Epstein on the Rule of Law
Jun 1 2009

Richard Epstein of the University of Chicago and Stanford University's Hoover Institution talks with EconTalk host Russ Roberts about the rule of law. Epstein lays out a minimalist definition and a more expansive definition when considering the protection that individuals might have when facing the power of the state or the sovereign. Applications include "takings" and the current government interventions in the auto industry and the financial sector.

Epstein on Property Rights, Zoning and Kelo
Richard Epstein, of the University of Chicago and Stanford's Hoover Institution, makes the case that many current zoning restrictions are essentially "takings" and property owners should receive compensation for the lost value of their land. He also discusses the Kelo...
Barry Weingast on Law
Barry Weingast, professor of political science at Stanford University and senior fellow at Stanford's Hoover Institution, talks with EconTalk host Russ Roberts about the nature of law. Weingast takes issue with some of the standard views of law, and proposes...
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Jun 1 2009 at 1:31pm

Want to download unimaginable amounts of information to your brain? The future is now! The future is Richard Epstein. Richard does it with speed, clarity AND accuracy. If I only had a similar upload speed.

Another top notch podcast.

Jun 1 2009 at 1:53pm

Before this podcast, I would have agreed with Epstein that property owners ought to be compensated by rezoning, but now I wonder whether we should make a distinction between land and other property rights, and if so, why? If not, do we compensate everyone for every legal change?

After all, new emissions laws (whether more restrictive or lenient) will change the value of automobiles? Should the gov’t write a check to people whose cars lose value? Should they tax those whose land or cars gain value bc of regulation? Taxes and labor laws change the value of human capital, should compensation be made? What about cap and trade, do we have to compensate polluters, if we stop allowing them to pollute? Who owns that property right?

It seems under Epsteins paradigm we can only have rule of law if every rule change is a compensated one. And if we should draw a line somewhere, where and why?

PS- implicit in this I ask a smaller question. If someone gets a zoning windfall, should they be taxed the benefit?

Russ Roberts
Jun 1 2009 at 6:11pm


Here is Richard Epstein’s response to your point:

The first point is that the identical conceptual framework properly applies to both, and this framework sees in the imposition of a tax or the imposition of any regulation a presumptive taking that is compensable unless justified. In both the zoning and the taxation case the permissible justifications are the prevention of harms for which individuals are entitled to redress in a world in which administrative costs are low enough to allow for direct suits between the parties. The emission tax almost always targets a legitimate end; the zoning restrictions often have no relationship to the prevention of nuisances but are intended to impose selective restrictions on competition. In the cases where there are no nuisance justification, the next question is whether there is some form of in-kind compensation, which does take place in some situations where parallel restrictions are imposed on a group in which the benefits and burdens are reciprocal. The way we know this has happened is to look at changes in property values. If the scheme is desirable for all, those will rise, and the issue of compensation will have taken care of itself.

But for zoning which is intended to protect against nuisances, like the removal of wild animals from residential areas, we don’t have to show compensation has been provided the owner any more than we have to show that a party who is enjoined from commission of a nuisance privately has retained full value. The wrongful conduct justifies under the police power a restriction on use rights that results in the loss of market value. Taxes for pollution follow the same rules, but the difficulty comes when we have to decide what is the optimal form of pollution tax. Not an easy question, but there are some markers. If the tax is one that does increase with increased pollution; if it treats some sources more favorably than others, then it operates like a phony trade barrier against foreign goods tagged with charges of being contamination. But if it avoids these pitfalls, then the right response is to allow for legislative tinkering which necessarily alters values because no one has strong enough knowledge to set the unique optimal tax. This is not distinctive to the public sphere. Private damage actions do not have unique values in nuisance cases; nor are the terms of an injunction unique in any concrete dispute Some discretion is built into the private law system on both issues, and there is no way to remove it completely from the public law system.

In practice, the usual zoning scheme has no police power justification relating to external harms; the pollution tax does. That distinction explains why the same unified framework looks more suspiciously on the conventional zoning ordinance.

Russ Bankson
Jun 1 2009 at 6:58pm

Richard is simply breathtaking. His mastery of his subject results in an epithanic clarity in place of what had been muddled public discourse.

At the same time, it is somewhat offputting due to its intellectual hurricane force delivery. Any panel or public forum on which he participates leaves the audience and sometimes the other panelists dumbstruck.

I wish his intellectual rigor could be packaged for greater mass exposure and understanding. Perhaps a popular rendition similar to M. Friedman’s ‘Capitalism and Freedom’ or ‘Free to Choose’

Jun 2 2009 at 9:04am

Yikes…I’m going to have to listen to that one again; he packed a lot of information in there!

Jun 2 2009 at 4:33pm

Epstein is hands down the most impressive individual I’ve ever heard speak. His ability to recall names, dates, case law, facts, etc., and integrate cross disciplines such as law, finance, economics, and psychology without missing a beat is simply astounding. Rarely do you come across someone whose verbal skills are as dense and nuanced as their actual writings but Epstein pulls it off somehow.

Jun 2 2009 at 7:42pm

This man is inhumanly prolific. It will take me some time to digest just one of his amazing streams of thought. I applaud Dr. Roberts for synthesizing all that info to offer relevant responses!

Jun 3 2009 at 7:32pm

Wow. Loved the podcast.

I have a question about Epstein’s philosophic opposition to legally mandated labor relations.

I learned in Macroeconomics that GDP, as an identity can be broken down into wages, the return to labor, and profits, the return to capital. On a number of occasions I have heard it argued that the legal protections for organized labor are a necessary balance to the legal protections afforded to organized capital in this struggle over each one’s share in the pie. Now certainly a labor union is not the same thing as a corporation, but does not the state sanction of the creation an artificial legal person generate burdens to uninvolved third parties? I don’t think it is a restriction on my freedom to engage in contracts, but at the same time, I am forced to respect the legal personhood of the corporation.

Jun 4 2009 at 8:45am

One of his arguments that puzzles me is that he believes a government must pay the total loss of value of a property to the owner as the result of, for example, a road being built. I’m not sure if any new highways could be built in such a case, and furthermore, should not then the owner be paying to the government any increase in value of a property that a new road may bring?

Joe d'Eon
Jun 4 2009 at 7:44pm

Epstein attacked the administration’s opposition to “bonuses” by pointing out that they were, in fact, not bonuses, but deferred compensation. He went on to condemn the administration for protecting the unions’ pensions (unsecured credit).

But wouldn’t the same principle apply to retirement pension funds as to these bonuses — aren’t they also “deferred compensation”? A retirement plan is part of an employee’s compensation package, and the company would ordinarily have to pay a higher hourly wage were it not for the promise of a retirement package.

Jun 5 2009 at 10:49am

Epstein at about 12:25 on freedom to contract – “When they combine their resources, do not have any greater (or lesser) claims against third parties than they did when they acted separately.”

Epstein illustrates this point with an example of labor coming together to try to force collective bargaining on an employer. He deems this to be interference with the right to contract for the above reason.

However, he’s silent in this podcast (as are you, for that matter) regarding a much more prevalent and prominent state sanctioned “combining of resources” that alters 3rd parties rights. Which is the “combining of resources” that corporations are able to accomplish (through use of the state charter), while at the same time shielding all the people/partners combining those resources from personal liability when it all goes bad. This appears to be the very defintion of parties coming together and using the power of the state to produce for themselves new rights as against 3rd parties (ie shielding themselves from personal liability for the contracts they enter into). Does Epstein ever deal with this fact? And, if not, why didn’t you ask him about it?

In other words, I also very much want to hear an answer to what ‘Jim’ from an above comment asked:

“Now certainly a labor union is not the same thing as a corporation, but does not the state sanction of the creation an artificial legal person generate burdens to uninvolved third parties?”

Russ Roberts
Jun 5 2009 at 4:05pm


Here is Richard Epstein’s response to your comment:

…here is a general answer. I have dealt with these various questions elsewhere. The labor stuff in How Progressives Rewrote the Constitution (2005), and the limited liability issue in Simple Rules for a Complex World (1995). In fact the two are related historically. Here is the short version.

On limited liability, the question one asks is whether third persons are left worse off by the imposition of the restriction. The problem has urgency because there is no voluntarist approach that blocks out the third person claims. But remember that our system is one that allows the use of state restrictions so long as the parties who are hurt by the restrictions are left better off in aggregate by the benefits they provide, which is the case with limited liability, when it is properly understood. With large corporations, the doctrine is the way to attract contributions from hundreds of different individuals who have limited knowledge about management, and no control over its operations. Giving limited liability thus increases corporate wealth, which in fact gives strong remedies to tort victims than private right of actions against countless partners spread over the globe. And where that is not adequate, liability insurance on the firm (which can be insulated from trade creditors) can fill in the gap. So the social justification here is very large.

But what about the second point on concentration. That was raised in the preamble to the National Labor Relations Act, where the privilege of corporate aggregation was said to justify the need for countervailing power on the other side. Not so. The aggregation under limited liability does not exempt companies from antitrust law scrutiny, and in and of itself wealth gives no sense of market power, so large corporations can operate in multiple competitive markets, including the market for labor. Unions are not just asking for the power of voluntary aggregation, which would be in principle subject to antitrust laws. But they also want a majorities to bind minorities, and to impose duties on firms to deal with state sponsored cartels. Note that even unions that have unanimous support gain rights to force bargaining on strangers in violation of the libertarian norm. And that a majority of workers could achieve this result compounds the structural error.

Jun 5 2009 at 4:41pm

Thank you Mr. Roberts. Could you also thank Richard Epstein for taking the time to reply?

I take it from the response that Epstein’s answer to Jim’s question:

“Now certainly a labor union is not the same thing as a corporation, but does not the state sanction of the creation an artificial legal person generate burdens to uninvolved third parties?”

is “Yes”.

The only difference is Epstein uses his (undefined in this context) conception of “aggregate benefits” to justify corporations’ limitations/burdens on 3rd parties (which sounds suspiciously capricious for a guy shouting about the benefits of one ‘rule of law’ to bind them all). In fact, it sounds like an argument minimum wage advocates make when they say the aggregate benefit of a minimum wage is the reason to have one in spite of the minimum wage’s bad effect on any individual employment seeker.

I find Epstein unconvincing in the extreme regarding this issue. I won’t go so far as to call him ‘intellectually dishonest’ without reading the complete arguments he points to in the references from above, but if this is the best he’s got, then I’d say he’s got real problems with his conception of ‘freedom to contract’.

He outlined that conception from minute 12:25 to about 13:00 in the podcast during which time he never included any caveat that 3rd parties rights may be additionally burdened by ‘combining parties’ and the power of the state IF there is an ‘aggregate benefit’ to be had from allowing the combination. In fact, this sounds suspiciously like the choosing of winners and losers that Epstein is all on about during the entire podcast. It’s just that Richard Epstein is doing the choosing and, therefore, he’s ok with it.

His answer to ‘Charlie’ regarding emissions law changes as a ‘taking’ under the Epstein conception of a ‘taking’ above is similarly infuriating, what with it’s use of weasel words like ‘almost always’ and ‘often’ to claim an emissions change is not a ‘taking’ under his conception of taking.

Both Epstein’s answers seem to be based less on the large theoretical framework he would have us believe he has developed for answering these questions and more on Epstein’s personal belief/biases about what is an ‘aggregate benefit’ or when ‘almost always’ & ‘often’ are sufficient to eliminate the need to discuss/determine what is a ‘taking’.

Justin Ross
Jun 5 2009 at 6:33pm

Richard Epstein is great as always, I had to listen twice just to take it all in.

However, I think the topic of zoning should be viewed as the result of a Hayekian process. As the frontiers of the United States expanded, there was competition among first movers to attract new residents and property rights over land were a primary concern in an environment that was extremely risky. The municipality structures were bottom-up formulations, and zoning was a critical competitive tool that people took seriously into consideration.

For a more Hayekian view of zoning, I would strongly suggest William Fischel’s book “Homevoter Hypothesis.” For a more Coasian view of zoning, I would recommend Fischel’s book “The Economics of Zoning.”

Jun 6 2009 at 3:19pm

This will be required listening for my class next semester.

Jun 7 2009 at 6:51pm

Richard Epstein’s brain is a national treasure. No one else I have read or heard comes even close to his ability to understand and convey the economic and legal implications–and dangers–of the government’s actions not only in the current crisis but in any context. Let’s start a movement to get his voice heard in as many forums as possible as often as possible. Why hasn’t the Wall Street Journal, at least, carried an article by him recently on these issues?

Jun 8 2009 at 2:18pm

Hi Russ,

What is the story behind roosvelt packing the courts?


Jun 9 2009 at 2:20pm

Interesting podcast – one of the things that I find refreshing about your podcast, and your approach is your willingness to challenge your own assumptions and assertions, and your recognition that some of the arguments in economics and politics are difficult to show definitively.

I don’t think Epstein does this in any meaningful way. I largely agree with keatssycamore’s comments above, and wonder if Epstein would be a little more convincing if he acknowledged that there are preferences involved, and sounding a little bit less like he is just stating the obvious facts (which may not be so obvious when challenged). Being an intellectual tour de force can be dangerous when you are too sure of your ideas.

You did mention at one point in the podcast that what he was outlining sounded a lot like it was leading to what you would have with libertarianism, but I think that is partly because that is what Epstein builds his intellectual structure on to start with. It seems a little bit like his conclusions are based on his assumptions, without ever challenging his own assumptions.

Keep up the good work. This is one of the few podcasts where, even when I disagree with the prescriptions or point of view, I also feel challenged intellectually and that there is genuine inquiry taking place.

Ray Gardner
Jun 11 2009 at 1:51am

I had the pleasure of hearing Richard Epstein at the Goldwater Institute and while it wasn’t the entire gist of his lecture, he did do a very good job of marking the differences between libertarianism and the classical liberal position.

Both books that he mentions are well worth the reading, and might help those that are biased against Epstein’s stated views to understand the subtleties that seem to be tripping them up.

Ray Gardner
Jun 12 2009 at 1:50am

Listened to the podcast again today while I was driving. I got a lot more out of it as opposed to listening in my office, half distracted.

One of the most intriguing parts was pointing out where the government has limited property to the right of exclusion.

Harold C. Cockerill
Jun 29 2009 at 8:14pm

It would seem to me were the takings clause more widely applied to the actions of government there would be less takings to deal with. The more government is restrained the better.

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Podcast Episode Highlights
0:36Intro. [Recording date: May 18, 2009.] Rule of law and current situation. Why is rule of law important? Difference in conceptions, some minimal. Minimalist: No extraordinary processes, everyone subject to the same legal system, sanctions, and court. Rule of law is parallel provision; "rule" captures that it can't be ad hoc with respect to individuals. No one wants to deny this definition, but no one thinks it's sufficient to deal with if you have a sovereign, plenary in power. Second portion also procedural: kinds of protections you have to give to individuals before you ask them to sacrifice money, property, liberty, or subject them to criminal sanctions. Indispensible elements: notion that tribunal has to be impartially constituted, not playing with loaded dice. Concerns about institutional arrangements about selection of the decision-makers. Independence of judges, term limits, no family connections. Notice function: have to be told the nature of the charges against you, and why what you did was wrong. Having had a tribunal, can you be heard and what does that mean? Right to be heard originally meant that you had the right for an oral hearing; witnesses; but can you use written testimony in addition? If you have these advantages, other side has to have them as well. In many instances the adversary turns out to be the state. More difficult because the state runs the prosecutor's office; have to have separation. Montesquieu talking about the separation of powers did not envision a very large role for the judiciary. Party that would hear the particular disputes.
6:05Substantive end: What kinds of rules do you have to have in order to deal with the fundamental fairness consideration? Weak version and stronger version. Weak version: two sorts of strong limitations you place on the limitations the state can enforce. In effect, we don't allow for retroactive laws. What makes a law retroactive is subject of much writing. Cannot regulate yourself with respect to rules that have not been announced. Corollary: If you know they are going to do something terrible, you can judge that because it's foreseeable; we never want to give the ability to threaten you by announcing it will pass a law, so you cut back on your conduct, with no law passed at all. Gaming. Other half more controversial: equal protection. Cannot impose special restrictions on one class of individuals that you don't impose on another. Improvements for public roads: everyone on the east side has to pay special assessment. Road is identical for people on both sides. Possible to shift income, opportunities, and favors, thought to be unattractive.
9:14Can you go further? Have to go further. Can think of oppressive legislation that meets above requirements but not satisfactory for anyone who thinks law ought to be an instrument of social welfare. Can have a system consistent with above but saying it's unjust for people to earn more than $10,000 a year and anybody who seeks to enter into such a contract is subject to criminal prosecution. Or, rules with respect to trespass are obsolete; anybody should be allowed to squat on anybody's land for any reason. First of these rules ends freedom of contract; second ends the right to exclude which is key component of private property. Yet the rule is prospective, general, will be enforced by the proper kind of tribunal; and traditional argument is this is such an egregious law that it will never be passed by a democratic government because everyone will be hurt by it. But minimum wage laws have exactly those kinds of characteristics. Have to blend concept of contract and property with rule of law. Definition of property includes not only right to exclude but right to use and develop. Key feature: all you could demand as property owner is duty to forbear from interfering. Property rules same in ancient Rome--scalable. Modern zoning, start seeing difficulties of special legislation. NY crisis on fiscal side, real estate. Contracts: Generalized duties of noninterference are not duties which allow for cooperation; must allow for cooperation or there will not be gains from trade or ability to switch assets. Partnerships. Collective bargaining statutes: cannot force employer to hire them; people who want to combine their entitlements to exercise them against third parties.
13:43Clarifying question: phrase "people who believe in the rule of law." Are there any people who challenge the weaker versions, argue that weaker judiciary better? Yes. New Deal period. Cases where things break down; last conception on retroactivity. Modern American Constitutional law; clear statement rule. If you have a statute and it doesn't specify retrospective or prospective, a court will read it as prospective only. If legislature wants to make it retroactive, it can. No due process protection. Started with black lung disease. Upheld by U.S. Supreme Court. Turner Elkhorn, 1976, Justice Marshall. Can have special assessments has also been attacked. Most famous case, 1905, Louisville and Nashville Railroad, Justice Holmes, road on one side, other side railroad in competition with highway. Charged railroad for half the cost of the road; no benefit to railroad. Question of neutrality and lack of bias: whether or not a state can decide that the party who investigates case can then decide on the merits after the investigation. Mixes prosecutorial and adjudicatory roles. In 1970s, Justice White okay by him. National Labor Relations Board: political linkage to the seats; getting a nomination difficult task; now only two members, one Republican and one Democrat. Partisan political appointments is asking for trouble. Better to have a district court judge. New Deal tradition: progressive government, big government cannot afford to be slowed down by all these meddlesome protections. Woodrow Wilson, theoretical architect of this, 1885, book on Congressional power, separation of powers in the Constitution was a mistake. Wilson a "progressive."
19:07General concept: judicial system. Rule of law: opportunity to use my property and take risks and there will not be arbitrary rule of man decisions about what my returns are for that. Classical liberal definition, but not earlier definition. Earliest definition: in a world without democratic processes, designed to restrict the arbitrary power of the king. Protection of private property part of that mandate. Other property definitions battered badly. People tried to work out the property system and had success until the 1937 Revolution, Supreme Court, not worth trying to keep these things in place any more. Older rules: police power formulated as having health, safety, morals, and general welfare. Concentrate on first two: could always pass rules that limit use of property if they created disease or contagion. Health and safety allowed sanitation and sewage; before 1850 life expectancy around 40 years; afterwards 47-48; then 54. Nobody wanted to stop that. Can you use a health justification to override freedom of contract. Famous cases: movie theater with doors that open to the inside, fire would crush people. Would have stopped 1911 Triangle Waist Factory disaster. Titanic. Rate of industrial accidents high. Labor statute: cannot put into place things that upset the play of economic forces in a competitive market. Require safety devices on trains; but Lochner vs. New York, state cannot mandate more than 60 hours of work per week. Labor statute. Workers slept on the job between evening and morning shift. Employer could be forced into collective bargaining agreement with workers. New Deal, distinction no longer worth drawing. 1938, Fair Labor Standards Act, difficult to enforce, still with us today. National Labor Relations Act. Systematic effort on part of judicial system to figure out how to identify areas of risk where you are entitled to seek a return, consequences. Didn't understand competitive markets, keen on setting up cartels.
26:01Hoover, 6-7 years ago, whimsical: wondered whether rule of law existed. Crowd chuckled, but intended seriously. Better or worse? On zoning, pretty much steady state. Point: when you start dealing with the rule of law the notions of procedural regularity matter. In United States, dealing with criminal prosecution that results in incarceration or forfeiture, for the most part the rule of law has held. But when you get to a town like Palo Alto, question who gets to build on particular lot. Individuals have to apply on individual basis. Nobody should be able to build a pollution factory, but nobody wants to pay a million dollars to breathe his own fumes. Rules have to do with height, setbacks, etc. Kinds of conditions that can be imposed for new construction are varied. Different time, place, location; arbitrariness. In 1977, Center for Advanced Studies, land acquired by state or city: we want to incorporate your land; if you do it now, you'll get $40,000; if you don't, we will rezone and it will be worth less. Zoning threat is thuggish; but there is no strong protection under law against down-zoning. Can result in serious sorts of abuses, inconsistent with rule of law. Compensation function is protection against the use of arbitrary power. Eminent domain. Rule of law with regard to exclusion but we do not have rule of law with regard to use and disposition of private property. Subject to arbitrary stuff Lucas vs. South Carolina Coastal Commission; worked in that case but not general; Justice Scalia said was compromise solution: if land use restriction wipes out the entire value of the land we'll treat it as a government occupation. Statute: If your house gets blown down you can't rebuild it; can't build on empty plot at all. Never asked: suppose we are going to let you build the house, 10 by 10 by 10. Is that different from the first case? Slightly bigger; where do you get past the point of wipe-out? Keep taking and residual use complementary and have to sum up to original value of the land. Taking a servitude, back to Roman times. Easement, restrictive covenant. Deep gap in property system. Lucas case, see the rule about complete wipe-out; in middle of case, put in impossible set of restrictions. Taking if it goes too far--Justice Holmes. Level of value destruction by local land use decision arbitrariness. Habitat preservation.
35:26Twitter, EconTalker: GM, Chrysler question, takings issue. Same question. Fundamentals: property interests can be possessory or non-possessory. If government occupies land it's a taking; if they only regulate it, it is not. Mortgage is a non-possessory interest in land; if you do not repay it, I can get absolute title, use that to pay off debt, if anything left over it goes to you. Aphorism: 1960, Armstrong against the United States. Material man, ship builder, did it for a contractor, contractor didn't pay. Can put lien on property; U.S. didn't want to pay, took the boat into international waters so as to not pay. Justice Black: it's very clear who ought to be paying for the ship, had to treat guy as a general creditor. Notion of a lien that is critical is absolute priority: financial institutions now are sophisticated, multiple liens. Parity unless priority organized by first to file. When you lend money, there is a first and second mortgage. Rule is that first has to be paid in full before second gets a dime. Third is holder of the equity, who gets whatever is left over. Bankruptcy; calculations of risk and reward, sequence of payments. Takings terms: Correct analysis: don't care about rules of physical possession. Absolute priority rule, if second mortgagee is promoted over the first, it's a taking. That's what happened in the Chrysler bankruptcy. Bond is obligation to pay fixed amount. Floating lien. Pension funds for Chrysler were unsecured. When it got to the Treasury Department, violated the rule of law; worked a deal to present to the bankruptcy court; threatened people who had taken TARP funds, back off on claims. Secured creditors got 10 cents on the dollar. In political world, can force it. No rational reason to relinquish priority unless threat from outside. Will it be challenged in court? Yes; but government is both regulator and defendant. President Obama at Arizona State, tax audit if you disagree. Not funny. Implicit threat to systems of property rights and credit. Credit disposition, law of mortgages being eroded. Nullification of contracts for AIG: sign waivers by tomorrow or else. AIG: compensation for key employees, bonuses, part of regular compensation. Common understanding is reward at end of year. In this industry, performance hard to measure, so deferred compensation given for tax and business reasons. Liddy, head of company; Treasury didn't like arrangement.
48:04Can't have an owner who is a regulator. Government getting a share is strange thing; interest of the owner is mediated through politics. Oakland Raiders: condemn the team rather than see it move. If government puts money in, put money in independent fund. Virtues of bankruptcy system is that there is no infusion of public cash. Bush, Obama: at first sign of trouble should have allowed bankruptcy. March 2008, Bear Sterns, not going to be a going concern on Monday morning, bankrupt; Bernanke and Paulson decided that this would have systemic consequences. Standard argument was that there were so many contracts and counterparties that whole system would grind to a halt. Brokered deal; but six months later left to die. Lehman-Brothers is in bankruptcy, not disruptive. What if Bear Sterns had been allowed to go into bankruptcy? Two definitions: cannot meet your obligations as they accrue in the short run. For Bear Sterns, it was actually cash-flow positive. Was value of asset pool sufficient to cover liabilities? Fair value of mark-to-market rules. Banking has never been completely unregulated. If it turns out that the amount of assets are insufficient, can require you to liquidate some of your position to cover. When you sell it, the price you get is independent of suffering. With Bear Sterns, by March 2008, no longer uncorrelated. Announce that a bank will have to liquidate, and the price you get will not be independent. Value of market goes down; then someone else has to revalue his position. Cascade. Theory of Bear Sterns arrangement was that if you parked the assets in government hands you could avoid this. Deep weaknesses in Bear Sterns; genuine split of opinion. Counterparties are going to be suffering. Characteristic feature was they kept the priorities straight. As a transaction, made some sense; as a precedent, could be disastrous. If they had kept to original model and reexamined fair value rules, might have been able to weather this storm. Holding fractional interests in mortgages. Can't keep the value of those high if you are simultaneously giving relief to every Tom, Dick, and Harry who can't pay his mortgage. Critical to not let government come in and upset the balance between the parties. Foreclosure properties with divided ownership: properties not kept up. Mortgage moratoria screws up value of property. Argument in favor of Bear Sterns is that if government messes them up, government has some obligation to keep them alive. Best solution is don't mess anything up. Allow private contracts to use a mark-to-market rule. Underpowered, committee controls that made it impossible to renegotiate. Not thinking about sustained disaster, contracts melded with loose money policy, coupled with aggressive subsidy policy through Fannie Mae and Freddie Mac, coupled with international capital market coming into the United States such as China.
59:30Telling 14-year old son about Roosevelt's packing the court. When age 10, told couldn't build an apartment building in your backyard, astonished: "In America?" Son has strong belief in rule of law and property rights. Stunned to hear Roosevelt tried to pack the court. Listener: What might check the power of the state? Constitution? Could say we are going through a bad time, government will have more power but when it's over we'll go back to the old days more or less. Court packing: no law violated. Constitution doesn't tell you the size of the court. Adding more gives too much power to one presidential administration; also, do all have to sit. Roosevelt violated customary norms. Part capitulation, part resistance. Everybody saw the writing on the wall in 1937, and justices would turn over anyway. Changed tune, regarded as country demands it so how can courts stand in their way. Weimar Republic. Not correct on the law. Modern situation: believe in separation of power, checks and balances. Facing now concordance of opinion, can't get system of checks and balances. Think long and hard about implications. Public relations skills, current and previous administration. TARP funds, can the funds be returned; may not be allowed.