The law gives credibility to financial instruments by casting a shadow over their applicability. But the effective enforcement of all legal obligations entered into in the past, regardless of changing circumstances, would inevitably collapse the financial system. However, if full legal force is relaxed or repealed to reflect such a change, the credibility that the law gives to funding will be undermined in the first place. Individual market participants will try to protect themselves from the vagaries of fragile finances. They will enter into hedging transactions or insurance policies that shift the burden of future losses onto their counterparties. If too many people rely on such assurance and the event that triggers the payment actually occurs (no matter how low the probability), these legal mechanisms put the system on autopilot for self-destruction. At this point, the system can only be saved by relaxing or suspending the entire force of the law: by providing funds where no funds are due, and by rescuing intermediaries who should be liquidated under the law. This article develops the constituent elements of a legal theory of finance. LTF believes that financial markets are legally constructed and, as such, occupy an essentially hybrid place between the state and the market, the public and the private. At the same time, financial markets are dynamic and often bring them into direct conflict with legal or contractual obligations.
This is particularly true in times of financial crisis, when the full implementation of legal obligations would lead to the self-destruction of the financial system. This paradox between law and finance tends to be resolved by suspending full legal force when the survival of the system is at stake; That is, at its peak. This is where power becomes important. Modern capitalist financial markets do not exist outside the rules, but are constituted by them. It is possible to distinguish between different rules and decision-makers, for example, private and public. This may give the impression that funding can be fully supported by private or self-regulatory agreements. However, there is no large-scale financial system that is not supported by a formal legal system capable of decisively defending the rights and obligations of the parties or using its coercive powers to assert such claims. The credibility and value of financial contracts (RCs), as well as the size and viability of the markets in which they are traded, depend on this support, even if rule-making has been delegated to private actors. The law is not equally binding throughout the system. It can be designed more or less elastic. However, the relative elasticity of the law is not accidental. It is inversely linked to the financial hierarchy, which is determined by the different actors` different access to liquidity.
The paradox of law and finance tends to be resolved by overriding the full force of law when the survival of the system is at stake, that is, at its core. This is where power comes into matter. Nevertheless, power is exercised throughout the financial system. It is exercised by those who have the means to provide for others without being legally obliged to do so, whether public or private. Those with access to central bank liquidity are better placed to support other private actors than those without. Those with access to unlimited resources have the most power: rulers who control their own currency and debt. The absence of any of these conditions can undermine a State`s credibility as an effective lender of last resort and bring it closer to the periphery of the global financial system. Anyone can issue promissory notes, whether public or private. But not all promissory notes are always sold; Even those that do so initially may not be saleable at a later date, when liquidity shortages favor liquidity or cash substitutes.
Cash is, of course, the legal tender that states, and not just private parties, can spend. This official currency is the default currency and the reference for valuing other assets traded in the economy. The final settlement between financial institutions and between them and the central bank takes place in official tender or narrow substitutes (government bonds). Money is also the currency used by the government to make its (domestic) payments and collect its debts, including its tax claims. Last but not least, when financial systems are on the verge of collapse, only a safety net with unlimited access to top-notch money can stabilize the system. Only states with a coordination capacity and fiscal sovereignty meet these requirements, as private companies are by definition subject to severe budgetary constraints. In short, financial systems are not state or market, private or public, but always and necessarily both. LTF calls for a reorientation of regulatory strategies. Instead of focusing exclusively on legal obligations and ex ante rule-making, it calls for particular attention to the causes of financial instability and their management. The first requires closer monitoring of liquidity generation by private and public actors; The latter for more safety valves to increase legal elasticity not only at the core, but also at the periphery of the financial system. At the top of the system, the law is elastic and force becomes important.
41, no. 2, 2013 Home > Faculty Publications > Faculty Scholarship > 2283. Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Related Works:This article may be available elsewhere in EconPapers: Search for articles with the same title. Downloads: (external link) www.sciencedirect.com/science/article/pii/S014759671300036X Full text only for ScienceDirect subscribers Katharina Pistor, A Legal Theory of Finance, Journal of Comparative Economics, Vol. 41, p. 315, 2013; Columbia Law School Public Law & Legal Theory Working Paper No. 13-348 (2013). Available on: scholarship.law.columbia.edu/faculty_scholarship/2283 JEL codes: B26 G20 G28 K2 N20 P16 (Search for similar articles in EconPapers) Date: 2013 References: View references in EconPapers See the full reference list of citations CitEc: View citations in EconPapers (19) Track citations via RSS feed The article is the product of a 2-year research project, the Global Finance and Law Initiative.
The support of the Institute for New Economic Thinking is greatly appreciated. The document could not have been written without the research of those involved in this project, their contribution to the discussions in the workshops that accompanied it, and the many comments I received from them on previous versions of this document. In alphabetical order, they are Dan Awrey, Bruce Carruthers, Anna Gelpern, Mitu Gulati, Alya Guseva, Rachel Harvey, Anush Kapadia, Tamara Lothian, Perry Mehrling and Akos Rona-Tas. This article also benefited from comments by Geoffrey Hodgson, Simon Deakin and Ernst-Ludwig von Thadden. Special thanks to Casey Quinn and Agnieszka Janczuk-Gorywoda for their excellent comments and revisions, and Ron Gilson, Locke McMurray, Jeremiah Pam, Richard Shamos and Matthias Thiemann for their detailed comments on previous versions. All the remaining shortcomings come from me. Permanent connection: EconPapers.repec.org/RePEc:eee:jcecon:v:41:y:2013:i:2:p:315-330 financial markets are neither private nor public, but essentially hybrid. Banking and financial law| | Law Law and economics | Public Law and Legal Theory Journal of Comparative Economics is currently edited by D. Berkowitz and G. Roland.
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