Abstract
Whereas the analysis of finance rests on rationality, its lived experience is one of euphorias and crashes that can have devastating consequences. This chapter discusses the evidence of crashes and the safeguards that the legal system uses, especially in light of the experience with the financial crisis of 2008, which circumvented the safety measures that had been designed largely in response to the Great Depression.
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Notes
- 1.
Henry M. Paulson Jr., Five Years Later: On the Brink—The New Prologue: A Look Back Five Years Later on What Happened, Why It Did, and Could It Happen Again? 40 (2013) (“Unemployment levels that topped out at 10 percent … could easily have risen to 25 percent”).
- 2.
See generally Ben S. Bernanke, The Federal Reserve and the Financial Crisis 78 (Princeton Univ. Press ed., 2013) (“The Fed provided cash or short-term lending to [brokerage houses] … Commercial paper borrowers received assistance, as did money market funds… [T]he Fed created some new liquidity programs to help get [the asset backed securities market] started again, which we were successful in doing.”); Hal S. Scott, Connectedness and Contagion: Protecting the Financial System from Panics 75–78 and Table 7.2 (2016) (listing the responses after the run on money market funds).
- 3.
Manuel Funke, Moritz Schularick & Christoph Trebesch, Going to Extremes: Politics After Financial Crises, 1870–2014, 88 European Econ. Rev. 227 (2016) (finding recessions lead voters toward the extremes and toward anti-immigration and anti-minority parties). See also Mass Politics in Tough Times: Opinions, Votes and Protest in the Great Recession (Nancy Bermeo & Larry M. Bartels, eds., Oxford U.P. 2014) (explaining why voters did not move to extremes more); Larry M. Bartels, Political Effects of the Great Recession , 650 Annals Am. Academy Pol. and Soc. Sci. 47, 48, 68 (Nov. 2013) (post-recession rise of right-wing populism, plus cultural and racial tensions).
- 4.
See, e.g., Alan de Bromhead, Barry Eichengreen, & Kevin H. O’Rourke, Political Extremism in the 1920s and 1930s: Do German Lessons Generalize?, 73 J. of Econ. Hist. 371 (2013) (“confirm[ing] the existence of a link between political extremism and economic hard times”). See generally Ian Kershaw, Hitler: 1889–1936 Hubris (2000).
- 5.
One may wonder how such a business may become insolvent at times of economic health but the paths to insolvency are many. Perhaps an accident occurred that reduced the business’s output or imposed an unmanageable obligation. For example, a facility might succumb to an uninsured calamity or a massive tort liability might hit the business. Then, the income stream of the business cannot service its obligations and insolvency arises despite the productivity of the business and the absence of a financial crisis.
- 6.
Indeed, economic systems have performed acceptably well without reorganization law. The primary example in the United States itself before the addition of the reorganization chapter to the old Bankruptcy Act in 1933. Railroads would become insolvent and would get reorganized through foreclosure sales in equity receivership to entities formed by their creditors. Professor Per Strömberg finds the performance of a system without reorganization law in Sweden satisfactory; see Per Strömberg, Conflicts of Interest and Market Illiquidity in Bankruptcy Auctions: Theory and Tests, 55 J. Fin. 2641 (2000). For a thorough assessment of the new reorganization chapters in the UK, Germany and Sweden, see David Smith & Per Strömberg, Maximizing the Value of Distressed Assets: Bankruptcy Law and the Efficient Reorganization of Firms, in Systemic Financial Crises: Containment and Resolution 232 et seq. (Patrick Honohan & Luc Laeven, eds., 2005).
- 7.
See, e.g., Patricia K. Smith, Welfare as a Cause of Poverty: A Time Series Analysis, 75 Pub. Choice 157, 158, 167–68 (1993) (outlining the work disincentive hypothesis and finding support).
- 8.
See, e.g., Yoonyoung Cho, David Robalino & Samantha Watson, Supporting Self-Employment and Small-Scale Entrepreneurship: Potential Programs to Improve Livelihoods for Vulnerable Workers, 5 IZA J. Lab. Pol. 1, 13, 23 (stating that programs that help the self-employed and small-scale entrepreneurs—the two most common types of workers—will help improve livelihoods); see also Indep. Evaluation Group, Social Safety Nets: An Evaluation of World Bank Support, 2000–2010, 79 (2010), https://openknowledge.worldbank.org/bitstream/handle/10986/21337/672860WP0Box3600ssn0full0evaluation.pdf [perma.cc/Y6LW-PL84] (“Continued effort is needed to develop [social safety nets] that are flexible and able to respond to shocks; to build country institutional capacity to address various sources of poverty, risk, and vulnerability…”).
- 9.
I have expanded on how securities law facilitates a virtuous cycle from accurate prices to cheaper trading and greater market liquidity, which begets accurate prices; see Nicholas L. Georgakopoulos, The Logic of Securities Law (2017).
- 10.
See generally Ben S. Bernanke, The Federal Reserve and the Financial Crisis (2013); see also Ivana Kottasova, $9 Trillion and Counting: How Central Banks Are Still Flooding the World with Money, CNN Money (Sept. 9, 2016), http://money.cnn.com/2016/09/08/news/economy/central-banks-printed-nine-trillion/index.html [perma.cc/S8VH-6QZ7] (stating that the Federal Reserve injected $3.9 trillion dollars over the course of three rounds of asset buying between November 2008 and October 2014); see also Frederic S. Mishkin, The Financial Crisis and the Federal Reserve , 24 NBER Macroeconomics Annual 495, 502 (2009) (explaining the Troubled Asset Relief Program after the Lehman bankruptcy and the AIG bailout).
- 11.
See Consumer Price Index for All Urban Consumers: All Items, Fed. Res. Bank of St. Louis, https://fred.stlouisfed.org/series/CPIAUCSL (visited Apr. 11, 2018) [perma.cc/DDU2-GUT6] (showing the consumer price index dropping from 218 in July of 2008 to 211 in December of 2008; being flat in 2010; and experiencing occasional small drops in 2012–2017). See also Simon Gilchrist, Raphael Shoenle, Jae W. Sim & Egon Zakrajsek, Inflation Dynamics During the Financial Crisis 1–3 (Fin. and Econ. Discussion Series, Federal Reserve Board, Working Paper No. 2015-012), https://www.federalreserve.gov/econresdata/feds/2015/files/2015012pap.pdf [perma.cc/4LAP-9CT9].
- 12.
See, e.g., Golden Pac. Bancorp v. United States, 15 F.3d 1066, 1074 (Fed. Cir. 1994) (rejecting takings arguments against an FDIC takeover).
- 13.
Technically speaking, the money market mutual funds that lend to businesses are called prime money market mutual funds, and only those funds experienced the run. Rather than directly invest in government securities, the withdrawn funds were redirected to money market mutual funds that invest exclusively in government securities. See Lawrence Schmidt, Allan Timmermann & Russ Wermers, Runs on Money Market Mutual Funds, 106 Am. Econ. Rev. 2625 (2016).
- 14.
See Nicholas L. Georgakopoulos, The Logic of Securities Law 157–58 (2017); Simon H. Kwan, Financial Crisis and Bank Lending (Fed. Reserve Bank of S. F., Working Paper No. 2010-11, 2010), https://www.frbsf.org/economic-research/files/wp10-11bk.pdf.
- 15.
See Footnote 2, above.
- 16.
Oversight of Dodd-Frank Act Implementation, Fin. Serv.’s Committee, https://financialservices.house.gov/dodd-frank/ [perma.cc/BB65-JKE2] (last visited Mar. 3, 2018).
- 17.
See 12 U.S.C § 5321(a) (2012) (establishing the FSOC); 12 U.S.C. § 5322(a)(2)(J) (giving the FSOC the power to identify systemically important financial institutions); 12 U.S.C. § 5323(a) (providing authority to require supervision and regulation of nonbank financial companies in material financial distress); 12 U.S.C. § 5384 (providing necessary authority to liquidate failing financial companies); 12 U.S.C. § 343 (broad-based lending authority by the Fed in “unusual and exigent circumstances”).
- 18.
12 U.S.C. § 343 (2012); see also Press Release, Fed. Reserve Bd. Approves Final Rule Specifying its Procedures for Emergency Lending Under Section 13(3) of the Fed. Reserve Act, Bd. of Governors of the Fed. Reserve Sys. (Nov. 30, 2015), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20151130a.htm.
- 19.
I have taken this position previously. See Nicholas L. Georgakopoulos, The Logic of Securities Law 172 (2017); Nicholas L. Georgakopoulos, Financial Armageddon Routs Law Again, 14 U.C. Davis Bus. L. J. 1, 39 (2013).
- 20.
Former Treasury Secretary Tim Geithner has this concern, see Justin Baer & Ryan Tracy, Ten Years After the Bear Stearns Bailout, Nobody Thinks It Would Happen Again, Wall Street J., https://www.wsj.com/articles/ten-years-after-the-bear-stearns-bailout-nobody-thinks-it-would-happen-again-1520959233 [perma.cc/4SZV-CJ4A] (last updated Mar. 13, 2018).
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Georgakopoulos, N.L. (2018). Financial Crisis Contagion. In: Illustrating Finance Policy with Mathematica. Quantitative Perspectives on Behavioral Economics and Finance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-95372-4_11
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