The CLS Blue Sky Blog presents the second installment of our new series, entitled “The Marketplace of Ideas.” Earlier installments are available here. The intent is to present different perspectives on the same subject by two or more authors.
Today, the subject is Professor Katharina Pistor’s Legal Theory of Finance (LTF). Her theory grew out of a two year research project – the Global Finance and Law Initiative (further described here) – that set out to critique existing theories in economics and sociology on the relation of law to finance and developed an alternative approach. It was distilled down from the work of many participating researchers who performed case studies on an array of financial markets. The result is provocative and has been generating widespread interest among those seeking to better understand domestic and international finance and the recent financial crisis. Pistor’s theory, which was recently published in a special issue of the Journal of Comparative Economics, is available here. The full edition of the journal, including an introduction from Pistor as well as the case studies, are available here.
There are 4 core elements to LTF:
- The Legal Construction of Finance: All financial assets are IOUs designed to create credible and enforceable commitment devices.
- The Law-Finance Paradox: Law is indispensable for developing modern day large-scale financial markets. Yet, if all legal commitments are enforced as written ex ante irrespective of fundamental change they can trigger the self-destruction of the system.
- The Elasticity of Law: The system’s self-destruction can be avoided by suspending the binding force of law or by offering liquidity even when no liquidity is owed. In general, law tends to be more elastic at the apex or core of the system than on its periphery.
- Finance’s Essential Hybridity: Contemporary financial systems are not public or private, state or market, but always and essentially both. This is revealed in times of crisis when all holders of financial assets seek to convert their assets into cash – the legal tender controlled by the central bank with potentially unlimited liquidity.
To help illuminate the theory for a wider audience, the CLS Blue Sky Blog has begun collecting analysis and commentary from a variety of experts in the field. We will release the posts from these experts in short intervals over the next one to two weeks. At the close of the releases, Professor Pistor will provide a concluding response.
Our first release comes from Professor Kathryn Judge of Columbia Law School. Her post “Systemic Stability and Fairness: An Analysis of Pistor’s Legal Theory of Finance“ tackles the concept of the elasticity of the law (using AIG as an example) and the potential consequences of embracing this elasticity. It claims, among other things, to reveal an alternative to Pistor’s claim that the law tends to be more elastic at the core and less at the periphery.