling to neo-classical economists, particularly those hostile to government “interference” in the market because it showed that even in the “spot” context where contracting is often feasible, fraud could flourish.  Indeed, Akerlof showed that fraud, unless blocked, could create a “Gresham’s” dynamic in which market forces became so perverse that bad ethics would drive good ethics from the markets.

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”

Akerlof’s 1970 article also emphasized that such a perverse dynamic was by no means certain.  Akerlof explained how a number of practices used in real markets could be viewed as institutional, contractual, and signaling means to avoid a Gresham’s dynamic.  Specifically, the honest merchant needed to find a way to signal to consumers that the merchant had made a reliable commitment to providing high quality goods when the consumer paid for high quality goods.  Again, Hill and Painter are focused on what the leading theorist in the field (Akerlof) has identified as the key means of preventing a Gresham’s dynamic.  Preventing future fraud epidemics led by financial elites is among the greatest of challenges that the world faces, and Hill and Painter offer their take on a key change to attempt to restrain such epidemics.

Akerlof was made a Nobel Laureate for his work on asymmetric information and his 1970 article on “lemons” – the fraudulent sale of poor quality used automobiles – was his most famous theoretical contribution.  Akerlof has returned to this subject many times, including his famous article entitled “Looting: The Economic Underworld of Bankruptcy for Profit” in 1993 with Paul Romer.  Their 1993 article explored the role of elite insider fraud as a fundamental cause of the second phase of the savings and loan debacle (“evidence of looting abounds”).  Their article rejected the conventional neoclassical story about the debacle – honest, but unlucky “gambling for resurrection.”  Their model showed that the CEO had an incentive to cause the bank to deliberately make enormous amounts of bad loans that would create the “sure thing” of huge reported (albeit fictional) accounting income in the early years but would actually produce massive losses that would only be recognized years later.  Akerlof and Romer stressed that the loans typically had a negative expected value at the time they were made.  This was a radical departure from normal neoclassical models, which almost always assume profit maximization.  “Agency” problems concerning CEO were discussed, but as Williamson noted, this was almost always limited to “shirking.”  Athreya’s book shows that macroeconomists continue to assume profit maximization.

The conventional wisdom of neoclassical economists about the S&L debacle was that it was simply “moral hazard,” or as the phrase went purportedly honest “gambling for resurrection.”  Akerlof and Romer’s model rejected that claim (as did we the regulators, the courts and juries, and the criminologists).  They first pointed out that fraud was a vastly superior strategy to gambling.

“[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution?” (Akerlof & Romer 1993: 4-5).

They then added that the pattern of conduct at the S&Ls made no sense for honest gamblers, but was optimal for insider “looting” through accounting fraud.

“[S]omeone who is gambling that his thrift might actually make a profit would never operate the way many thrifts did, with total disregard for even the most basic principles of lending: maintaining reasonable documentation about loans … verifying information on loan applications…. applications”5

5Black (1993b) forcefully makes this point.

(Akerlof & Romer 1993: 4-5 & n. 5).

Akerlof and Romer emphasized how weakly developed economic theory was when it came to understanding elite frauds by financial elites, particularly when aided and abetted by “independent professionals.”  Their concluding paragraph, obviously addressed to economists, ended on an optimistic note.

“Neither the public nor economists foresaw that the [S&L deregulations] of the 1980s were bound to produce looting.  Nor, unaware of the concept, could they have known how serious it would be.  Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better.  If we learn from experience, history need not repeat itself” (1993: 60).

As Hill and Painter document and explain, we did not “learn from experience” and history repeated itself in increasingly nasty reruns – the Enron-era frauds and the three most destructive epidemics of financial fraud in history that hyper-inflated the U.S. real estate bubble, caused the financial crisis, and triggered the Great Recession.  Those three epidemics, the fraudulent origination of loans through appraisal fraud and “liar’s” loans and the fraudulent sale of those loans to the secondary market through fraudulent “reps and warranties,” created intense Gresham’s dynamics.  Hill and Painter give many useful details on the nature of this third fraud epidemic and even more useful descriptions of how the secondary market and mortgage derivative markets made the “sausage” of toxic mortgages that opportunistic behavior by credit rating agencies, deliberately induced by the sausage-makers transmuted into “AAA” gold.

One of the strengths of Hill and Painter’s book is repeatedly providing evidence on the exceptional income generated by purportedly independent professionals that “blessed” the creation and sale of mortgages and financial derivatives where the “underlying” was actual or “synthetic” mortgages.  None of this was possible without massively overstating the value of the mortgages.  Akerlof and Romer explained the point.

“We begin with a point about accounting rules that is so obvious that it would not be worth stating had it not been so widely neglected in discussions of the crisis in the savings and loan industry. If net worth is inflated by an artificial accounting entry for goodwill, incentives for looting will be created. [E]ach additional dollar of artificial net worth translates into an additional dollar of net worth that can be extracted from the thrift” (Akerlof & Romer 1993: 13).

The heart of Hill and Painter’s reform proposals are premised on their accurate description of how we have run an uncontrolled experiment for 30 years in which we have – without the benefit of any cost-benefit analysis – systematically removed or rendered illusory the historic sources of private and public discipline of elite market participants.  Hill and Painter make a convincing case that one of the most destructive changes was to ownership form.  By virtually eliminating true partnerships in which the general partners bore “joint and several” liability we encouraged the leadership of former true partnerships to make people senior managers who would have been rejected for partnership in a true partnership because of their lack of integrity and dramatically reduced the incentive of senior managers to engage in the costly process of monitoring their peers.

At the same time as we rendered nugatory the private and public barriers to opportunism, we dramatically increased the potential gains from opportunism through radical changes to executive and professional compensation.  The result, as Williamson and Akerlof predicted (as did white-collar criminologists and real financial regulators) was an epidemic of purposeful “opportunism” by elites.  Hill and Painter explain why finance was the “canary” – it is inherently easier to cheat (as the macroeconomists now stress), the rewards to elites cheating are now vastly greater, the ability of elite bankers to cheat through “accounting control fraud” makes fraud a “sure thing” and means that the frauds will frequently never be discovered, and banking more than any other industry counted on independent professionals in true partnerships (particularly attorneys, auditors, investment bankers, and credit rating agencies) to restrain such fraud opportunities.  Financial deregulation, desupervision, and de facto decriminalization (the three “de’s”) has also been far more radical than deregulation in other fields because of the power of finance and the deliberate instigation of the international “regulatory race to the bottom”) in which the largest banks threaten to move to other nations with even weaker public controls.  The apex of this problem of lost controls is occupied by the systemically dangerous institutions (SDIs) that are treated as “too big to fail.”  These firms hold the global economy hostage.  When Lehman was allowed to collapse it triggered (not “caused”) the acute phase of the global financial crisis.  The independent professionals lost their independence when they ceased to be true partnerships.  It became easy for financial CEOs engaged in opportunism to suborn auditors at the top tier firms into becoming their most valuable fraud allies.

Hill and Painter’s thesis is that we broke the most fundamental rule adults should live by in the financial sphere – “if it ain’t broke; don’t fix it.”  They show that rather than fixing the problem, our radical abandonment of institutional and contractual forms that had been developed over the course of centuries as essential means of reducing opportunism by CEOs made the CEOs’ already perverse incentives far nastier.  Hill and Painter correctly urge that part of the solution is to go back to what works.

As I hope I have explained, this places their work dead center of where micro and macroeconomists are struggling to figure out how to explain what has gone so calamitously wrong with finance – because what has gone wrong is automatically excluded as a possibility by their neoclassical models of general equilibrium.  Hill and Painter, in essence, have confirmed that Akerlof, Romer, and Williamson (and the criminologists and real regulators) have made “a better model” that beats the existing models and explains why they fail.  Falsified paradigms die ugly, after lengthy rearguard actions to protect their intellectual retreats.  Hill and Painter have added another barrage on that failed conventional wisdom and have proposed a real world answer that could be part of a realistic solution to the pathologies of modern finance.


Review by Dr. William K. Black.

Black is an Associate Professor of Economics and Law at the University of Missouri at Kansas City and the Distinguished Scholar in Residence for Financial Regulation at the University of Minnesota’s Law School.  Black is also a former financial regulator and a white-collar criminologist.  His research focus is on financial regulation, financial crises, and elite white-collar crimes.


FAC 6 (First Amendment Conversations) Powell Law Clerk David O. Stewart Discusses the Origins of Central Hudson’s 4-Prong Test

[T]he Central Hudson test is susceptible to a wide variety of interpretations . . . . Martin Redish (2001)

After a period of much controversy, the Court in 1980 in Central Hudson articulated a general test for determining the constitutionality of regulations of commercial speech. Although the test has subsequently been interpreted from radically different perspectives, and although it has been attacked by numerous Justices, it has nevertheless remained the dominant test. — Robert Post (2000)

Before Sorrell v. IMS Health Inc. (2011) and 44 Liquormart, Inc. v. Rhode Island (1996), there was Central Hudson Gas & Electric v. Public Service Commission (1980).

When it comes to commercial speech and the First Amendment, Central Hudson was the coin of the realm in its day. Recall, the vote was 8-1 with Justice Lewis Powell writing the majority opinion (joined by Justices Stewart, White, Marshall, and Chief Justice Burger), with separate concurrences by Justice Brennan, Blackmun, and Stevens. Justice William Rehnquist wrote a lone dissent.

David O. Stewart, former Powell law clerk

David O. Stewart

Recall as well that Telford Taylor (counsel for the prosecution at the Nuremberg Trials) argued the case on behalf of the Appellants and Burt Neuborne filed an amicus brief on behalf of the Long Island Lighting Co. supporting the Appellants.

Justice Powell was virtually silent during oral arguments. Justices Byron White, John Paul Stevens, Potter Stewart, William Rehnquist, and Harry Blackmun asked the lion’s share of the questions. Even so, the Chief Justice assigned the opinion to Justice Powell.

Central Hudson was the case where the famed four-prong test was announced. Recently, I had occasion to look through the Powell papers archived at the Washington and Lee School of Law library. In browsing through those papers, I came upon a batch of memos and draft opinions concerning the Central Hudson case.

Much to my surprise, a good friend of mine, David O. Stewart, played a major role as the law clerk responsible for drafting Justice Powell’s Central Hudson majority opinion. In that regard, I asked David if he would answer a few questions about the case and his involvement in it. He kindly agreed; his responses are set out below. Read More


Better Bankers Book Symposium – a Perspective from Across the Pond

“Better Bankers, Better Banks” is an intriguing account of all the scandals and problems in banking that we appear to have become accustomed to. Professors Hill and Painter offer a fascinating new proposal on how to address these problems, which is as topical in the US as it is in Europe. In short, what their proposal amounts to is to rebalance the upside and the downside participation of bank managers in the profits and losses of their bank. Whereas before the crisis, regulatory efforts have long sought to align bankers’ incentives with the upside (by offering variable pay, bonuses, etc), there was very little attention on how to account for the downside risk. The idea of “covenant banking”, i.e. a form of self-commitment in the firm’s losses, is an important contribution to the current debate on how to improve banking culture post-crisis.

Inevitably, as soon as a proposal is on the table, market participants will want to know how it works in practice. In the following, I offer a few thoughts and questions that may broaden the debate towards its effects and implications.

First, how strongly would we encourage banks (or bankers) to make use of covenant banking. I am a little sceptical on whether they might adopt covenants deliberately. Some form of a government nudge would certainly be required. Different nuances in the regulatory toolkit are available. It seems to me that offering a best practice recommendation or a legislative menu with different options could be a sensible step to take. Findings from behavioural science support the effectiveness of such soft law standards.

Secondly, how will the market respond? Will clients and customers appreciate the stronger commitment that an individual banker’s “covenant” involves? Will they be able to digest the additional information appropriately? I would argue that a certain standardization of the covenant might help. If a small number of different covenants were “on offer”, endorsed by legislature or best practice code, the public would be much better placed to appreciate them. By contrast, if you leave firms to develop a million different tailor-made types – with exceptions, limitations and exclusions – creditors will not be able to price in their value correctly. This even more when you add an international perspective – jurisdictions will differ in their prescriptions and make it difficult to appreciate them in cross-border cases.

My final point is a little provocative: do we really get “better” bankers by making them liable for the firm’s debts? My pessimistic view of human nature is that bankers will still have strong incentives to work around their covenants – and possibly even use them as a commitment signal but do the opposite. Monitoring by creditors is therefore essential. This is another reason for why the rules should be clear, transparent, and somewhat standardized.

Hill and Painter have started a captivating journey, and I congratulate them on designing a stimulating new conceptual framework to address evil banking behaviour. I am convinced that their book will be the starting point for a long and fruitful discussion.



Better Bankers Book Symposium: Forget “God’s Work,” Just Do your Clients’

If Oliver Stone made another Wall Street movie, he might include Goldman CEO Lloyd Blankfein’s remarkably tone-deaf quip about his bank doing “God’s Work”. This quote has come to represent just how out of touch and unscrupulous Wall Street has become. Talk like this is what made the modern pitchfork wielders excoriate the whole banking enterprise. Stephen Colbert, after repeating the quote called the bank Goldman Calf. Matt Taibbi called Goldman “the great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” Many people have demanded that bankers go to jail, disgorge their bonuses, and that banks should be broken up. It’s either Golden Calves or God’s work—greed is good or it is evil.

Hill and Painter’s Better Bankers, Better Markets comes in like a grownup to this squabble to describe banks not as vampire squids, but as a collection of people motivated by the same things that motivate you and me. Hill and Painter are not naïve nor do they sugarcoat the banks’ collective bad behavior. The first few chapters of the book thoroughly outline the misdeeds from the specific (LIBOR manipulations) to the general (putting lipstick on worthless assets). The book is valuable if only for the thorough and well-explained cataloguing of the ways in which banks as a collection of individual decision makers defrauded clients or otherwise engaged in unethical behavior.

Hill and Painter accept that bankers and shareholders are motivated by personal profit, they’re  just asking that they don’t “rip their clients’ eyeballs out.” This book is firmly grounded in reality of modern banking industry without excusing or soft pedaling the problematic behavior of those banks. And they are clear that there is a big problem. Hill and Painter explain the genesis as the investment banking world’s shift from the partnership structure to the shareholder structure. In other words, there is no skin in the game, they aren’t eating their own cooking, the incentives are all wrong. It seems to me that Hill and Painter are joining (though not explicitly) a growing chorus of critics who doubt that market discipline can properly reign in Wall Street excess.

While most other reform proposals focus on changing the banks’ incentives—making them smaller, higher capital, more skin in the game—Hill and Painter look to change the individual bankers’ incentives. They are realistic enough to not suggest that we go back to partnerships, but they want bankers to feel some obligation or duty to the firm and to their clients. Hill and Painter suggest that the best way to do this is through covenant banking: to impose both contractual obligations and fiduciary duties, make banking to be a professional enterprise like law or medicine—a career with ethical boundaries, codes, and consequences for violating those.

Hill and Painter’s proposals are both traditional in that they want banking to return to the days when bankers felt duty-bound to both the firm and their clients, but also forward-thinking in that it recognizes that current activity restrictions and bright line rules in banking can easily be averted and real reform happens only insofar as the bankers’ and the publics’ incentives are aligned. The strength of the book’s argument is that the authors are not suggesting radical change, rather a look back to what worked in the past and distill those lessons to meet the needs of the present. While the bankers of the past are not perfect, perhaps there is comfort in the fact they were never accused of being vampire squid.






Twelfth Amendment Follies

One thing that we can say about this election is that the odds of a significant third-party candidacy are at their highest since 2000.  Maybe it will be Michael Bloomberg.  Maybe it will be a conservative who can’t stand Donald Trump.  Maybe it will be Donald Trump.

With this in mind, we should pause to consider how poorly the Twelfth Amendment was designed to handle situations where no presidential or vice-presidential candidate receives a majority in the Electoral College.  For example:

The House of Representatives must choose from the top three presidential candidates, but in this ballot each state gets one vote and a majority of the states is required to win.  (The assumption here is that you need a majority of a state delegation to cast a vote.)  This means that the member from Delaware gets the same vote as 28 Representatives from the California delegation.  It also means that states with equal divided caucuses may be unable to cast a vote, or that an illness that prevents some member from voting could swing a state’s vote.  Egads.

Next, the Senate gets to choose the Vice-President by an ordinary majority vote but only from the top two candidates.  [Query:  Could you filibuster this?  Maybe.]  This means that the President could get saddled with a Vice-President from the other party.  Worse still, the third candidate for President cannot get his or her running mate.  (Basically, the Vice-President would have to resign and then allow the new third-place President to nominate a new one.)

This creaky machinery has not been used since 1837 (when the Senate had to pick the Vice-President).  Let’s hope we don’t need it next January.



FAN 95 (First Amendment News) “Fifty Shades of Grey” too Blue for Idaho?

Coming tomorrow: FAC 6 (First Amendment Conversations) Powell Law Clerk David O. Stewart Discusses the Origins of Central Hudson’s 4-Prong Test


new-scenes-from-fifty-shades-of-greyThe Associated Press reported that a “movie theater is suing the Idaho State Police for threatening to revoke the theater’s liquor license because it served alcohol while showing ‘Fifty Shades of Grey.'”

“Village Cinema in Meridian, just west of Boise, has a liquor license and lets people drink alcohol in a restaurant or while watching movies in a designated 21-and-older VIP area, The Idaho Statesman reported. But state law prohibits places that are licensed to serve alcohol from showing movies that depict sexual acts.”

“Idaho police say a waitress at the theater served beer and rum to two undercover detectives watching the risque ‘Fifty Shades’ in the VIP seating last February. . . .”

“Idaho State Police later told Meridian Cinemas that it served alcohol while showing “Fifty Shades” from Feb. 13 to 18 and on Feb. 26, and attempted to revoke the theater’s liquor license.”

Counsel for Plaintiff: Jeremy Chou

→ Plaintiff’s complaint here. Among other things, Plaintiff’s counsel relies on the following precedent:

The Court decided 44 Liquormart on May 13, 1996.  The incidents in question here occurred in 1997. Thus, at the time that the Officials warned the Center’s management that hosting LSO’s art exhibition might subject the Center to sanctions, it was clearly established that liquor regulations could not be used to impose restrictions on speech that would otherwise be prohibited under the First Amendment. Thus, LSO’s right was “clearly established.” — LSO, Ltd. v. Stroh (9th Cir., 2000)

Michael Deeds, “Idaho theater lawsuit should spank stupid alcohol law,” Idaho Stateman, Jan. 22, 2016

 Eugene Volokh, “Idaho trying to revoke theater’s liquor license for showing ‘Fifty Shades of Grey’,The Volokh Conspiracy, Jan. 26, 2016

Missouri State lawmakers consider mandatory First Amendment classes

This from ABC News: “JEFFERSON CITY, Mo. The House committee on higher education considered a bill in Jefferson City Tuesday morning that would boost First Amendment education for Missouri students.

If passed, the legislation would require all college students to take a freedom of speech course before receiving a diploma.

The bill’s sponsor, Rep. Dean Dohrman, says last year’s protests on the MU campus was the main influence for this proposed legislation. . . .” (see Associated Press story here)

See also: Erik Wemple, “Mizzou professor Melissa Click charged with third-degree assault in quad clash,” Washington Post, Jan. 25, 2016

→ Jim Suhr, “Mizzou Chancellor Says He’s Not Going To Rush To Fire Melissa Click,” Huffington Post, Jan. 26, 2016

Campus Free-Speech Watch Read More



better bankers

We are delighted to introduce Professors Claire Hill and Richard Painter, along with the participants of our online symposium on Better Bankers, Better Banks:  Promoting Good Business Through Contractual Commitment (University of Chicago Press, 2015).  In the book Professors Hill and Painter trace the history of American banking to explain how we have arrived at what they term the “irresponsible banking” of today.  They argue that it is the failures of bankers themselves that causes banks to fail.  Their provocative solution is to hold bankers personally liable for bank failure.  As Larry Cunningham wrote on Concurring Opinions last year, Better Bankers, Better Banks offers a “fresh and compelling assessment of global financial stability.”

For roughly a half century after the Wall Street crash of 1929, the financial boom and bust cycle seemed to come to an end. Part of the reason was a change in the structure of banking; organizations that benefitted from federal deposit insurance had strict limits on the type of transactions in which they could engage and less regulated entities, such as investment banks, had to be owned as partnerships.   Another part of the reason is that the memory of the Great Depression restrained banking practices for decades after it occurred.   By the 1980s, however, those memories had faded, and a new era of high interest rates, greater international competition, and free market ideology encouraged deregulation of the financial section. The result contributed to the housing bubble and a series of scandals resulting in a new financial crisis from which we have yet to recover.   Few believe either that the government responses to date or the changes in banking culture the large banks have promised will eliminate the risk of another crisis. Yet, there is little agreement on the best ways to approach the risk.


Hill and Painter offer a straightforward solution: bring back an easily administered idea that worked. Require that those engaged in banking remain personally liable for their decisions. During the era in which investment banks could only be held in partnership form, partners could not easily buy and sell their interests. They had to be concerned about the long haul, and they jealously safeguarded their reputations and those of the companies they oversaw.   Once again making bankers personally liable for their actions will change the incentives that underlie banking, in an era in which transactions have become so complex that trying to anticipate each new abuse has become practically impossible.

To consider these and many other fascinating questions, we have invited a group of leading banking and corporate law scholars,  and of course, Professors Hill and Painter.

We look forward to a discussion on how to better our banks – and bankers.



The Tenth Amendment in 1791

I’m reading William Crosskey’s Politics and the Constitution, which contains many wonderfully strange arguments and observations.  Here’s one that I found interesting.

When the constitutionality of the First Bank of the United States was debated in 1791, critics such as Thomas Jefferson invoked the Tenth Amendment to support their position.  But there was a problem with this.  The Amendment was not yet ratified (that did not happen until after the Bank bill was signed into law.)

What was the rationale for citing a proposed but unratified amendment?  Clearly Jefferson et. al. were not acting as legal positivists.  Maybe everyone thought that the Tenth Amendment would be ratified, thus it should be taken into consideration.  Or maybe the thought was that a proposed amendment that gets the required supermajority in Congress is some sort of persuasive authority.  (Arguably the Supreme Court did something similar in Frontiero by citing the passage of the ERA by Congress in its decision striking down a law discriminating on the basis of sex.) Or maybe the Tenth Amendment was seen as just declaratory.



Journal of Legal Ed Symposium: Ferguson & Its Impact on Legal Education


The latest issue of the Journal of Legal Education (vol. 65, #2) is out. And here is the table of contents. (Go to this link for PDF files of each article). Beyond the Ferguson symposium, there is an essay on modern criminal procedure along with three book reviews.

* * * *

Reverse Broken Windows by  Christopher R. Green

At the Lectern

A Reader’s Guide to Pre-Modern Procedure by David L. Noll

Book Reviews


Warren Buffett’s Timeless Ten Investing Rules

cunningham buffett 4e coverAbout 10 years ago, editors of Investing Rules asked me the top ten rules from Warren Buffett on investing.  Last week, the editors asked me to update the list for a new edition.  After studying the list for the first time in a decade, guess how much change was needed?

None. Given the timeless quality of Buffett’s method, I did not elect to change a word.  Herewith the list, as good today as ten, twenty or more years ago. And for elaboration of these and other insights, see The Essays of Warren Buffett, recently updated to a fourth edition.

  1. Don’t be the patsy.

If you cannot invest intelligently, the best way to own common stocks is through an index fund that charges minimal fees. Those doing so will beat the net results (after fees and expenses) enjoyed by the great majority of investment professionals. As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy’.

  1. Operate as a business analyst.

Do not pay attention to market action, macroeconomic action, or even securities action. Concentrate on evaluating businesses.

  1. Look for a big moat.

Look for businesses with favorable long term prospects, whose earnings are virtually certain to be materially higher 5, 10, 20 years from now.

  1. Exploit Mr. Market.

Market prices gyrate around business value, much as a moody manic depressive swings from euphoria to gloom when things are neither that good nor that bad. The market gives you a price, which is what you pay, while the business gives you value and that is what you own. Take advantage of these market mis-pricings, but don’t let them take advantage of you.

  1. Insist on a margin of safety.

The difference between the price you pay and the value you get is the margin of safety. The thicker, the better. Berkshire’s purchases of the Washington Post Company in 1973-74 offered a very thick margin of safety (price about 1/5 of value).

  1. Buy at a reasonable price.

Bargain hunting can lead to purchases that don’t give long-lasting value; buying at frenzied prices will lead to purchases that give very little value at all. It is better to buy a great business at fair price than a fair business at great price.

  1. Know your limits.

Avoid investment targets that are outside your circle of competence. You don’t have to be an expert on every company or even many – only those within your circle of competence. The size of the circle is not very important; knowing its boundaries, however, is vital.

  1. Invest with ‘sons-in-law’.

Invest only with people you like, trust and admire – people you’d be happy to have your daughter marry.

  1. Only a few will meet these standards.

When you see one, buy a meaningful amount of its stock. Don’t worry so much about whether you end up diversified or not. If you get the one big thing, that is better than a dozen mediocre things.

  1. Avoid gin rummy behavior.

This is the opposite of possibly the most foolish of all Wall Street maxims: ‘You can’t go broke taking a profit’. Imagine as a stockholder that you own the business and hold it the way you would if you owned and ran the whole thing. If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.