In the wake of the recent Hobby Lobby decision by the US Supreme Court readers may be interested in my earlier take on the corporate personhood debate published on line at Dissent Magazine here.
This post is co-authored by Stephen Diamond and Jennifer Kuan. Jennifer is an economist based at the Stanford Institute for Economic Policy Research. The post is based in part on an event study we conducted on the impact of Reg. NMS. We will be presenting the paper at the meetings of both ISNIE (Duke) and SASE (Northwestern) this summer.
A firestorm erupted on Wall Street recently sparked by author Michael Lewis’ accusation that the stock markets are “rigged.” Mr. Lewis’ bases his claim on the allegedly manipulative behavior of so-called “high frequency traders,” or HFTs, in today’s financial markets.
Our own study of the changing structure of those markets over several years leads us to conclude Mr. Lewis is correct when he contends many investors trade at a disadvantage to HFTs. We found a significant widening of “spreads,” and therefore costs to investors, following rule changes by the SEC in 2007. Significant structural reform will be needed to restore transparency and fairness to our financial system.
While the issues at stake are complex, the heart of the matter is that HFTs have largely replaced stock exchange “specialists” as intermediaries between buyers and sellers of shares. HFTs trade large volumes of stock, so they claim to provide “liquidity” to the markets. This sounds reassuring to investors who think they can easily buy or sell at reliable and visible prices.
In fact, HFTs are largely free of the obligations and oversight once imposed on specialists by the New York Stock Exchange. HFTs are not mandated to maintain an orderly market like specialists and often disappear at the very moment they are so desperately needed. There is evidence this kind of behavior contributed to events like the “flash crash” of May 2010 as well as the failed IPO of Facebook in 2012.
Exchanges are now eager to profit from HFTs’ vast trading volumes so they help HFTs exploit advantages over other investors, allowing the use of complex and arguably manipulative order types as well as selling them access to data about other investors’ orders. Other enablers of HFTs include the telecommunications firms that allow the HFTs to engage in “fiber arbitrage” to gain privileged high-speed access to data and markets. HFTs use these advantages to move more quickly and flexibly than other investors and thus to trade ahead of ordinary investors at a profit.
The most important enabler, however, is the federal government itself. In 1975 Congress mandated the creation by the SEC of a “national market system.” Congress decided that if the SEC could create computer-based competition with the long dominant New York Stock Exchange’s manual trading floor then costs for the average investor would fall.
The SEC implemented a wave of new rules over the next thirty-five years that did, in fact, reduce trading costs. New electronic markets such as the Nasdaq now compete effectively with the NYSE. Smaller startup companies like Intel, Apple and Microsoft, which did not meet the stringent listing standards of the NYSE, were able to access investor capital on the Nasdaq.
But this was not enough for the SEC. Their goal was an end to the NYSE’s dominance of trading in blue chip firms listed on the NYSE. As the Charlie Sheen character Bud Fox would famously say in the film Wall Street, they were “going after the majors.” One backer of the new approach was Bernie Madoff, who led the automation of the Cincinnati Stock Exchange in the 1980s to draw trading volume away from the NYSE.
The NYSE and the large banks that dominated its board resisted these efforts for many years. But new demand for faster trades from institutional investors provided the political support the SEC needed to push through Regulation National Market System, or Reg. NMS, in 2007.
This was the straw that broke the camel’s back.
Until 2007, despite the earlier rule changes by the SEC, the NYSE still handled more than 80% of the trading volume of companies listed there. The NYSE was a monopoly but it stabilized price changes with narrow spreads using a self-regulatory framework crafted over its 200-year history.
Two features were key to that framework. First, because large underwriting firms wielded significant influence at the non-profit member-owned NYSE, they could and did impose stringent standards on firms that wanted to list their shares on the Exchange. Second, to attract investors to trade on the Exchange those same underwriters insured that floor brokers and specialists behaved fairly. The result was good quality information about listing firms as well as orderly pricing facilitated by specialists in both bull and bear markets.
But Reg. NMS uprooted that system. Brokers could now route their clients’ trades to any electronic venue even if it meant that the client did not get a better price available on the NYSE floor. As a result, the volume of NYSE shares traded off the NYSE exploded. The motivation to own the Exchange in order to attract investors with orderly prices was gone and the underwriters quickly sold the Exchange to public investors.
With stock prices no longer kept in check by the NYSE’s longstanding rules, our study found that spreads widened, volatility increased and the cost to the average investor went up. Congress had a useful idea in 1975 when it helped create a market for risky technology start-ups and other small firms. They need to step in again to deal with the unintended consequences of that important innovation.
It was clear enough during the 2008 campaign but many ignored it. It became more clear as Obama took office and attempted to “engage” with authoritarian regimes all around the world. Even then the commentariat, particularly on the left, did not understand what was going on. One by one the left ignored the implications of Obama’s approach – in Tibet (snubbing the Dalai Lama, in Iran (snubbing the Green Revolution), in Venezuela (cozying up to Chavez), in Cuba (cozying up to Raul Castro), in Egypt (standing by the military), in Syria (erasing his own red line).
But now with the invasion of Ukraine by Putin the results of five years of Obama foreign policy are undeniably clear.
Obama has thought all along he could appease authoritarian regimes and lure them into a fantasy world of global trade and governance. The fact is that despite the end of the cold war more than 20 years ago authoritarian regimes persist and have shown incredible resiliency. China’s neo-stalinist model is working, for the party and its allies in the new entrepreneurial class. And in Iran, Syria and elsewhere, authoritarianism continues to draw widespread support. These authoritarians have no interest in neo-liberal fantasies about free trade and free markets. The volatility and instability of those markets, brought home to hundreds of millions when the western financial system collapsed in 2008, is fuel for the fires of the authoritarian alternative.
To this alternative Obama has no answer. He rode the wave of naive liberal left distaste for global war and politics to office and now that political capital has exhausted itself.
This is a huge problem for the American national security apparatus and for American global economic power as well. The country is led by someone who does not understand what is going on in the world and cannot craft a coherent response to it. He is wedded to a relativist outlook born in the pro-third world neo-stalinist rhetoric of the late 1960s that helped shape his early world view. He will not be able to shed that history or outlook and it is extremely difficult for the institutional apparatus of US power to act coherently when the White House is led by a team that is so intellectually and politically stunted.
But it is an equally large problem for the global left. This global left emerged in the late 1990s, a product too of the end of the Cold War. There was hope in the protests against the WTO and globalization that a new democratic alternative could emerge from below, linking the workers movements of Poland with those of Brazil, the environmental movements of the first world with the movements for agrarian reform in the third world. But since 9/11 that nascent left has spun this way and that completely disoriented by the continued health of authoritarian regimes. Thus the left has become largely only an anti-war left and sometimes worse, offering apologies for the behavior of regimes like those of Syria and Iran and no doubt now in defense of Putin. So much for the defenders of Pussy Riot.
The left must firmly declare its opposition to authoritarianism wherever it appears. To do so is not to give comfort to the war mongers on the right. Instead it will help establish the left as a credible alternative to US unilateralism. From that position the left must then begin to articulate a new foreign policy for the US based in our own deeply held democratic instincts and institutions. I began one such approach with the call for a new “Solidarity Doctrine” here.
The risks of the new era are now clear to all – the statist authoritarianism is in a clash to the death with western market fundamentalism. Neither can win but they can both destroy.
As I said in 2012:
“We have the technological and economic resources to solve these problems and build healthier alternatives. We know the institutional framework – democracy and freedom – that must be in place for those resources to be effective. Instead of developing a foreign policy that matches our resources with that institutional framework, we have instead used the crude tools of neo-conservative intervention or the dangerously naive relativism of spent late-60s ideology. A “Solidarity Doctrine” offers a new approach.”
My spring seminar, Law and Labor in the Fields, is underway.
Our first guest speaker will be here this coming week, Thursday, January 30. He is Frank Bardacke, the author of a magisterial and award winning new history of the United Farm Workers called Trampling Out the Vintage: Cesar Chavez and the Two Souls of the United Farm Workers published by Verso.
The event is open to the public and will take place in Room 333 in Bannan Hall on the Santa Clara University campus, 500 El Camino Real, Santa Clara, CA 95053. It starts at 4:05 and runs until 5:45. The talk and discussion will be followed by a reception to which all who attend the talk are invited.
There will be several other public talks during the semester. The schedule for the entire semester can be found here: Seminar Schedule.
The seminar is dedicated to the memories of both Cesar Chavez, who passed away 20 years ago last year and the late Herman Levy, our Santa Clara Law School colleague who played a key role in drafting the Agricultural Labor Relations Act, who passed away ten years ago.
Links to video of presentations can be found here.
My first time on NPR’s Marketplace! (But I would never the use the word “squat” outside the gym.)
I discussed this issue on Nightly Business Report with Julia Boorstin recently.
Vic Fleischer gets it right about tenure (even though I disagree with his views on VC’s carried interest.)
The recent downturn in the general economy is impacting legal hiring and too many recent law graduates got caught in the downdraft. The loans they thought they could afford have, for the time being, become unaffordable. They are suffering as are many millions of home owners, car owners and consumers.
I have argued here and elsewhere about the importance of providing debt relief and job programs for these highly trained graduates. Sadly the leading players in the “law school death watch” crowd refuse to endorse such efforts. Clearly they have another agenda altogether. This includes supporting law suits against law schools for specious allegations of fraud. (Lawyers suing law schools – sounds almost as desperate as screen writers writing about Hollywood.)
The calls by the “law school death watch” folks for shutting down law schools, firing faculty (including personal attacks on individual faculty who voice support for law schools’ academic role), increasing teaching loads and other short sighted efforts fail to recognize, as Yale’s Owen Fiss recently did with such eloquence, the unique value of our academic institutions, particularly the important role that law schools play in a law-bound society such as ours.
These calls also fail to account for the natural volatility of a capitalist economy. In other words, the very reason I think Fleischer is wrong about the “capital” as opposed to “labor” nature of carried interest points to the inherent cyclicality of our economy.*
Law schools and legal hiring have never been immune from these cycles, even in the heyday of the Kingsfield era. But as I explained in a recent paper here, we try to protect the law school from some of that cyclicality in order to maintain the law school’s integrity with respect to the surrounding society. Faculty accept lower salaries and the other perks of taking on the risks of the private marketplace in return for their commitment to pursue knowledge and train future lawyers. The entire society gains thereby.
And while the recent downturn has been more painful and long lasting than many in the recent past, it is only a shortsighted institution – apparently including venerable Seton Hall University – which throws away blithely its invested intellectual capital.
*As opposed to Professor Fleischer, I think it is credible to argue that carried interest represents risk taking that is distinct from wage labor, but that is more properly explored elsewhere (for example, by tax scholars Doug Kahn and Jeff Kahn here.) Of course, the thuggish and short sighted attacks he suffered for his work are beyond the pale.
As the ordinary Egyptian population stood up and said it was no longer willing to follow Iran and other middle eastern countries into the abyss of authoritarian and fundamentalist Islamist politics, the mouthpiece of western arch-conservatism, the editorial board of the Wall Street Journal, was thrown into a panic. In an editorial published, sadly, on our Independence Day, the paper called for the installation of a Pinochet-like General in Egypt.
Either the Journal has been struck by some kind of severe cognitive disorder that allows it to paint over the history of one of the most brutal regimes to have ever ruled or they really mean it. If the former, they owe their readers and the Chilean and Egyptian people an apology and should retract the statement. If the latter, then they are in fact the leading edge of a new fascism emerging here in America. Since I am not a medical professional, I will simply comment on what it means to suggest that fascism is the right outcome in Egypt.
First, for any of my younger readers, if you want a taste of what it means to be for a Pinochet then go to iTunes and download this week’s Editors Choice – the film “NO” which recounts the very final stages of the Pinochet regime, after the blood had been washed off the streets. If you have a stronger stomach, then find a copy of the magnificent Battle of Chile, an important long documentary film that includes amazing and disturbing footage of the Allende era and the imposition of the U.S.-backed brutal Pinochet dictatorship, now viewed as a political model for the middle east by such august figures at the Journal as Paul Gigot, Daniel Henninger and the recent Pulitzer winner Bret Stephens. (Stephens, the recent recipient of a Pulitzer, we have encountered before on these pages – it seems he looks for his ideas all over the place and is not always willing to give proper credit.) The Battle is hard to find but you can also look at Missing the fictional account of an American, Charles Horman, who was kidnapped and tortured to death by Pinochet’s thugs.
Here is a capsule summary of the Pinochet period, though, just so we are all on the same page: 3,000 murdered; 30,000 tortured; political parties outlawed; trade unions smashed; nearly two decades of brutal repression and fear. Two of those killed were blown up by Pinochet’s secret DINA police force on the streets of Washington D.C. The regime was installed with the not very covert support of Henry Kissinger and the Nixon Administration. Pinochet was feted by “Lady” Margaret Thatcher and other right wing thugs in order to burnish their own domestic reactionary politics. Pinochet’s regime was advised by economists trained in the shock therapy politics developed by Milton Friedman at the University of Chicago.
For brevity’s sake I will spare readers an account of the book burnings carried out by the regime.
Now that we are all up to speed on what one is talking about when one invokes the name of Pinochet, what does it mean that the Journal would react to the unfolding events in Egypt like this? It means, most likely, that American conservatives are in a full blown panic over the popular uprising we have witnessed there in recent days but not only there. It signals broader panic among the Wall Street and D.C. elite over what is known as the Arab Spring, the region wide unfolding of a new democratic era in a part of the world that has for many decades found itself in the grip of what ever great power rivalries were taking hold in Europe, first, and later, in the cold war, between the great US and Russian blocs. For the first time, the region’s own populations are speaking up independently and saying, as the Chileans did to Pinochet, No.
This kind of democratic uprising is, inevitably, messy and volatile. There is, undeniably, also the presence of opportunistic forces that are not democratic, most clearly the Islamists. That makes the situation particularly complex but does not mean that the overall direction is one we should fear or condemn. Chile was able to make a more peaceful transition but only because a pre-existing political culture that had thrived in a long period of relative stability and democracy prior to the Pinochet period was able to survive underground and re-emerge when the regime finally was pushed aside. Egypt, Syria and Libya do not have that luxury, as they have been either under the direct colonial thumb of imperial powers such as Britain or held down by the local thugs representing post-imperial powers for generations.
Since the great powers have invested billions and many decades in creating the authoritarian regimes now being challenged, it appears to the mouthpieces of those same forces, like the Wall Street Journal, that all is chaos. Even “liberal intellectuals” like Harvard’s Noah Feldman are frightened by the disorderly nature of the popular effort to recreate these long repressed societies. He condemned the Egyptian millions as a “mob” as I explained here.
No doubt, when one is threatened with the loss of a significant investment panic is a reasonable enough reaction. But should they really be surprised that the “order” they imposed on the backs of the middle east is now under challenge?
It is a sign of how the world is turning on its axis now that the Journal would go this far. The Egyptian people are to be congratulated for being among the first to put their shoulder to the wheels of history and pushing.
Let’s hope the American people will find the courage to join them. Then the Journal’s editorial writers can join their fascist comrade in arms Pinochet in the ash can of history.
Cheers went up loudly around Silicon Valley today, at least in the C-suites of the large incumbent companies. Why? Because now the President, who has been a heavy fund raiser here in the Valley, is promising to institute reforms of the nation’s intellectual property regime that favor those incumbent companies and potentially harm inventors and entrepreneurs. This follows a recent shift in our patent regime, also heavily tipped in favor of large well established technology companies, that favors those who are the first to file for a patent not the first to invent a new technology.
For years, law firms, academics and lobbyists working for big technology companies like Apple, HP and Intel have been pushing for these kinds of reforms. But the individual entrepreneurs and inventors who have historically been “present at the creation” of these now giant companies are not able to make their voices heard in the same way. They are widely dispersed, often young and without the huge resources of the incumbents.
Many new inventions threaten the existing invested capital of the incumbents and they are in fact worried about the impact they could have on their existing business models. In fact, many new ideas are unable to find investors or are swept up into the giant portfolios that the big companies now assemble and are never heard from again.
That’s why a young Bill Gates in the 1970′s made a passionate defense in favor of the IP rights of writers of software code for startups like his, but years later Gates started attacking the granting of patents to code writers. As Richard Stallman of the Free Software Foundation discovered:
“Here’s what Bill Gates told Microsoft employees in 1991: ‘If people had understood how patents would be granted when most of today’s ideas were invented and had taken out patents, the industry would be at a complete standstill today…A future start-up with no patents of its own will be forced to pay whatever price the giants choose to impose.’”
Of course, Microsoft was fast becoming one of those giants and now it uses that power to back groups like Intellectual Ventures which is scooping up thousands of patents and providing expensive mass licenses to firms that want a moat around their business model. Valley VC’s recently established a firm called RPX that does much the same thing.
It is no surprise then that an older successful Bill Gates was once asked what kept him awake at night and he answered – to an audience in Palo Alto – the fear that two guys in a garage somewhere nearby were developing a new way of doing things that would threaten his business model. Ironically, at that very moment, in the late 90s, Sergey Brin and Larry Page had started a little company called Google, first in their dorm rooms at Stanford and then in a nearby garage.
In other words, when the IP system helped a young Gates he tried to enforce it, when it began to threaten him he found ways to change it. Gates is not alone in this, of course, as Apple and Intel and Cisco and HP and ATT and IBM all do the same thing. But do we ever stop to ask, where will the new forms of these companies come from?
One of the targets of the patent reform movement are companies derisively labelled “trolls.” In the pure form these are companies formed solely to buy up orphaned technology that may have value because it is possible there are infringers out there in the world of existing companies. Thus, these companies provide a valuable secondary market for the exploitation of technology that inventors can no longer afford to pursue. Our entire economy is built on similar kinds of secondary markets, for IP and for financial instruments and for entertainment products, heck, even for used cars.
The advantage of these markets is that inventors know there is at least some value they can get out of their invention even if they cannot build an entire company around it. The existence of this market also signals to incumbent players that they have to play by the rules. I spent eight years on the board of directors of a technology company whose original inventions were trampled on by big players, like AMD, Apple and Intel. That destroyed the company and only an aggressive licensing and litigation strategy helped recover some value for our shareholders.
That (eventually successful) strategy was long, complex, expensive and unpredictable. Now the new reforms will make defending the original ideas of our entrepreneurs and inventors even more difficult.
The bottom line is that in many ways we are all “trolls” now because the pace of innovation is so intense that every inventor and firm must have an aggressive IP strategy, both defensive and offensive.
And yet when firms like the one I helped out as a lawyer and a board member try to defend their own technology, they are dismissed as “trolls.” When firms like Acacia Research emerge to provide a secondary market for IP that might otherwise be grabbed without compensation by larger players they are dismissed as trolls.
Meanwhile, it is the large incumbent and increasingly less innovative companies that are using their resources to capture the political process in order to defend their slowing business models.
We will all pay a price in a weaker culture of innovation.