Momentary Lapses of Reason: The Psychophysics of Law and Behavior

Article published in the Michigan State Law Review

Authentic Happiness, Self-Knowledge and Legal Policy

This Article analyzes three questions: can, how, and should legal policy help people in their individual quests for authentic happiness. This Article adopts psychologist Martin Seligman\u27s definition of the phrase authentic happiness. This Article provides an introduction to examples of legal policies based upon empirical and experimental research in positive psychology, measures of subjective well-being, and quality of life studies

Prelude to Glass-Steagall: Abusive Securities Practices by National City Bank and Chase National Bank During the “Roaring Twenties”

From the late 1990s through 2008, the United States experienced the largest boom-and- bust cycle in its securities and housing markets since the “Roaring Twenties” and the Great Depression. Scholars have studied the events that led to the recent financial crisis and have compared those events to the causes of the Great Depression. In particular, analysts have considered whether “universal banks” – financial conglomerates that control deposit-taking banks as well as securities broker-dealers – played central roles in both crises. Congress responded to the Great Depression by adopting the Glass-Steagall Act of 1933, which outlawed first-generation universal banks and established a wall of separation between commercial banks and securities firms. During the 1980s and 1990s, regulators and courts steadily undermined Glass-Steagall, and Congress finally repealed the statute in 1999. Is it more than a coincidence that the demise of Glass-Steagall was followed by the most spectacular economic boom since the 1920s and the most serious financial and economic crisis since the 1930s? This article is part of a larger project in which I plan to examine the rise and fall of first-generation universal banks during the 1920s and 1930s and to compare their experience with the performance of second-generation universal banks during the 1990s and 2000s. As described in this article, first-generation universal banks became leading underwriters and distributors of securities in the United States during the 1920s. The preeminent universal banks of the 1920s were the two largest U.S. commercial banks – National City Bank (National City) and Chase National Bank (Chase). National City and Chase and their securities affiliates earned huge profits during the economic boom of the 1920s but suffered massive losses during the Great Depression. Both banks received bailouts from the Reconstruction Finance Corporation in December 1933. The Pecora Committee’s investigation in 1933 revealed that National City and Chase used deceptive and manipulative techniques to sell massive volumes of foreign bonds and other high-risk securities to ordinary investors and smaller financial institutions. Both banks made unsound loans to support the activities of their securities affiliates. Both banks organized trading pools to pump up the prices of their own stocks as well as the stocks of favored clients. Insiders took advantage of both banks’ securities operations to reap extraordinary financial gains. Revelations of both banks’ securities abuses and their top executives’ self-dealing triggered widespread public outrage and generated public support for enactment of the Glass-Steagall Act as well as the Securities Act of 1933 and the Securities Exchange Act of 1934. The abuses and conflicts of interest that occurred at National City and Chase illustrated the potential dangers of allowing commercial banks to affiliate with securities broker-dealers. The evidence produced by the Pecora Committee supported Glass-Steagall’s fundamental premise that universal banks created intolerable hazards that could not be resolved without dismantling the universal banking model. National City and Chase mobilized their deposits, lending resources, and retail branches to underwrite and sell high-risk securities to unsophisticated investors who trusted in both banks’ presumed soundness and investment expertise. National City and Chase exhibited pervasive conflicts of interest that caused both banks to make unsound loans to their securities affiliates, to investors who purchased securities from their affiliates, and to companies that issued securities underwritten by their affiliates. The disastrous experiences of National City and Chase demonstrated the clear dangers of allowing commercial banks to use their deposits and lending resources to promote speculative underwriting and trading operations. The near-collapse and bailouts of both banks also highlighted the systemic risks that arise when major banks establish close links with the securities markets. The hazards of universal banking became manifest again in the 1990s and 2000s. Second-generation universal banks played leading roles in securitizing and marketing high-risk, asset-backed securities (and related derivatives) that helped to precipitate the greatest worldwide boom and crash since the Great Depression. To prevent a collapse of global financial markets, government officials in the United States, United Kingdom, and Europe rescued troubled universal banks and supported not only their banking units but also their securities and other nonbanking subsidiaries. U.S. regulators arranged emergency deals that (1) converted two leading securities firms (Goldman Sachs and Morgan Stanley) into universal banks and (2) enabled existing universal banks (JPMorgan Chase and Bank of America) to become even larger by acquiring troubled securities firms. The foregoing government measures confirmed the existence of a “too-big-to-fail” (TBTF) policy that embraced the banking system as well as major segments of the securities and insurance markets. The Dodd-Frank Act of 2010 promised to end TBTF. However, many analysts believe that goal is a long way from being accomplished. As policymakers evaluate the desirability of further reforms to end TBTF, they should reconsider the lessons of the Great Depression as well as the wisdom of Glass-Steagall’s regime of structural separation between the banking industry and the securities markets

Moonshots

In the last half-century, technological progress has stagnated. Rapid advances in information technology disguise the slow pace of productivity growth in other fields. Reigniting technological progress may require firms to invest in moonshots—long-term projects to commercialize innovations. Yet all but a few giant tech firms shy away from moonshots, even when the expected returns would justify the investment. The root of the problem is corporate structure. The process of developing a novel technology does not generate the kind of interim feedback that shareholders need to monitor managers and managers need to motivate employees. Managers who anticipate these agency problems invest in incremental innovations instead. In the last few years, a new structure designed to commercialize long-term innovations has emerged—the venture carveout. A venture carveout is a private company with one or two public company parents, outside private investors, and employee ownership. The parents provide intellectual property and a long-term strategic commitment. The private investors supply patient capital that insulates the project from short-term shareholder pressure. The employees’ equity motivates them to bring a product to market. The first venture carveouts are attempting to commercialize autonomous vehicles. If they succeed, they will validate a new model for innovation. This Article argues that venture carveouts could enable more companies to invest in moonshots, compete with the tech giants that dominate our economy, and accelerate technological progress

Risk-Seeking Governance

Venture capitalists (“VCs”) are increasingly abandoning their traditional role as monitors of their portfolio companies. They are giving startup founders more equity and control and promising not to replace them with outside executives. At the same time, startups are taking unprecedented risks—defying regulators, scaling in unsustainable ways, and racking up billion-dollar losses. These trends raise doubts about the dominant model of VC behavior, which claims that VCs actively monitor startups to reduce the risk of moral hazard and adverse selection. We propose a new theory in which VCs use their role in corporate governance to persuade risk-averse founders to pursue high-risk strategies. VCs are motivated to take risks because most of the gains in venture funds come from the exponential growth of one or two outlier companies. By contrast, founders are reluctant to gamble because they bear firm-specific risk that cannot be diversified. To compensate founders for their risk exposure, VCs offer an implicit bargain in which the founders agree to pursue high-risk strategies and, in exchange, the VCs provide them private benefits. VCs can promise to give founders early liquidity when their startup grows, job security when it struggles, and a soft landing if it fails. In our model, VCs who develop a founder-friendly reputation have a competitive advantage in ex ante pricing but are more exposed to poor performance ex post due to suboptimal monitoring. Stakeholders who are not party to the VC-founder bargain—and society at large—are forced to bear uncompensated risk

Risk-Seeking Governance

Venture capitalists (“VCs”) are increasingly abandoning their traditional role as monitors of their portfolio companies. They are giving startup founders more equity and control and promising not to replace them with outside executives. At the same time, startups are taking unprecedented risks—defying regulators, scaling in unsustainable ways, and racking up billion-dollar losses. These trends raise doubts about the dominant model of VC behavior, which claims that VCs actively monitor startups to reduce the risk of moral hazard and adverse selection. We propose a new theory in which VCs use their role in corporate governance to persuade risk-averse founders to pursue high-risk strategies. VCs are motivated to take risks because most of the gains in venture funds come from the exponential growth of one or two outlier companies. By contrast, founders are reluctant to gamble because they bear firm-specific risk that cannot be diversified. To compensate founders for their risk exposure, VCs offer an implicit bargain in which the founders agree to pursue high-risk strategies and, in exchange, the VCs provide them private benefits. VCs can promise to give founders early liquidity when their startup grows, job security when it struggles, and a soft landing if it fails. In our model, VCs who develop a founder-friendly reputation have a competitive advantage in ex ante pricing but are more exposed to poor performance ex post due to suboptimal monitoring. Stakeholders who are not party to the VC-founder bargain—and society at large—are forced to bear uncompensated risk

Too Many to Fail: Against Community Bank Deregulation

Since the 2008 financial crisis, policymakers and scholars have fixated on the problem of “too-big-to-fail” banks. This fixation, however, overlooks the historically dominant pattern in banking crises: the contemporaneous failure of many small institutions. We call this blind spot the “too-many-to-fail” problem and document how its neglect has skewed the past decade of financial regulation. In particular, we argue that, for so- called community banks, there has been a pronounced and unjustifiable shift toward deregulation, culminating in sweeping regulatory rollbacks in the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018. As this Article demonstrates, this deregulatory trend rests on three myths. First, that community banks do not contribute to systemic risk and were not central to the 2008 crisis. Second, that the Dodd-Frank Act imposed regulatory burdens that threaten the survival of the community bank sector. And third, that community banks cannot remain viable without special subsidies or regulatory advantages. While these claims have gained near- universal acceptance among legal scholars and policymakers, none of them withstands scrutiny. Contrary to the conventional wisdom, community banks were key participants in the 2008 crisis, were not uniquely burdened by postcrisis reforms, and continue to thrive economically. Dispelling these myths about the community bank sector leads to the conclusion that diligent oversight of community banks is necessary to preserve financial stability. Accordingly, this Article recommends a reversal of the community bank deregulatory trend and proposes affirmative reforms, including enhanced supervision and macroprudential stress tests, that would help mitigate systemic risks in the community bank sector