Author: Jonathan Lipson


The Arc of Covenant Banking: Hill & Painter’s Better Bankers, Better Banks


University of Minnesota law professors Claire Hill and Richard Painter do a great service in their new book, Better Bankers, Better Banks, by focusing concretely on an issue that many have discussed but few have offered to change: how to align the incentives of bankers and banks.

They argue that “bankers [should] be personally liable from their own assets for some of their banks’ debts” for money owed due to insolvency, fines, or fraud-based liability. Thus, they propose formal, liability-creating contracts—which they call “covenants”—between banks and bankers: “Covenant banking operates directly on bankers’ monetary rewards” because, under their proposal, “highly paid bankers would bear some personal liability if their banks become insolvent, are fined by regulators, or are found liable in civil cases involving fraud. The liability would not be unlimited, but should potentially adversely affect the banker’s standard of living.”

The Hill/Painter proposal is valuable and interesting both in its own right, and for the harder questions that it raises.

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The Rule of Flaw: Ibanez and the Too-Big-to-Succeed Problem

The Massachusetts Supreme Judicial Court’s recent ruling in U.S. Bank v. Ibanez  is the latest and loudest salvo in what may be the most engaging and gruesome legal aspect of the credit crisis yet:  The day of reckoning for the staggering sloppiness that infected virtually every step of the mortgage-securitization process.

Ibanez held that, according to well-established Massachusetts precedent, a mortgagee cannot foreclose unless — surprise, surprise — it actually isthe mortgagee, or a legitimate assignee thereof.  In Ibanez,  lenders or servicers had foreclosed mortgages prior to completing (or commencing) the process of taking assignment of the note and  mortgage  on which they foreclosed.  When they later sought to clear title, Massachusetts courts balked.   “Utter carelessness,” Justice Cordy scolded the plaintiffs.

mistakes were made

This is potentially a huge problem for mortgage servicers (among others), given the long and convoluted chains of title through which mortgages may have passed in order to create mortgage-backed securities (MBS).   Not surprisingly, many observers are apoplectic, warning that this will lead to the end of the financial markets as we know them. 

How did this happen? 

There are probably several answers, but I think one is that the elite financial services sector (EFSS) that created the MBS is (or believes itself to be) a unique institutional force, unchallengeable by the ordinary legal or political mechanisms that keep institutions in check.  It is immune from the rules and norms  that apply to the rest of us.  But we know that spoilt children often lack discipline, so persistent failures of scrutiny have led inevitably to failures of competence. The drip, drip, drip of deregulation left us with firms that are not only too big to fail: they’re also too big to succeed. 

What will happen next? 

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The Numbers are REALLY In–Plus Two Modest Proposals

For those of you who had any doubts, our friends at Kaplan have just confirmed it:  Aspiring law students care more about law school rankings than anything else, including the prospects of getting a job, quality of program, or geography.

Sayeth Kaplan:

1,383 aspiring lawyers who took the October LSAT . . . [were] asked “What is most important to you when picking a law school to apply to?” According to the results, 30% say that a law school’s ranking is the most critical factor, followed by geographic location at 24%; academic programming at 19%; and affordability at 12%. Only 8% of respondents consider a law school’s job placement statistics to be the most important factor. In a related question asking, “How important a factor is a law school’s ranking in determining where you will apply?” 86% say ranking is “very important” or “somewhat important” in their application decision-making.

Mystal at ATL expresses shock–shock!–that potential law students could be so naive. Surely, he fairly observes, they should care most about job prospects.

Yes, that would be true if they were rational.  Yet, we all know from the behavioral literature that we apply a heavy discount rate to long-distance prospects.  How much can I or  should I care today about what may happen 3 (or 4) years from today?

If you think about it from the perspective of any law school applicant today, the one concrete thing they can lock onto that has present value is the school’s ranking:  It is simple, quantified, and–perhaps most important–tauntable.  No one’s face burns with shame because their enemy (or friend)  got into a law school with a better job placement rate.  Jealously and envy–the daily diet of anxious first-years–are driven by much simpler signals:  Is mine bigger (higher) than yours?

This is not to defend the students who place so much faith in numbers that have repeatedly been shown to be incredibly stupid.  It just means that Kaplan’s survey (and I have not seen the instrument or data) makes intuitive sense.

Which leads to me to offer two modest (and probably unoriginal) proposals:

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Stalking About Your Generation

Yesterday, I had the all-too-brief pleasure of sitting in on the first couple of talks at the Wisconsin Law Review’s Symposium, Intergenerational Equity and Intellectual Property, here in Madison.

Organized by my colleague, Shubha Ghosh (and starring, among others, CoOp-erator Deven Desai), the goal is important:  How do we understand the intergenerational consequences of a legal regime—intellectual property—that is strongly determined by the present, but which has significant, but under-theorized, consequences for the future?  Fights about extending the term of the Mickey Mouse copyright—or any set of long-haul rights—don’t just affect my kids, but potentially their kids, their kids’ kids, and so on.  These are, in short, really fights about intergenerational equity.

I was only able to hear Michigan’s Peggy Radin (Property Longa, Vita Brevis) and Penn’s Matt Adler (Intergenerational Equity: Puzzles for Welfarists), but as expected, both provided awesome overviews of these sorts of problems.  As Radin pointed out, intellectual property (knowledge and information law generally) always involves two types of generational problems: One is temporal (my parents, me, my kids, their kids, etc.); the other is technological (my students barely know from videotape; I will never beat my daughter at any computer game).

Adler explained that it is easy (and perhaps imprudent) to dismiss the utility of welfare economics as a tool to make these sorts of decisions.  Certainly, we might say, Benthamite sums of utils could predict little for those not in existence (the future):  what would their utility function be, really?

Hope I die before you get old

Yet, he observed, robust and subtle analytic models and conceptual frameworks are being developed by the Sens and Arrows of the world, and they may (if the future is bright) help develop more equitable and effective decision tools for matters with a long temporal reach.

Those who follow state politics may find this all a bit ironic. Wisconsin’s recent election was a decisive victory for Republicans, who captured both houses of the legislature and the Governor’s office on a message which may strain the state’s motto, “Forward.”

If Republicans keep their word, tax breaks for the rich and elderly will replace education and healthcare spending for the young and unborn; fossil fuel (old tech) subsidies will replace biofuel (new tech) development; and the University may have to fight to continue its path-breaking stem-cell research, certainly a way to kill both jobs in the present and medical miracles in the future. This may be good for baby boomers, but isn’t likely so hot for their grandkids.

Hope you die before I get old

Wisconsin’s liberals are, of course, despondent over their loss of power and position.  Yet, forecasting and discounting long-term causation are among the things that make questions of intergenerational equity  so interesting and difficult.  I doubt Newt Gingrich thought in 1994 that the Contract with America would virtually assure Bill Clinton a second term, but today the former seems to have led to the latter.   Likewise, it is certain that neither Jeremy Bentham nor Pete Townshend could have predicted the duration of their memetic contributions to today’s discussions about tomorrow.  They probably just thought it was all rock and roll.


Sexing the Law Firms

The Am Law Daily recently had the following lede:  “Can Bill Henderson, the one-man idea factory and Indiana law professor, do for the study of law firms what Indiana’s most famous academic, Alfred Kinsey, did for the study of sex?”

Per Am Law, Henderson and others have started Lawyer Metrics which, according to their website, will  “design and build evidence-based systems to select, develop and retain world-class lawyers and counselors.”

No beef there.  The part I didn’t understand was Am Law’s analogy to Kinsey.  At first I thought it was a typo:  They must have meant McKinsey, the management consulting gurus who brought you Enron.   But no.   That’s really a reference to the man who, according to Wiki,

Kinsey's lawyers, in lust

is generally regarded as the father of sexology, the systematic, scientific study of human sexuality. He initially became interested in the different forms of sexual practices around 1933, after discussing the topic extensively with a colleague, Robert Kroc. It is likely that Kinsey’s study of the variations in mating practices among gall wasps led him to wonder how widely varied sexual practices among humans were.

Now that’s evidence-based for you.

This leads to two questions.  First, is Henderson’s goal viable?  His work is great, so I have no doubt that if it can be done, he can do it.  But if, as my friend Claire Hill points out, career development in large law firms is as  much about social skills and judgment as technical acumen, what is the formula going to look like?  According to Am Law, Henderson is starting with expressed preferences of lawyers at large firms.   But is that really what matters?  Is it, instead, about dollars, wins, losses, closings or something else entirely?  Is the dependent variable simply “partner,” against which we regress everything we can think of (e.g., LSAT, GPA, law school, etc)?  Doubtless, Henderson & Co. have thought of these questions, so we will have to await any findings they publish.

Second,  is the analogy to Kinsey so inapt?  Given the f*cking many recent (and not-so-recent) grads have experienced in Big Law, maybe not.

Mating gall wasps courtesy of Wikimedia.


Flaming the Victims

Two recent items have me wondering about overinvesting in victim claims: (1) Christine Hurt’s new article on the implications of the Madoff scandal, Evil has a new name, and (2) Janet Tavakoli’s claim (if the link doesn’t work, this is also squibbed in the margin) that financial institutions caused the mortgage mess, the “biggest fraud in history.”  Both tell important—and perhaps accurate—stories about massive frauds that certainly produced victims. But both overlook an obvious point:  Not all victims are created equal.  As Pogo said, “we’ve seen the enemy, and he is us.”

Pogo victim dance

When Madoff first hit, I heard two interesting things from (reasonably) reliable sources which complicate the victim calculus.  First, one person who claimed to know a number of Madoff investors, said that many  believed that Madoff was able to guarantee outsized returns because of his access to inside information.  This, of course, is a kind of securities fraud. So, my friend said, “everyone knew Madoff was committing fraud—they just thought it was a different fraud.” You have to wonder how innocent investors were if, as Hurt reports, they were sworn to secrecy when they gave him their money.

I realize I will likely be flamed by holocaust survivors for insensitivity to their losses.  To the extent they were innocent, of course, I have nothing but sympathy for them.  The point, however, is that, as Madoff’s bankruptcy trustee is learning, there is little moral clarity in some of these claims.

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Mad Glee-actica: The Virtues of Extreme Recycling

I don’t watch much TV.  So, I am hardly the person to make strong claims about its quality or trends.  That said, I find it fascinating that three of the best shows of the past few years—Battlestar Galactica, Madmen, and Glee—share a really odd structural feature:  They have all taken ridiculously bad ideas from cringe-able eras and turned them around completely, made them not only fresh, but evocative, disturbing, intriguing.

Where's the goo?

They are, in short, evidence of the virtues of extreme recycling.

Just imagine the pitch meeting for Galactica:  We’ll take what has to have been one of the dumbest pop-culture packing peanuts ever and make it stronger, faster, better:  How about an allegory about civil liberties and faith after 9/11 using Cylons and vats of goo?

Or what about Madmen:  Let’s explore the most virulent cancers on our culture with lovingly pornographic attention to detail, to demonstrate the complex symbiosis among banality, beauty, evil and exculpation.  Madmen is the money shot of commodity fetishism, proving once again the truth of Chomsky’s admonition that if you want to learn what’s wrong with capitalism, don’t read The Nation, read the Wall Street Journal.

And Glee?  Well, all I can say is:  Don’t Stop Believing.

Which may lead you to this question:  No one really takes the “and everything else” part of CoOps’s desktop mantra seriously, so what the frak does this have to do with law? Read More


Broken Records: It’s About Bankruptcy Relief, Stupid

If hypocrisy is your cup of tea, you can’t get much better than this. The New York Times reports that hedge funds—who stand a good chance of being the direct or indirect beneficiaries of about $1 trillion in U.S. financial bailout money—do not think homeowners should catch a break. They—like banks and bondholders before them—have come out against any proposal to amend the Bankruptcy Code to provide relief to homeowners by giving judges the power to modify mortgages to fair market value. According the the Times,

“Hedge funds are fighting proposals to ease the terms of home mortgages, arguing that such a move would hurt their investments. Two funds recently warned mortgage companies that they might take action if the companies participated in government-backed plans to renegotiate delinquent loans in a way that undercut the funds’ interests”

Although there is evidence that that there has been some drop in mortgage foreclosure numbers in the last month, it remains true that we are experiencing record numbers of home foreclosures, and this will likely continue well into the future absent some sort of government intervention.

One reason for the recent dip is that some states are apparently making it more difficult to foreclose, although this would seem only to forestall the inevitable. For her part, Sheila Bair, FDIC chair, has proposed streamlining restructuring procedures at the homeowner level in order to facilitate renegotiations.

While these are laudable attempts to address the fundamental market failure that has occurred by virtue of the investor-servicer-homeowner CF (“CF” is a term of art. The first letter stands for the word “cluster.” I cannot print the second word), I remain convinced that the most fair and efficient way to deal with this is through bankruptcy.

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Live, From Tsinghua University, It’s Saturday Night!

Okay, just about everything in the title is false, except that I have been at Tsinghua University, in Beijing, to present a talk entitled “Enron Rerun: The Credit Crisis in Three “Easy” Pieces.” [ Download file]

Every year, Tsinghua, which partners with Temple’s China LLM program, puts on an international conference on corporate or commercial law. This year’s theme: Corporate Restructuring. Speakers from around the world (but mostly Asia) gathered to talk about everything from bringing the ineffable elegance of the reverse triangular merger to China to the scourge of needless transactional complexity.

Organized by Tsinghua Professors Wang Baoshu and Zhu Ciyuan, speakers included Helmut Kohl (University of Frankfurt); Professor Chih-Cheng (Spencer) Wang (National Chung Cheng University (Taiwan)); Professor Len-Yu Liu (Chengchi University, Taiwan; Professor Alain Couret (Sorbonne); Jennifer Hill (Sydney University); Daniel Ohl (Orleans); Nicholas Howson (Michigan) and Daniel Kleinberger (William Mitchell).

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The Biggest Fraudulent Conveyance Lawsuit Ever

New York Attorney General Andrew Cuomo has been making headlines because he has strong-armed AIG into trying to recover “outrageous” bonuses and other perks while its financial condition was not so great.

Cuomo’s leverage (so to speak) arises from, among other things, laws forbidding fraudulent conveyances and similar transactions. Fraudulent conveyance law is a complex, if vital, corner of debtor-creditor law. It essentially says that a company cannot convey property for less than “reasonably equivalent value” if it is “insolvent,” undercapitalized, or the like. If you’re in financial trouble, the saying goes, “you must be just before you are generous.”

Among other things, this means that if a company like AIG was paying bonuses (or redeeming stock) while it was in fact in distress, those who received AIG’s cash—like Joe Cassano, who was paid millions for running AIG’s brilliant credit default swap shop–should have to pay it back unless they gave AIG “reasonably equivalent value.” Gifts are axiomatically not supported by any (much less reasonably equivalent) value.

But if AIG is Cuomo’s only target, he’s thinking WAY TOO SMALL. Today’s New York Times reports the following “grim milestone: All of the combined profits that major banks earned in recent years have vanished:”

In the case of the nine-largest commercial banks — Citigroup, Merrill Lynch, Bank of America, Morgan Stanley, JPMorgan Chase, Goldman Sachs, Wells Fargo, Washington Mutual and Wachovia — profits from early 2004 until the middle of 2007 were a combined $305 billion. But since July 2007, those banks have marked down their valuations on loans and other assets by just over that amount


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