Notice & Comment

Wallach vs. Conti-Brown on the Fed and Lehman: What did we learn?

Pardon my long hiatus from blogging. The reason was a move, from Princeton, NJ where I was working (and will continue to work) on my PhD in financial history, to Philadelphia, PA, where I am now an assistant professor at Wharton/Penn, teaching in the Legal Studies and Business Ethics Department (those who follow any aspect of law and financial regulation will know my colleagueDavid Zaring, a leader in this field). I’m delighted by the move but, as you may know, moving is miserably and wholly consuming and I haven’t made time for blogging in the interim.

I’m most embarrassed by my long absence from blogging because I forgot to thank our guest blogger in May and June, Philip Wallach. I’m grateful that he could spend the month with us and share somany provocative and interesting posts. I hope your interest was piqued, and that you promptly buy, read, review, and debate his book. (An aside, and speaking of reviews and David Zaring, David reviews Wallach here at the excellent The New Rambler—take a look.)

One of the features of Philip’s stint here was a debate we had on the Fed’s claim that it lacked the legal authority to save Lehman Brothers. I say that’s a post-hoc invention; Philip thinks it’s not, or at least,not so obvious. What do we learn from this fascinating exchange?

First, we learn that the statute is indeterminate. There simply isn’t much there. In fact, Philip and I seem to agree that everything comes down to one clause: that an emergency loan must be “secured to the satisfaction of the Federal reserve bank.”

I argued that this is an entirely discretionary standard, such that a claim that the law prevented action in the Lehman case is facially false because the law left that conclusion to the Reserve Bank itself. Philip sees in this a more historically nuanced requirement that “satisfaction” must mean fully collateralized. As a historian, I’m interested in Philip’s counter-argument, but I have seen no evidence that “satisfaction” was used as an objective term of art by the congressional drafters. Indeed, some very famous instances of central bank lending in a crisis were to “insolvent” institutions (I’m thinking of the Bank of England’s consortium lending to Barings in 1890—for more, see Ziegler’s excellent account.).

I put the term “insolvent” in quotes because the term starts to lose its meaning in a financial crisis, and in any case becomes endogenous to the very actions the central bank takes. For these reasons, the whole “satisfaction” question doesn’t seem to settle anything.

What I value about Philip’s book, though, is that he invites readers to resist two views of law that will do us no good in trying to understand the financial crisis and the actions the government took in that crisis. The first is the dismissive, overly realist view that law is politics by another name. Government and private actors alike will make any argument to justify their favored course of action. Legal arguments are just a different flavor of those arguments. The second is the formalist, dogmatic view that law is this brooding omnipresence that awaits only careful exposition to reveal its universal truths. Of course, I’m referencing a very old debate in jurisprudence here. Philip’s book, while it leans a bit too heavily to a kind of formalism that I don’t find convincing, is refreshing in that it stakes a middle ground. Law clearly means something different than politics. There is a different but related phenomenon of legitimacy that must be taken seriously, even if its contours as a separate schematic lens aren’t very easy to limn. If Philip doesn’t provide the answers, he is asking the questions in a thoughtful way that we should all take very seriously.

I still think those inside the Fed—whether at the Board of Governors or the Federal Reserve Bank of New York—had the authority to do whatever they wanted with Lehman. And given the political maelstrom they faced, I’m not sure I would have done a thing differently than they did. My critique of their legal analysis is not a critique of their crisis decision-making. But the legal arguments are distracting from the bigger question, about the appropriate levels of discretion that a central bank should have in using its lender of last resort authority. What the debate with Philip has shown me is that, even if I’m not wrong—and, well, I’m not—the law is something of an omnipresence in the way the government faced the financial crisis. That omnipresence may even have brooded from time to time.

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