Much of the law, especially the common law courses (Property, Torts, and Contracts) which dominate both the curriculum and the pedagogical method of the first year of law school, is focused on the construction of a legal market sphere. The law lays out, with varying amounts of clarity, the activities within the market sphere that will be considered ‘legal’ or ‘illegal’. Often those definitions fail to follow a 1L’s natural moral sentiments on what is ‘right’ and what is ‘wrong’. For instance, a person may fail to follow the written demands of a contract, yet will not face any penalty for such action if his breach is not considered ‘material.’
A free market ideology, particularly prized during the development of 19th century common law which still forms much of the overall bedrock of American legal thought, often fails to acknowledge the role that law plays in the construction of a market. The basic myth seems to view the market, and its associated processes as natural, while the law imposes constructed limitations that circumscribe the free economic transactions present in everyday human interaction. Proponents of this belief may unconsciously be engaging in circular reasoning. How do you exchange goods without legal definitions for contract & property?
Allied to a free market ideology is the rational actor model promulgated by neo-classical economists. The precise contours of the rational actor model, as this essay argues, are difficult to draw. Furthermore, continuing advances, particularly in the field of behavioral economics, have forced the rational actor model to bend itself to something more closely (if still not particularly closely) resembling an actual human being. Nonetheless, the rational actor model still contains the idea of a calculating individual making rational choices designed to serve their individual preferences. This loose summary resembles the central thesis of the Callan & Kay article – “one of the ways law shapes social reality is by implicitly fostering the assumptions that people are self-interested, competitive, and untrustworthy.” Although not within the scope of this blog post, it would be an intriguing study to examine whether exposure to the bedrock terms of the financial system elicited the same type of reactions observed by this article in reaction to legal terminology. More directly, the Callan & Kay article raises questions about the effect of legal socialization on a group that stands at the intersection of Finance & Law, Wall Street Financial Firms.
A continuing theme of the financial crisis has been the widespread disjunction between broad cultural perceptions of the activities of the financial industry leading up to the events of September, 2008 and the indignant response of said financial industry, which crudely summarized, seems to mainly consist of a highly legalistic defense, ‘we didn’t directly break the law.’ The relative lack of prosecutions of the financial industry so far (leaving aside potential civil litigation) seems to provide some support for their viewpoint, although there are certainly other possible explanations. The entire disagreement provides a marvelous illustration of the longstanding debate over the difference between moral wrong and legal wrong. However, Callan & Kay’s article helps us evaluate this dispute from a broader perspective, with perhaps more awareness of the contribution which a legal environment, especially the law of the financial market, may have made to providing an implicit justification of the forms and types of behavior which led to the financial crisis.
My first postulate is that the legal culture which surrounds Wall Street delineates certain limited forms of activity as clearly ‘unlawful’. These forms of activity, primarily limited to fraud and insider trading, are universally condemned. It is widely acknowledged, by all relevant parties, that these types of activity are crimes. By comparison, financial activities that do not fall within these categories may be considered lawful. Furthermore, applying the argument of Callan & Kay, the image of human behavior fostered by the law may make regular financial behavior more understandable, as the natural actions of a self-interested, competitive individual.
In practice, of course, the border between the two zones is much fuzzier than a legal conception may be willing to admit. Intriguingly, cinematic depictions (Wall Street, Boiler Room) of the financial industry do a much better job of capturing the overlap between the competitive drive for advantage thatpowers ‘legitimate’ financial success, and the way that same drive can push previously law-abiding individuals into illegal activities.
My second postulate is that the regular activities of the Wall Street firms involve continued exposure and interaction with legal processes. Wall Street firms regularly engage in activities (i.e. Investment Banking) that demand the assistance of highly technical legal
expertise. The continued symbiosis between Wall Street firms and Big Law firms is by this point utterly unremarkable. Without any direct backing, it seems that the intense involvement of lawyers in a Wall Street firm’s activities acts as a continued assurance that the actions which the firm takes are legal. The variety of regulations surrounding financial activity, represented in organizations such as the SEC or the Federal Reserve, further reinforce, in the form of a blizzard of paperwork, the idea that the firm’s activities are done within the cloak of the law of the market. Utterly ignored in this self-conception, of course, is the vast influence pressure which Wall Street firms engage in to shape the law in the form most beneficial to them.
Secure in the rationalization that their actions are legal, and further reinforced by the process of legal socialization which reinforces notions of competition and self-interest, the protection that Wall Street finance has sought in the warm security blanket of formalistic legal protection may start to make much more sense. It may no longer be dismissed as simply the only possible defense due to the cold comfort provided by most normative moral frameworks that are unreceptive to the general Wall Street ethos of ‘Greed is Good’; rather, this legal defense of their actions is a deeply held conviction about the correctness of their actions, reinforced by the particularly acute process of legal socialization engaged in by Wall Street firms. The inner strength of this belief may be seen in the following examples; each of which, crudely summarized, are an example of the financial industry, and its auxiliaries in government, using the law not just as a shield but also a sword to advance their interests.
Particularly striking, in Michael Lewis’ new article about the Irish financial crisis, is a brief explanation of the Irish government’s decision to guarantee the financial losses incurred by Irish banks. This decision, currently wrecking havoc in Europe, is given a somewhat unsatisfactory explanation by Irish officials, attempting to justify their choice to guarantee all losses of the banks, and not just the accounts of depositors.
“A single decision sank Ireland, but when I ask Lenihan about it he becomes impatient, as if it isn’t a fit topic for conversation. It wasn’t much of a decision, he says, as he had no choice. The Irish financial markets are governed by rules rooted in English law, and under English law bondholders enjoy the same status as ordinary depositors. That is, it was against the law to protect the little people with deposits in the bank without also saving the big investors who owned Irish bank bonds.
This rings a bell. When U.S. Treasury secretary Hank Paulson realized that allowing Lehman Brothers to fail was viewed not as brave and principled but catastrophic, he, too, claimed he’d done what he’d done because the law gave him no other option. But in the heat of the crisis, Paulson had neglected to mention the law just as Lenihan didn’t bring up the law requiring him to pay off the banks’ private lenders until long after he’d done it. In both cases the explanation was legalistic: narrowly true, but generally false. The Irish government always had the power to impose losses on even the senior bondholders, if it wanted to. “Senior people have forgotten that the government has certain powers,” as Morgan Kelly puts it. “You can conscript people. You can send them off to certain death. You can change the law.”
Implicit in this idea is the relative responsibilities of governmental and private actors. Private actors are allowed to take whatever actions they like, as long as they fall within proscribed legal limits, without regard for the well-being of others or society as a whole. Legal socialization may reinforce these instincts. By contrast, the Government, the administrators of said law, are expected to take actions with the good of society in mind; they must also act within the boundaries of the law, although here, in the Irish government’s eyes, they are expected to act in a benevolent, and charitable fashion which the law they administer doesn’t demand of the individual actors which it regulates.
During the AIG bonus fiasco, a particularly memorable letter was posted to the NY Times by an enraged trader, Jake DeSantis, who was furious that his bonus, guaranteed through a contract, may be withheld. DeSantis voiced a variety of grievances; he viewed himself as an ‘American Dream’ story, risen from humble origins to attain the heights that materialistic bliss can provide. This self narrative is obviously a touchingly common depiction of success within the rubric of American society. But to the extent that DeSantis mounted an actual defense of AIG executives’ right to their bonuses, it was dependent on a rock-solid faith in the unbreakable nature of a legal contract.
“As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.”
The mentality behind DeSantis’ comment may be viewed as another variation on the legal socialization theme; DeSantis behaved in the aggressive, self-interested fashion which the law expected of him. In reward for this behavior, he received a legal contract guaranteeing a certain amount of remuneration. DeSantis is therefore shocked, shocked when there are indications that the law may be retroactively changed to punish, in some form, the self-interested behavior that DeSantis may believe it has, up to this point, not just reified but encouraged.