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NY Reviw of Books, FEBRUARY 13, 2020 ISSUE
How ‘Big Law’ Makes Big Money
by Adam Tooze
The Code of Capital: How the Law Creates Wealth and Inequality
by Katharina Pistor
Princeton University Press, 297 pp., $29.95
“There is an estate in the realm more powerful than either your Lordship
or the other House of Parliament,” one Lord Campbell proclaimed to the
peers in the House of Lords, in 1851, “and that [is] the country
solicitors.” It was the lawyers, in other words, who kept England’s
landed elite so very, well, elite: who shielded and extended the wealth
of the landowners, even granting them legal protection against their own
creditors. How did they pull off this trick? Through a nimble tangle of
contracts, carefully and complicatedly applied, as Katharina Pistor
explains in her lucid new book, The Code of Capital: by mixing “modern
notions of individual property rights with feudalist restrictions on
alienability”; by employing trusts “to protect family estates, but then
[turning] around and [using] the trust again to set aside assets for
creditors so that they would roll over the debt of the life tenant one
more time”; and by settling the rights to the estate among family
members in line for inheritance. Solicitors maximized their clients’
profits and worth through strategic applications of the central
institutions at their disposal: “contract, property, collateral, trust,
corporate, and bankruptcy law,” what Pistor calls an “empire of law.”
The landowners themselves may not have understood this morass of legal
relationships, this web, in Pistor’s words, of “claims and
counterclaims, rights and restrictions on these rights.” No matter: by
lawyers’ legal codifications, their wealth was increasing. The sort of
legal logic applied in nineteenth-century England grows only more
complicated, and more profit-generating, when the asset in question is
not a hectare of country land but stocks and bonds and shares—when an
entire organization is coded as a legal person (who can own assets and
who can sue) through incorporation. The very form of a corporation, “by
encouraging risk taking, by broadening the investor base and thereby
mobilizing funding for investments, and by creating the conditions for
deep and liquid markets for the shares and bonds that the corporation
issues,” maximizes profit. And though today we live in a nominally
democratic society, Pistor argues that a “feudal calculus” extends to
our age: superior legal coding—that is, fancy private lawyers. Using the
central institutions of private law, they make certain assets more
valuable, and more likely to create value. “For centuries,” she writes,
private attorneys have molded and adapted these legal modules to a
changing roster of assets and have thereby enhanced their clients’
wealth. And states have supported the coding of capital by offering
their coercive law powers to enforce the legal rights that have been
bestowed on capital.
Corporate law is “no longer primarily a legal vehicle for producing
goods or offering services but has been transformed into a virtual
capital mint.” Nowhere is this more true than in financial services
corporations.
In 2008, for example, when Lehman Brothers investment bank failed, its
legal structure was byzantine. It consisted of a parent holding company
with 209 registered subsidiaries spread over twenty-six jurisdictions.
This structure, constructed by some of the sharpest legal minds on Wall
Street, was a machine designed to minimize Lehman’s regulatory burden by
placing assets in locations with lax oversight, while still maintaining
control over those assets from its managerial base in Manhattan. Lehman
took huge but carefully hidden risks and stretched its collateral
wafer-thin. When the going was good, it was immensely profitable. It
also turned out to be dangerous—allowing Lehman to take on giant levels
of leverage that, when the subprime mortgage market collapsed and
liquidity dried up in money markets, threatened not just the firm and
its shareholders, but the entire financial system.
Since the 1960s lawyers associated with the school of “law and
economics,” developed at the University of Chicago by Aaron Director and
Ronald Coase, among others, have been explaining how legal devices are
invented to enable transactions to be conducted more efficiently. The
basic line of argument is clever but monotonous. In case after case, the
true function of a legal construction is shown to be that it aligns
incentives of various economic actors—businesses, consumers, workers,
and governments—in efficient and productive ways. For example, although
granting property rights secures a kind of monopoly for owners, it
encourages investment because legal owners can expect to reap the
long-run benefit of up-front expenditures.
Clarifying the boundaries of property rights prevents arguments over who
owns what and thereby reduces transaction costs. The hidden logic of
Lehman’s complex legal structure, according to a law and economics
analysis, was that it allowed assets to be assigned to separate
entities, thus enabling creditors to focus their attention on particular
components of the business, thus achieving a better balance of risk and
return.
The analysis of property rights also informs grand historical accounts
of the rise and fall of nations. According to a long line of Whiggish
authors, regimes that recognize encompassing and stable property rights
will prosper. Those that succumb to the rapacious interests of
short-sighted rulers or narrow special interests will undercut the
incentives for productivity growth. They are doomed to stagnation and
ultimately to failure. According to its Western critics, even the mighty
Chinese Communist Party will have to bend to this historical logic. If
it does not establish secure private property rights and the predictable
rule of law, China’s growth will grind to a halt.
For fifty years the law and economics movement has had a huge influence
on America’s law schools. But today it faces a challenge from a new
cohort of radical legal thinkers who gather under the banner of “law and
political economy.” The “About” page of the Law and Political Economy
blog, which arose out of a seminar led by Professor Amy Kapczynski at
Yale Law School, declares, in what amounts to the cohort’s manifesto:
Our blog begins from the observation that democratic political
processes have lost control over fundamental decisions about how
resources are allocated in our society. Legal doctrines enable champions
of capital to subordinate democracy to “the free market.” We seek to
develop a response by mapping how legal rules concentrate economic and
political power amongst dominant social groups, and simultaneously build
and expand modes of legal thinking which embed the economy in social life.
There is a similarity between this moment of agitation within legal
academia and earlier moments in American history, such as the
progressive era, when antitrust laws were first passed. But today’s
critique of law has multiple sources beyond the muckraking tradition,
and its point of attack is deeper. What is ultimately at stake is the
alignment between a rights-based model of political and social
organization and the highly unequal political economy that the crisis of
2008 so starkly exposed.
The Code of Capital brings together the ferment in American law schools
and the more broad-based continental critical tradition, with concerns
derived from Thomas Piketty’s history of inequality and recent thinking
within so-called heterodox economics about the unstable nature of
financial capitalism. The result is nothing less than a crisis theory of
law. Law as it currently functions is, for Pistor, constitutive of the
order that creates and perpetuates inequality, opacity, dysfunction, and
crisis, and ultimately puts at risk the legitimacy of the rule of law as
such.
Her rethinking of the purpose of law starts from the ground up. In the
liberal account of property rights, the crucial question is how far law
and the courts can protect private property against the capricious,
self-interested, and short-sighted acts of the government. Individual
property must be protected, in this view, not only because of the
inalienable right to enjoy what one owns without fear of damage or
theft, but also because if there were no guarantee of this right,
economic progress would be impossible. Few would make an investment in a
business that couldn’t seek redress for major acts of vandalism or larceny.
In Pistor’s reading, the basic question is the reverse. What is decisive
is which private claims to property governments have been willing to
underwrite with the force of the law and what consequences those
decisions have for wealth creation and distribution and the development
of the economy at large.
This shift in perspective also implies a reconceptualization of capital.
Whereas to a conventional understanding, capital is most readily
conceived as a physical thing—a steel mill, for instance—that must be
shielded against grasping hands, Pistor insists, quoting the University
of Chicago historian Jonathan Levy, that capital is a “legal property
assigned a pecuniary value in expectation of a likely future pecuniary
income.” What turns a steel mill from a physical unit into a claim on a
likely flow of cash income are laws, backed by the force of the state,
establishing ownership of the mill and the means by which its products
can be sold for profit.
For Pistor, as for others in the critical tradition, the entanglement of
law, power, and property goes back to the moment that Karl Marx called
“primitive accumulation.” Beginning in the sixteenth century in Northern
Europe, land previously used in common was enclosed and made into the
basis for a new, market-based agricultural system. As the Oxford legal
comparativist Bernard Rudden put it:
The traditional concepts of the common law of property were created for
and by the ruling classes at a time when the bulk of their capital was
land. Nowadays the great wealth lies in stocks, shares, bonds and the
like, and is not just movable but mobile, crossing oceans at the touch
of a key-pad…. In terms of legal theory and technique, however, there
has been a profound if little discussed evolution by which the concepts
originally devised for real property have been detached from their
original object, only to survive and flourish as a means of handling
abstract value. The feudal calculus lives and breeds, but its habitat is
wealth not land.
The enduring entanglement of modern property law with this original
“feudal calculus” is a thread running throughout Pistor’s book. Most
importantly, it informs her skepticism about the alignment that is
commonly assumed in liberal grand narratives among progress, property
rights, and the rule of law (understood in the sense of the universal
applicability of general rules, such that no one class received
preferential treatment by the state). There have been revolutionary
moments, Pistor concedes, in which property owners did line up behind
the demand for general rights—the American and French Revolutions being
cases in point. But once their property was established, owners became,
like their feudal predecessors, defenders of privilege. They have
advocated not universal binding rules, but what Max Weber called a
“modern particularism,” finding ways around the law when it suited their
interests.
In the twenty-first century, examples of this modern particularism are
rife. Pistor describes, for instance, the exceptions from general
bankruptcy rules negotiated by the derivatives industry. In normal
bankruptcy cases, secured creditors can claim access to their collateral
first, and unsecured creditors have to divide what remains of the
company or estate. For fast-moving financial transactions, that
procedure is too cumbersome, so the collateral pledged in derivatives
deals is granted an exemption from the usual queue of claims. In cases
of bankruptcy, it is transferred directly to the counterparty, leaving
unsecured creditors empty-handed. Another example would be the right
claimed by foreign investors to challenge the normal operation of
national courts in their host countries. Or the deals negotiated
annually with the authorities by large taxpayers over what their tax
bill will actually be. Or the haggling between regulators and banks over
whether they meet the criteria laid down by the Dodd-Frank legislation
of 2010.
The result is a legal order that is relentlessly insistent on the
priority of rights and of property rights above all, and yet shot
through with exceptions and reservations. Indeed, in the unwinding of
Lehman’s derivatives holdings, it turned out that so many creditors
could claim exceptions to the normal bankruptcy rules that the value of
the privileges themselves was put in question.
The modern network of powerful property owners is knit by the clique of
“big law” firms that operate around the world, above all from bases in
London and New York. The legal codes that they prefer are the English
common law and the law of the state of New York. What lets them choose
their code, regardless of where their operations are legally domiciled,
are so-called conflict-of-law rules that allow the parties to a contract
to choose the legal code by which they wish to be governed. The standard
framework contract, or “Master Agreement,” devised by the International
Swaps and Derivatives Association to govern trades running into the
hundreds of trillions of dollars, specifies that the parties should
agree to be bound either by English law or the law of New York State.
For tricky issues like intellectual property, which is granted through a
patent by a particular government, special treaties have been arranged
in order to protect patents abroad.
Across this patchwork empire of law, the same tools (which Pistor calls
“modules”) are employed again and again to “code” property and assets,
such that they are protected as sources of private wealth and future
income. The four principles of the coding procedure that Pistor
identifies are priority, durability, universality, and convertibility.
The priority of claims regulated by law is what ultimately confers
ownership: the priority of my claim to an asset allows me to remove an
asset from the common pool and privatize it. Durability gives assets a
life that may extend beyond the biological lifespan of their owners.
Trusts and corporations are classic modes of ensuring legal longevity.
Universality provides that contracts between two parties are recognized
by erga omnes, i.e., all others. It is a claim that presupposes a
third-party guarantor in case of disputes over the agreement; in the
last instance, the state can compel the parties to abide by its
interpretation of the contract. Finally, convertibility is the most
attractive link in a chain that starts with the transferability of
property. If it can be bought and sold between private parties, property
can circulate. Once it circulates widely enough, it can serve as a means
of payment. But the ultimate means of payment is state-issued cash.
Convertibility is the privilege of certain classes of preferred
financial assets—such as highly rated debts—that ensures they may be
exchanged for cash at close to face value.
The modules are abstract and capable of reinterpretation. Lawyers are
creative, and contracts are incomplete. They always fail to capture some
unexpected feature of reality. So there is plenty of room both for
innovation and for confusion and dispute. But that by itself is not
enough to explain the recurrence of capitalist crises. For that we need
to add a further dimension: how law facilitates the gigantic speculative
dynamic of modern finance.
As Pistor puts it, “Debt, the private money that has fueled capitalism
since its inception, is coded in law and ultimately relies on the state
to back it up,” by way of the courts under normal circumstances and
through bailouts if a debtor is too big to fail:
The history of debt finance can therefore be retold as a story about
how claims to future pay have been coded in law to ensure their
convertibility into state money on demand, without suffering serious
loss…. By dressing private debt in the modules of the legal code of
capital, it is possible to mask the liquidity risk for a while, but not
forever. Whenever investors realize that, contrary to their
expectations, they may not be able to convert their debt assets into
cash, they head for the exit; and if many do so simultaneously, this
will precipitate a financial crisis.
Note that the law does not just constitute and codify claims to
property. In Pistor’s reading, the function of law in finance is to
sustain a fiction. It is to “mask,” or “dress up” and “garnish” claims
by packaging debt-ridden assets into products such as derivatives. And
she roots this in a familiar impulse: “The dream to create something
from nothing is as old as mankind. Alchemists have long searched for
recipes….” But it is not just private creators of credit who succumb to
the lure of debt alchemy. States too create purchasing power by
monetizing debt. As Pistor points out, the difference is that “states at
least have the power to impose obligations on their citizens to make
good on these promises.” States can impose taxes to generate the revenue
necessary to service their debts. By contrast, “private parties do not
possess such powers…. They imagine fantastic returns in the future, but
in fact will have to obtain new loans to cover old debts”
Lawyers, therefore, sustain a fiction by dressing up claims and placing
them in opaque asset-backed legal entities and applying an alphabet soup
of labels—SPVs, MBS, CDOs. But, Pistor insists, there is a basic
constraint on this exercise in the nature of the assets that underlie
such entities: “At the other end of the deal, there are still the same
little old houses, which their owners can barely afford and that may not
hold their value once the funding machine that helps fuel prices in real
estate dries up.” The fantasy that a subprime mortgage could be turned
into a AAA-rated security collapses, just like the alchemical promise to
turn lead into gold.
Pistor thus lays out a double indictment of the law. On the one hand,
the law codes the original violence of enclosure, such that something
that was everyone’s becomes one person’s legally protected private
property in perpetuity. On the other hand, the law is the conjurer of a
delusion. By creating securities out of debt, the law preys on our
desire to believe that something is ours that is not real at all, that
value can be created ex nihilo.
This is a powerful polemic. But is it enough to deliver on Pistor’s
subtitle, to account for the structure of wealth and inequality in
modern society? What about the more routine drivers of growth and
inequality, such as the unequal rewards to labor and capital and the
extreme divergence between different types of managerial and routine
labor? Once we pose the question this way, what is remarkable is how
little space Pistor gives to what was once the central terrain of
critiques of capitalism, namely production, labor, and accumulation.
Once upon a time, if the question was how law created wealth and
inequality, the focus would have been on labor law and how the state and
the courts systematically favor the employer over the employed. But the
only mention that labor law receives in The Code of Capital is a brief
discussion of the role of noncompete clauses in distorting competition
in Silicon Valley.
In seeking to mark her position off against Marxist arguments that the
capitalist state creates inequality by sanctioning “primitive
accumulation” and exploitative labor practices, Pistor claims that her
focus on the process through which private law is used to code capital
allows her to “explain the political economy of capitalism without
having to construct class identities, as Marxists feel compelled to do.”
But any Marxist would surely reply that this is a sleight of hand. If
one confines the thrust of one’s analysis to issues like derivatives
regulation and intellectual property, class identities are, indeed,
unlikely to play an important part. What is at stake in those deals is
the distribution of surplus within the capitalist class. When that goes
wrong, it can have a disastrous impact on the entire economic system. As
we saw in 2008, it can even cause an enormous financial heart attack.
But no one ever claimed that markets for interbank lending were the main
arena in which the line between the haves and the have-nots is drawn. In
the modern world, in which so much production has been outsourced, the
main arena for class conflict in the classic sense is probably in the
factories of East Asia, and the function of law in that struggle is far
from obvious. Where Pistor does address important areas of
distributional struggle, notably with regard to land enclosure, she
unhesitatingly invokes distinctions between landlords and
peasants—precisely the kind of class categories she claims to be able to
do without. The violence of that moment of early modern enclosure and
expropriation no doubt echoes down to the present, but that can explain
only part of modern-day inequality.
The closest that Pistor comes in The Code of Capital to analyzing what
might be called a site of production is in her interesting discussion of
intellectual property. Once again, she gives us fascinating insights
into the role of legal lobbyists in the construction of the global
intellectual property rights regime. The Agreement on Trade-Related
Aspects of Intellectual Property Rights (TRIPS) secures extraordinary
protections for large Western firms in their dealings all over the
world, on the pain of sanctions by the United States.
In Pistor’s reading, it is a classic instance of “modern particularism”
writ large, the “feudal calculus” extending to the very cutting edge of
modern science, as in the case of patents on synthetic cDNA molecules.
Fittingly, her chapter title “Enclosing Nature’s Code” harks back to the
struggles that founded agrarian capitalism in early modern England. Yet
there is a subtle but crucial shift. In manipulating the patent system
and applying it to parts of the human genome, lawyers are up to their
usual tricks. They are repurposing the modules of their code to create
new capital. But what creates the opportunity for profit in this case is
neither the conquest of someone’s ancestral grazing ground nor legal
artifice of the type on display in the construction of derivatives
contracts and asset-backed securities. What creates the opportunity for
profit is a major scientific innovation, backed by the industrial
infrastructure of labs and hospitals that generate the value of the
discoveries by manufacturing and selling them.
And here the oldest defense of the law enters back in. It can hardly be
denied that the search for profit does fire a large part of research and
development, on which productivity growth across the economy depends. Of
course, that is not the only motivation for research. Pistor highlights
the explosion of scientific creativity in molecular biology since Crick
and Watson’s discovery of the double helix. And public funding on both
sides of the Atlantic helped keep the human genome in the public realm.
But precisely because the goal of this research was not profit but
scientific discovery, the human genome is hardly a typical case of
research and development. Especially given the decline of publicly
funded science, most research is now done by universities and
corporations and directed from the outset toward the generation of
profit, for which the legal protection of patents or the shroud of trade
secrecy is essential.
But Pistor waves that kind of argument aside. We have seen, after all,
how the doctrine of improvement has been implicated in the brutal
process of dispossession and enclosure all over the world. The
self-serving justifications of the pharmaceutical industry for their
excessive drug pricing have gone a long way toward discrediting the
patent system altogether. As Pistor says, we need no more such “fairy
tales” to justify the privatization of common property. That is
certainly true. But when one treats biotech patents as equivalent to
Elizabethan land enclosure and equates modern finance to alchemy, and
when one gives pride of place to these as opposed to accumulation and
labor as modes of producing and distributing wealth, one is engaged in
one’s own kind of storytelling. The question must surely be what purpose
that storytelling serves.
The work that the apologetic discourse of law and economics does in
justifying the status quo has been starkly revealed by the crises of the
last decades. In the name of efficiency, high-powered legal academia
justified both dangerous financial practices and the creation of
monopoly. If instead, like Pistor, we attribute the production and
distribution of wealth to a combination of legalized theft and an
elaborately veiled ponzi scheme that moves money around without creating
anything of real value, we are certainly speaking the language of the
left, but it is a language with a distinctly populist tinge. A true
Marxist would at this point interject that only a politics that grasps
exploitation at its root, not in the sphere of distribution but in the
sphere of production itself, can really offer any escape from prevailing
conditions of inequality. But Pistor holds Marxism at a distance both
analytically and politically. Understandably enough, she dismisses any
prospect of a Marxist revolution against capitalism. Leftist populism,
on the other hand, is enjoying a substantial vogue both in Europe and
the Americas. And perhaps the best way to read Pistor is as offering a
highly sophisticated program for a leftist economic populism.
Pistor concludes her powerful book with a list of practical policy
suggestions. Their basic aim is to make clear and visible the ultimate
dependence of private assets on public legitimation, to subject private
coding of property rights to public scrutiny, and to undercut the
monopoly of “big law” on legal coding. Specifically, she argues that
there should be a clear rule banning any further extensions of
capitalist legal privilege in legislation and treaties. There should be
obstacles put in the way of corporations choosing the jurisdiction of
greatest convenience. The role of private arbitration in settling
disputes between corporations and consumers should be curbed in order to
assert the sovereignty of state courts. Private legal arrangements that
generate large externalities—costs borne by others, such as
environmental damage—for the public should be subject to restraint. The
outsized influence of lobbyists should be redressed. Old limits on
coding capital such as the nonenforceability of purely speculative
contracts should be revived, however hard it may be to draw such a line.
These are technical suggestions. But their ultimate aim is political—to
offer an effective answer to right-wing populism. As Pistor says, in
recent years we have seen “rampant attacks on independent judiciaries
and the free press, not only in relatively young democracies, such as
Poland or Hungary, but in countries with a long tradition of democracy
and the rule of law, such as the United Kingdom and the United States.”
These, in Pistor’s view, are political responses by electorates
“desperately trying to regain control over [their] own destiny.” The
nightmare she invokes is Karl Polanyi’s diagnosis of the interwar
backlash against the predominance of capital that in his view spawned
both fascism and communism.
But the promises this right-wing populism makes of “taking back control”
are dishonest, since power usually ends up concentrated in few hands and
with little oversight from the people. The best response to the appeal
of this kind of populism, Pistor suggests, would be a real demonstration
of popular sovereignty. And what prevents that demonstration are not the
bugbears of national populists: international treaties, the EU, or an
influx of foreigners. The main limitation is capital. What is required,
therefore, is a “rolling back” of laws favorable to wealthy corporations
and individuals, and a forceful demonstration that “the power to
determine the contents of law lies ultimately with the people as the
sovereign.” That is the ultimate purpose of her technical
recommendations, which have no chance of realization without a dramatic
assertion of popular will. The proper responsibility of a reformed and
self-critical legal profession, reorganized around a new model both for
funding law schools and determining professional compensation, would be
to support this assertion of popular sovereignty. The result, Pistor
hopes, will be nothing less than a “true transformation, not an
elimination, of rights and of law.”
Pistor’s proposals are surely worthy of applause. But one is left
wondering whether her emphasis on the clash between capital and the
people, with the legal profession as the crucial mediator, does justice
to the third party in her story: the administrative state. Again and
again, the state is invoked in Pistor’s analysis as the ultimate
enforcer of the law. As she says, “Without power, law is at best
fleeting and at worst ineffective.” But as crucial as the state is to
Pistor’s account, it remains a shadowy and abstract presence, as if to
reflect a sad reality: the administrative state, particularly in the US,
has withered away in the face of decades of political and fiscal
assault, and through the insidious work of the “private coders of
capital,” their clients, and their cheerleaders in the mainstream legal
academy.
If a rebalancing of public interest and private right is essential, if
what we need is a reassertion of political sovereignty, then one of its
central prerequisites is a reconstruction of state capacity. This, too,
is a project in which the law and lawyers have a crucial part to play.
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