David Skeel's posted an interesting new paper, Making Sense of the New Financial Deal:
In this Essay, I assess the enactment and implications of the Dodd-Frank Act, Congress’s response to the 2008 financial crisis. To set the stage, I begin by very briefly reviewing the causes of the crisis. I then argue that the legislation has two very clear objectives. The first is to limit the risk of the shadow banking system by more carefully regulating the key instruments and institutions of contemporary finance. The second objective is to limit the damage in the event one of these giant institutions fails. While the new regulation of the instruments of contemporary finance - including clearing and exchange trading requirements for derivatives - is promising, its treatment of systemically important financial institutions is likely to create a troublesome partnership between these institutions and the government. I also argue that our financial world is just as prone to bailouts after Dodd-Frank as it was before, and that it would have made a lot more sense to focus on bankruptcy as the solution of choice for troubled financial institutions.
After this initial assessment, I discuss the CEO compensation issues that have gotten so much attention in the press. I conclude by considering the legislation from a distinctively Christian perspective.
It's the conclusion that is the most provocative part of the paper. Skeel makes 5 points about "faith and finance":
The first is that we always need to be careful about how much we expect from secular law. Law is essential in a fallen world, but it cannot save us and can be used to oppress. It is important to be modest about our aspirations for law. This is true with social issues like abortion and gambling, and it is true with economic issues like credit and banking.
I would invoke the Fall for a somewhat different purpose; specifically, to suggest that economics may be more relevant to legal analysis than theology. In my view, the assumptions about human behavior made by economists are largely congruent with the fallen state of man. If Economic Man is a fair description of Adam after the Fall, the rational choice model used in economics is not a bad model for predicting the behavior of fallen men.
To be sure, Christians are called to a higher standard of behavior than that of fallen man. If the purpose of economic analysis is to predict how people will respond to changes in legal rules, however, can we assume Christian behavior by the masses of a secular and God-less society? As Michael Novak observed somewhere or another, no realistic social order can assume “heroic or even consistently virtuous behavior” by its citizens. A realistic social order therefore must be designed around principles that fall short of Christian ideals. In particular, the rules must not be defined in ways that effectively require every citizen to be a practicing Christian. Christian visions of Justice therefore cannot determine the rules of economic order. Instead, legal rules and predictions about human behavior must assume the fallen state of Man, which is precisely what economic analysis does.
Back to Skeel:
Second, with this caveat in mind, the most useful contribution that legal reform can make is often to fix rules that have the unintended consequence of encouraging people to misbehave.
The trouble, of course, is that determining what constitutes "misbehavior" can be quite difficult. Skeel posits, for example, that:
The implicit governmental subsidy enjoyed by banks that are “too big to fail” has this kind of effect, since it invites risk-taking, as does the tax treatment of executive compensation ...
As the Parable of the Talent teaches, however, we want servants to take risks on behalf of their masters when it comes to investing the master's assets. This is so because risk and return are positively correlated. As such, or so I assume, the real problem is "excess" risk taking and the moral hazard inherent in government subsidies. If so, however, does the faith Skeel and I share (even though he's on the wrong side of the Tiber), tell us very much about how to identify what constitutes "excess" risk taking? To answer that question, I revert to the fallen nature of humankind. Because regulators are fallen people, we cannot trust them to adopt optimal rules. In an incisive essay Catholic Social Teaching, Free Enterprise and Poverty, Paul Atkins argues that:
It is a blunt instrument at best, and subject to the frailties of the human regulators. If the regulator does not use an effective cost/benefit screen to analyse its proposed rules properly, or does not listen to public comments, or tries to regulate through enforcement, the consequences can be inconsistent, distortive, and not easily corrected. We must remember that investors ultimately pay for regulation. If regulations impose costs without commensurate benefits, investors suffer the costs of lack of effectiveness and efficiency, not only through higher prices but also through constrained investment opportunities. That ultimately hurts them in their investment performance, because it means less opportunity for diversification. ...
Can regulators do the jobs of industry better than industry can? In his last book, The Fatal Conceit: The Errors of Socialism, Friedrich Hayek, the Austrian-born economist, wrote in 1989 about the dangers of a paternalist attitude toward regulating the economy. He labels as the “fatal conceit” the idea that “man is able to shape the world around him according to his wishes.” Hayek argues: “To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm.”
As Hayek teaches, at some point, we must recognize that businesses are better than governments at business. To suggest that regulators somehow know more than a company about its own business and the risks its faces is both egotistical and naïve. In addition, by removing risk management from firms and placing it in the hands of government, there is a danger that firms will become careless and take on additional risk, believing regulators are protecting them. This is the moral hazard that we all try to avoid. Simply put, the risk management function must remain in the hands of the firms that face the risk.
Back to Skeel:
Third, I believe that the income inequality that we hear so much about— the enormous gap between the income at the highest level and income at lower levels—is a genuine issue with obvious Christian implications. The real estate bubble disguised the gap between those in the executive suites and ordinary Americans by encouraging Americans to buy and live beyond their means.
As a Catholic, I accept that social policy ought to reflect what the Church calls the preferential option for the poor. Once we move beyond basic wealth redistribution questions, however, turning the preferential option into policy becomes difficult. many people truly thought that promoting home ownership would reduce wealth inequality, help the poor to build assets, and, of course, provide shelter. As Skeel's excerpt suggests, however, the pre-2008 policies that drove home ownership ever higher may actually have been detrimental to the poor.
That point is affirmed in Atkin's essay:
The fundamental problem was that mortgage loans were made to borrowers who, if they had had tighter underwriting standards, might not have been able to get those loans. They put little money down, in general, so the amount of money lent on the house was pretty close to what the house was worth. That means not much room for error if the house price declined.
The policies pursued by the government thus increased the vulnerability of the poor.
Skeel's fourth point is that "Congress would have done far more to make the biggest banks and their executives more accountable—and more responsible—if it had taken serious steps to downsize them, and had looked to bankruptcy as the strategy of choice if they fail." Which strikes me as a true point, but not one especially driven by faith-based insights.
The same seems to be true of Skeel's fifth point, which is that there is a "cultural cost of the recent bailouts" in that they "may have made homeowners less hesitant to default on their own home loans." Again, it's not clear to me that this insight is uniquely faith-derived.
In sum, I liked this piece a lot, but I came away once again wondering if faith-based reasoning really leads to unique scholarly insights when it comes to issues like corporate governance or finance.
The late William Stuntz was a friend of both Skeel and I. At a conference many years ago, I heard Stuntz observe that, before His public ministry, Jesus made tables and whatever else it was that ancient Middle Eastern carpenters made. Bill went on to ask whether there was anything uniquely Christian about those tables. Bill's insight suggests that we need to ponder what, if anything, makes Christian perspectives on law distinctive.
In doing so, we need to differentiate between several different types of "law and religion" scholarship:
- Studies of how the law impacts religion. This probably is the dominant form of law and religion scholarship, but it's really mostly Constitutional law dealing with the free exercise and establishment clauses of the First Amendment. Not really distinctively Christian.
- Critiques of policy recommendations made by religious figures. This is what I mostly do in the law and religion field. Where US Catholic Bishops have made legal and regulatory proposals grounded in Catholic social thought, for example, there is a space for distinctively Christian legal scholarship that engages those proposals not only from secular grounds like economics but also from theological perspectives.
- Christian critiques of laws like Dodd-Frank. This is the area where I think it is hardest to do something that is both rigorous and distinctively Christian. As far as I can tell, for example, there's very little in either the Bible or the Magisterium that would help me answer the question of whether executive compensation at TARP recipient firms should be capped.
For more on these issues, see Skeel's excellent article The Unbearable Lightness of Christian Legal Scholarship.
, Trillin relates that:
