By James Kwak
Apparently my former professor Ian Ayres has made a lot of people upset, at least judging by the Wall Street Journal article about him (and co-author Quinn Curtis) and indignant responses like this one from various interested parties. What Ayres and Curtis did was point out the losses that investors in 401(k) plans incur because of high fees charged at the plan level and high fees charged by individual mutual funds in those plans. The people who should be upset are the employees who are forced to invest in those plans (or lose out on the tax benefits associated with 401(k) plans.)
In their paper, Ayres and Curtis estimate the total losses caused by limited investment menus (small), fees (large), and poor investment choices (large). Those fees include both the high expense ratios and transaction costs charged by actively managed mutual funds and the plan-level administrative fees charged by 401(k) plans.
Continue reading “The Problem with 401(k) Plans” →
By James Kwak
Constitutional law is not my field. I think we spent one day on the Commerce Clause in my constitutional law class. I’ve barely been following the Supreme Court oral arguments this week because I figured (a) they would be silly, (b) we won’t know anything useful until June, and (c) with the rest of the commentariat focusing on it I would have nothing to add. But even at that distance, I can’t help but be shocked by the ludicrous nature of the proceedings, best represented by the framing of the case in terms of individual freedom and government coercion. According to the Times, the case may turn on Anthony Kennedy’s notion of liberty.
What’s wrong with this? Liberty should have nothing to do with this case. I’ll repeat the analysis, made my dozens of law professors more expert than I (Charles Fried, for example). The question is whether Congress has the power to impose the individual mandate under the Commerce Clause, which gives it the power to regulate interstate commerce. If the individual mandate does in fact regulate interstate commerce, then it’s fine unless it violates some other part of the Constitution.
Continue reading “What’s Liberty Got To Do With It?” →
By James Kwak
This week’s Atlantic column is my somewhat belated response to Judge Jed Rakoff’s latest SEC takedown, this time rejecting a proposed settlement with Citigroup over a CDO-squared that the bank’s structuring desk created solely so that its trading desk could short it. I think Rakoff has identified the heart of the issue (the SEC’s settlements are unlikely to change bank behavior, so what’s the point?) but he’s really pointing to a problem that someone else is going to have to fix: we need either a stronger SEC or stronger laws. I’d like to see an aggressive, powerful SEC that can deter banks from breaking the law, but we don’t have one now.
By James Kwak
A number of friends have asked me what I thought about David Segal’s article in the Times a couple weeks ago on law schools, so I thought I would share my thoughts here. The short answer is that I thought it was pretty silly.
I admit that law schools aren’t perfect. The simple fact that many (no one really knows how many) law school graduates can’t find jobs as lawyers is a problem. Now, it’s not obvious that that’s the fault of law schools as a group: when you pile a severe recession on top of an ongoing shift among law firms away from first-year associates and toward contract lawyers, the number of entry-level jobs is going to go down, and no matter how good a job the law schools do, that isn’t going to increase the number of jobs. Furthermore, you could make exactly the same criticism about all of higher education: it leaves people with large debts, and many don’t get jobs; imagine the article you could write about humanities Ph.D. programs! Still, Segal’s earlier article pointed out some of the ways in which rankings pressure has pushed some law schools to be less than candid about their graduates’ job prospects, which can’t be good. (And people like making fun of anything that has to do with lawyers. It comes with the territory.)
Continue reading “Thoughts on Law School” →
By James Kwak
Yes, I have said some critical things about Posner in the past, usually about his penchant for abstract theoretical arguments that presume perfectly functioning markets. But I’m happy to say we can make common cause on an issue of much greater importance: the Bluebook.
The Bluebook is the 511-page “uniform system of citation” that is prescribed by — well, actually, by the editors of the main student law reviews at Columbia, Harvard, Penn, and Yale — and enforced by the student editors of law reviews (almost) everywhere. But it is not enforced by the courts, whose citation systems vary from jurisdiction to jurisdiction and are not effectively enforced by anyone, anyway. Posner calls it “a monstrous growth, remote from the functional need for legal citation forms, that serves obscure needs of the legal culture and its student subculture.”
Continue reading “Richard Posner Is My New Hero” →
By James Kwak
Bob Lawless points me to this 2006 blog post by Elizabeth Warren. Warren describes a first-year contracts class on the case that upheld a fine-print forum selection clause (a clause saying that if you want to sue us, you have to sue us in X jurisdiction–Florida, in this case) on the back of a cruise ship ticket.
Warren’s entire class (Harvard, let me say for the record) insists that, as a factual matter, this decision is good for consumers because . . . well, regular readers of this blog should be able to fill in stock Mickey Mouse economistic hand-waving as well as any first-year law school student. Of course! Forcing people to sue in Florida (or to accept binding arbitration in the forum of the company’s choice) deters frivolous lawsuits and lowers costs for the company, and it can pass those savings onto consumers. Why does it pass those savings onto consumers instead of putting them into shareholders’ (or managers’) pockets? Because in a perfect competitive market, if Alpha Cruise Lines doesn’t, then Beta Cruise Lines will, and Beta will underprice Alpha, . . . Consumers will read the fine print and can make an informed choice between the lower price with the forum selection clause and the higher price without the forum selection clause.
Continue reading “Yet Another Reason to Like Elizabeth Warren” →
By James Kwak
Last November, we criticized a decision by the Court of Appeals for the Seventh Circuit in Jones v. Harris Associates in which Judge Frank Easterbrook wrote that mutual fund companies can charge their mutual funds whatever they can get away with (assuming disclosure and absent fraud), because prices are set by The Market. The case was remarkable because of a dissent by Judge Richard Posner, part of his recent (partial) disavowal of his earlier free market views, arguing that markets could not be trusted to set mutual fund fees. However, we predicted that the Supreme Court would pass up the opportunity to strike a blow on behalf of mutual fund investors and against excessive mutual fund fees:
“It can take the easy way out and resolve the case on the sole question of what ‘fiduciary duty’ means. Or it could limit itself to deciding what standard should be used in reviewing mutual fund fees and then tell the 7th Circuit to hear the case again. Most likely it will either sign off on the efficient-markets myth or dodge the question in one of these ways.”
We were partially right; technically speaking, the Court (opinion here) simply clarified the standard to be used when assessing mutual fund fees. Substantively speaking, however, it went a bit further. As Jennifer Taub explains, not only did it strike down Easterbrook’s bit of outdated free market theory, it also held that courts should compare the fees that a mutual fund company charges its captive mutual funds and those it charges institutional clients who can negotiate fees directly. In Jones v. Harris Associates, Harris Associates was charging its captive mutual funds fees that were more than double those it charged institutional asset management clients.
It still doesn’t look that great for the plaintiffs–mutual fund investors who claim they were charged excessive fees. The district court that first heard the case found that, under the existing Gartenberg standard, the plaintiffs had no case. The Supreme Court in its opinion said that it was reaffirming Gartenberg, but as Taub and William Birdthistle have pointed out, it really was modifying Gartenberg slightly in a pro-plaintiff way. So what happens now is that the case goes back to the Seventh Circuit to deal with the case in a manner consistent with the Supreme Court ruling (and I think the Seventh Circuit could hand it back to the district court). But it’s still a small step.
By James Kwak
As many of you know, I am a law student. The law is a fascinating subject . . . if you are fascinated by the art of making fine distinctions that most people think are silly. So I thought that the subject of John Yoo and the torture memos might be good material for a good primer on how lawyers think.
The procedural facts are that the Justice Department’s Office of Professional Responsibility wrote a report severely criticizing John Yoo and Jay Bybee for various ethical lapses. Associate Deputy Attorney General David Margolis, however, decided not to take further action against Yoo and Bybee.
Continue reading “Introduction to Legal Reasoning” →
This guest post was contributed by Dan Geldon, a fellow at the Roosevelt Institute. He is a former counsel at the Congressional Oversight Panel and a graduate of Harvard Law School.
Over the past year, there has been much discussion about how the financial crisis exposed weaknesses in free-market theory. What has attracted less discussion is the extent to which the high priests of free-market theory themselves destroyed meaningful contracts and other bedrocks of functioning markets and, in the process, created the conditions for the theory’s weaknesses to emerge.
The story begins before Wall Street’s capture of Washington in the 1980s and 1990s and the deregulatory push that began around the same time. In many ways, it started in 1944.
Continue reading “How Supposed Free-Market Theorists Destroyed Free-Market Theory” →
Let’s hope this gets laughed out of consideration. According to the New York Times, the Securities Industry and Financial Markets Association is considering a lawsuit on the grounds that “a tax so narrowly focused would penalize a specific group.” The Times articles doesn’t use the words, but I’m guessing they are thinking of claiming that it is a “bill of attainder”–an act of Congress that punishes specific people for alleged wrongdoing, without a judicial process–which is specifically prohibited by the Constitution.
But even leaving aside the fact that the Supreme Court has rarely overturned anything as a bill of attainder, there are not one, but two barriers in the way. The first is that the original TARP legislation mandated that the government had to recover the costs of TARP from the industry. The second is that the bank tax is really a (too small) tax on large banks that enjoy a too-big-to-fail subsidy from the government. And since the banks enjoy an implicit government guarantee, they should pay a fee for it (in this case, a mere fifteen basis points on uninsured liabilities), both to defray the costs of future bailouts and to (very partially) level the playing field relative to smaller banks without government guarantees. For political reasons, the administration is trying to dress the tax up as punishment for Wall Street, which begins to sound like a bill of attainder. But under the covers, it’s simply sound regulatory policy (though, again, too small).
Update: Greg Mankiw thinks that “on the economic merits, there may be a case for the bank tax” as a means of offsetting the implicit government subsidy for TBTF banks. “It certainly won’t be perfect. But it is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.”
By James Kwak
If I ever go to another school, you should run away from it as fast as you can. That is the practical implication of Felix Salmon’s post a few days ago rounding up arguments for why you should not get a Ph.D. in the humanities or go to law school.
Thomas Benton’s article, “Graduate School in the Humanities: Just Don’t Go,” nails the basic reasons why I went to UC Berkeley nineteen years ago: excitement in the subject, a history of high grades, the comforting structure of academia, romanticization of university life, and no practical application of academic skills. (See the six bullets halfway down the article.) When I left Berkeley in 1997, I could not get an academic job that I wanted … and the rest is history, I guess. If you do get a Ph.D. in the humanities these days, the numbers are even more heavily against you than they were then. First, American universities as a whole are shifting from tenure-track jobs to untenured adjunct positions; second, within universities, the jobs are shifting from the humanities into vocational fields like accounting and nursing. The ongoing bloodbath in state finances is only making things worse, since most of the good universities in the country are public.
Continue reading “Leading Indicator of Me” →
Felix Salmon has been helping popularize Paul Collier’s idea of bankslaughter. (No, it’s not what you wish it were.) The idea is that there would be a crime called bankslaughter, or “managing a bank irresponsibly.” If a bank blows up, there could be a criminal investigation to determine if the bank managers behaved recklessly (more on that term later); if so, they would be convicted. The analogy is to manslaughter, which is actually a family of crimes; Collier probably means criminally negligent homicide, or causing death through negligent or reckless (more on those terms later) behavior.
Not surprisingly, the conservatives are not happy about this, even though it seems to conform to the conservative principle that people should bear responsibility for the consequences of their actions. (Or maybe that only applies if you are a pregnant teenager.) Salmon cites John Carney, who calls bankslaughter “the worst idea of the week.”
Continue reading “Bankslaughter, Tort Law, and Optimal Deterrence” →
Paul Krugman is generally credited with coining the term “fifty little Hoovers” to refer to our state governments and the current economic crisis. The macroeconomics textbook says that when a recession hits, the government should implement expansionary policy, whether monetary – making cheap money available – or fiscal – borrowing money and spending it to compensate for falling private-sector demand. However, states have no monetary policy, since they don’t control the money supply, and they generally can’t engage in expansionary fiscal policy, because most have made it prohibitively difficult to borrow money and go into deficit. So in a recession, states tend to cut spending and raise taxes, which only compound the effect of a recession. Since most states’ fiscal years end on June 30, some of the effects of this belt-tightening should be hitting right about now.
One thing that states spend money on, but that people generally don’t think about, is legal services for poor people. I think about this because I am spending the summer working (for free) for a legal services provider in Massachusetts. In Massachusetts, like in many states, funding for legal services for the poor comes mainly from two sources: (a) interest on lawyers’ trust accounts (IOLTA) – that is, the short-term interest paid on money that your lawyer is holding for you for some reason; and (b) direct appropriations in the state budget.
Continue reading “Little Hoovers, Part-Time Employment, and Me” →
A few readers have asked us for our thoughts on Richard Posner’s recent writings on the economic crisis, beginning with his new book and continuing with his epic blogging for The Atlantic. (To read his account from the beginning you need to find the well-hidden Archives section in the right-hand sidebar of the blog.) The challenge is that every time I try to catch up Posner has written another couple of thousand words. So I’m going to have to do this in pieces.
Posner is a giant of legal scholarship and in the theoretical branch of law and economics, which (judging from my own education) is the dominant paradigm for several fields of law, including torts and contracts. To simplify his importance greatly, he helped shift the legal profession, including both the academy and the courts, from a focus on justice – law should redress the harm suffered by the victim – to a focus on incentives – law should create incentives that will produce the greatest good for society in the future. For example, in general, firms should only be held liable for injuries they negligently cause if the expected total damages they cause exceed the cost of preventing those injuries; if we require firms to conduct inspections whose cost exceeds the cost of the injuries that those inspections would prevent, then we are reducing aggregate utility.
As you might guess, Posner is also generally a pragmatic conservative, who thinks that free markets usually lead to better societal outcomes than government intervention, and that public policy should focus on making sure that independent rational actors have the right incentives to behave in ways that will benefit society as a whole. Not surprisingly, his account of the crisis focuses not on the actions of people in the financial industry but on the failings of people in government.
Continue reading “Posner, Part 1: Two Conceptions of Blame” →
My colleague Ilya Podolyako is back with a comment on the Geither Plan to buy toxic assets, as well as an update to his previous post about the constitutionality of government takeovers of private property. He discusses in particular the possibility (also suggested by one of our readers) that the government could “seize” toxic assets and pay “just compensation,” even in the absence of a bankruptcy or a takeover. Ilya is a 3rd-year student at the Yale Law School and, among other things, an executive editor of the Yale Journal on Regulation. The post below is by Ilya.
PPIP for Legacy Loans = Free Put Options for Banks
I finally got a chance to read through the PPIP plan in detail. I noticed one curious point: under the program as announced, auctions for the legacy loans do not appear to be binding on the contributing entity.
The Process for Purchasing Assets Through The Legacy Loans Program: Purchasing assets in the Legacy Loans Program will occur through the following process:
. . .
Pools Are Auctioned Off to the Highest Bidder: The FDIC will conduct an auction for these pools of loans. The highest bidder will have access to the Public-Private Investment Program to fund 50 percent of the equity requirement of their purchase.
Financing Is Provided Through FDIC Guarantee: If the seller accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee.
This is quite odd, since, if I read it correctly, it turns the entirety of the program into a put option for participating banks. That is, they could identify certain assets, put them up for auction seemingly risk-free, check the result, and reject anything below their internal valuation without any further capital contribution.
Continue reading “Gaming the Legacy Loan Auctions” →