How ‘Big Law’ Makes Big Money

“There is an estate in the realm more powerful than either your Lordship or the other House of Parliament,” one Lord Campbell proclaimed to the peers in the House of Lords, in 1851, “and that [is] the country solicitors.” It was the lawyers, in other words, who kept England’s landed elite so very, well, elite: who shielded and extended the wealth of the landowners, even granting them legal protection against their own creditors. How did they pull off this trick? Through a nimble tangle of contracts, carefully and complicatedly applied, as Katharina Pistor explains in her lucid new book, The Code of Capital: by mixing “modern notions of individual property rights with feudalist restrictions on alienability”; by employing trusts “to protect family estates, but then [turning] around and [using] the trust again to set aside assets for creditors so that they would roll over the debt of the life tenant one more time”; and by settling the rights to the estate among family members in line for inheritance. Solicitors maximized their clients’ profits and worth through strategic applications of the central institutions at their disposal: “contract, property, collateral, trust, corporate, and bankruptcy law,” what Pistor calls an “empire of law.”

The landowners themselves may not have understood this morass of legal relationships, this web, in Pistor’s words, of “claims and counterclaims, rights and restrictions on these rights.” No matter: by lawyers’ legal codifications, their wealth was increasing. The sort of legal logic applied in nineteenth-century England grows only more complicated, and more profit-generating, when the asset in question is not a hectare of country land but stocks and bonds and shares—when an entire organization is coded as a legal person (who can own assets and who can sue) through incorporation. The very form of a corporation, “by encouraging risk taking, by broadening the investor base and thereby mobilizing funding for investments, and by creating the conditions for deep and liquid markets for the shares and bonds that the corporation issues,” maximizes profit. And though today we live in a nominally democratic society, Pistor argues that a “feudal calculus” extends to our age: superior legal coding—that is, fancy private lawyers. Using the central institutions of private law, they make certain assets more valuable, and more likely to create value. “For centuries,” she writes,

private attorneys have molded and adapted these legal modules to a changing roster of assets and have thereby enhanced their clients’ wealth. And states have supported the coding of capital by offering their coercive law powers to enforce the legal rights that have been bestowed on capital.

Corporate law is “no longer primarily a legal vehicle for producing goods or offering services but has been transformed into a virtual capital mint.” Nowhere is this more true than in financial services corporations.

In 2008, for example, when Lehman Brothers investment bank failed, its legal structure was byzantine. It consisted of a parent holding company with 209 registered subsidiaries spread over twenty-six jurisdictions. This structure, constructed by some of the sharpest legal minds on Wall Street, was a machine designed to minimize Lehman’s regulatory burden by placing assets in locations with lax oversight, while still maintaining control over those assets from its managerial base in Manhattan. Lehman took huge but carefully hidden risks and stretched its collateral wafer-thin. When the going was good, it was immensely profitable. It also turned out to be dangerous—allowing Lehman to take on giant levels of leverage that, when the subprime mortgage market collapsed and liquidity dried up in money markets, threatened not just the firm and its shareholders, but the entire financial system.

Since the 1960s lawyers associated with the school of “law and economics,” developed at the University of Chicago by Aaron Director and Ronald Coase, among others, have been explaining how legal devices are invented to enable transactions to be conducted more efficiently. The basic line of argument is clever but monotonous. In case after case, the true function of a legal construction is shown to be that it aligns incentives of various economic actors—businesses, consumers, workers, and governments—in efficient and productive ways. For example, although granting property rights secures a kind of monopoly for owners, it encourages investment because legal owners can expect to reap the long-run benefit of up-front expenditures.

Clarifying the boundaries of property rights prevents arguments over who owns what and thereby reduces transaction costs. The hidden logic of Lehman’s complex legal structure, according to a law and economics analysis, was that it allowed assets to be assigned to separate entities, thus enabling creditors to focus their attention on particular components of the business, thus achieving a better balance of risk and return.

The analysis of property rights also informs grand historical accounts of the rise and fall of nations. According to a long line of Whiggish authors, regimes that recognize encompassing and stable property rights will prosper. Those that succumb to the rapacious interests of short-sighted rulers or narrow special interests will undercut the incentives for productivity growth. They are doomed to stagnation and ultimately to failure. According to its Western critics, even the mighty Chinese Communist Party will have to bend to this historical logic. If it does not establish secure private property rights and the predictable rule of law, China’s growth will grind to a halt.

For fifty years the law and economics movement has had a huge influence on America’s law schools. But today it faces a challenge from a new cohort of radical legal thinkers who gather under the banner of “law and political economy.” The “About” page of the Law and Political Economy blog, which arose out of a seminar led by Professor Amy Kapczynski at Yale Law School, declares, in what amounts to the cohort’s manifesto:

Our blog begins from the observation that democratic political processes have lost control over fundamental decisions about how resources are allocated in our society. Legal doctrines enable champions of capital to subordinate democracy to “the free market.” We seek to develop a response by mapping how legal rules concentrate economic and political power amongst dominant social groups, and simultaneously build and expand modes of legal thinking which embed the economy in social life.

There is a similarity between this moment of agitation within legal academia and earlier moments in American history, such as the progressive era, when antitrust laws were first passed. But today’s critique of law has multiple sources beyond the muckraking tradition, and its point of attack is deeper. What is ultimately at stake is the alignment between a rights-based model of political and social organization and the highly unequal political economy that the crisis of 2008 so starkly exposed.

The Code of Capital brings together the ferment in American law schools and the more broad-based continental critical tradition, with concerns derived from Thomas Piketty’s history of inequality and recent thinking within so-called heterodox economics about the unstable nature of financial capitalism. The result is nothing less than a crisis theory of law. Law as it currently functions is, for Pistor, constitutive of the order that creates and perpetuates inequality, opacity, dysfunction, and crisis, and ultimately puts at risk the legitimacy of the rule of law as such.

Her rethinking of the purpose of law starts from the ground up. In the liberal account of property rights, the crucial question is how far law and the courts can protect private property against the capricious, self-interested, and short-sighted acts of the government. Individual property must be protected, in this view, not only because of the inalienable right to enjoy what one owns without fear of damage or theft, but also because if there were no guarantee of this right, economic progress would be impossible. Few would make an investment in a business that couldn’t seek redress for major acts of vandalism or larceny.

In Pistor’s reading, the basic question is the reverse. What is decisive is which private claims to property governments have been willing to underwrite with the force of the law and what consequences those decisions have for wealth creation and distribution and the development of the economy at large.

This shift in perspective also implies a reconceptualization of capital. Whereas to a conventional understanding, capital is most readily conceived as a physical thing—a steel mill, for instance—that must be shielded against grasping hands, Pistor insists, quoting the University of Chicago historian Jonathan Levy, that capital is a “legal property assigned a pecuniary value in expectation of a likely future pecuniary income.” What turns a steel mill from a physical unit into a claim on a likely flow of cash income are laws, backed by the force of the state, establishing ownership of the mill and the means by which its products can be sold for profit.

For Pistor, as for others in the critical tradition, the entanglement of law, power, and property goes back to the moment that Karl Marx called “primitive accumulation.” Beginning in the sixteenth century in Northern Europe, land previously used in common was enclosed and made into the basis for a new, market-based agricultural system. As the Oxford legal comparativist Bernard Rudden put it:

The traditional concepts of the common law of property were created for and by the ruling classes at a time when the bulk of their capital was land. Nowadays the great wealth lies in stocks, shares, bonds and the like, and is not just movable but mobile, crossing oceans at the touch of a key-pad…. In terms of legal theory and technique, however, there has been a profound if little discussed evolution by which the concepts originally devised for real property have been detached from their original object, only to survive and flourish as a means of handling abstract value. The feudal calculus lives and breeds, but its habitat is wealth not land.

The enduring entanglement of modern property law with this original “feudal calculus” is a thread running throughout Pistor’s book. Most importantly, it informs her skepticism about the alignment that is commonly assumed in liberal grand narratives among progress, property rights, and the rule of law (understood in the sense of the universal applicability of general rules, such that no one class received preferential treatment by the state). There have been revolutionary moments, Pistor concedes, in which property owners did line up behind the demand for general rights—the American and French Revolutions being cases in point. But once their property was established, owners became, like their feudal predecessors, defenders of privilege. They have advocated not universal binding rules, but what Max Weber called a “modern particularism,” finding ways around the law when it suited their interests.

In the twenty-first century, examples of this modern particularism are rife. Pistor describes, for instance, the exceptions from general bankruptcy rules negotiated by the derivatives industry. In normal bankruptcy cases, secured creditors can claim access to their collateral first, and unsecured creditors have to divide what remains of the company or estate. For fast-moving financial transactions, that procedure is too cumbersome, so the collateral pledged in derivatives deals is granted an exemption from the usual queue of claims. In cases of bankruptcy, it is transferred directly to the counterparty, leaving unsecured creditors empty-handed. Another example would be the right claimed by foreign investors to challenge the normal operation of national courts in their host countries. Or the deals negotiated annually with the authorities by large taxpayers over what their tax bill will actually be. Or the haggling between regulators and banks over whether they meet the criteria laid down by the Dodd-Frank legislation of 2010.

The result is a legal order that is relentlessly insistent on the priority of rights and of property rights above all, and yet shot through with exceptions and reservations. Indeed, in the unwinding of Lehman’s derivatives holdings, it turned out that so many creditors could claim exceptions to the normal bankruptcy rules that the value of the privileges themselves was put in question.

The modern network of powerful property owners is knit by the clique of “big law” firms that operate around the world, above all from bases in London and New York. The legal codes that they prefer are the English common law and the law of the state of New York. What lets them choose their code, regardless of where their operations are legally domiciled, are so-called conflict-of-law rules that allow the parties to a contract to choose the legal code by which they wish to be governed. The standard framework contract, or “Master Agreement,” devised by the International Swaps and Derivatives Association to govern trades running into the hundreds of trillions of dollars, specifies that the parties should agree to be bound either by English law or the law of New York State. For tricky issues like intellectual property, which is granted through a patent by a particular government, special treaties have been arranged in order to protect patents abroad.

Across this patchwork empire of law, the same tools (which Pistor calls “modules”) are employed again and again to “code” property and assets, such that they are protected as sources of private wealth and future income. The four principles of the coding procedure that Pistor identifies are priority, durability, universality, and convertibility. The priority of claims regulated by law is what ultimately confers ownership: the priority of my claim to an asset allows me to remove an asset from the common pool and privatize it. Durability gives assets a life that may extend beyond the biological lifespan of their owners. Trusts and corporations are classic modes of ensuring legal longevity. Universality provides that contracts between two parties are recognized by erga omnes, i.e., all others. It is a claim that presupposes a third-party guarantor in case of disputes over the agreement; in the last instance, the state can compel the parties to abide by its interpretation of the contract. Finally, convertibility is the most attractive link in a chain that starts with the transferability of property. If it can be bought and sold between private parties, property can circulate. Once it circulates widely enough, it can serve as a means of payment. But the ultimate means of payment is state-issued cash. Convertibility is the privilege of certain classes of preferred financial assets—such as highly rated debts—that ensures they may be exchanged for cash at close to face value.

The modules are abstract and capable of reinterpretation. Lawyers are creative, and contracts are incomplete. They always fail to capture some unexpected feature of reality. So there is plenty of room both for innovation and for confusion and dispute. But that by itself is not enough to explain the recurrence of capitalist crises. For that we need to add a further dimension: how law facilitates the gigantic speculative dynamic of modern finance.

As Pistor puts it, “Debt, the private money that has fueled capitalism since its inception, is coded in law and ultimately relies on the state to back it up,” by way of the courts under normal circumstances and through bailouts if a debtor is too big to fail:

The history of debt finance can therefore be retold as a story about how claims to future pay have been coded in law to ensure their convertibility into state money on demand, without suffering serious loss…. By dressing private debt in the modules of the legal code of capital, it is possible to mask the liquidity risk for a while, but not forever. Whenever investors realize that, contrary to their expectations, they may not be able to convert their debt assets into cash, they head for the exit; and if many do so simultaneously, this will precipitate a financial crisis.

Note that the law does not just constitute and codify claims to property. In Pistor’s reading, the function of law in finance is to sustain a fiction. It is to “mask,” or “dress up” and “garnish” claims by packaging debt-ridden assets into products such as derivatives. And she roots this in a familiar impulse: “The dream to create something from nothing is as old as mankind. Alchemists have long searched for recipes….” But it is not just private creators of credit who succumb to the lure of debt alchemy. States too create purchasing power by monetizing debt. As Pistor points out, the difference is that “states at least have the power to impose obligations on their citizens to make good on these promises.” States can impose taxes to generate the revenue necessary to service their debts. By contrast, “private parties do not possess such powers…. They imagine fantastic returns in the future, but in fact will have to obtain new loans to cover old debts”

Lawyers, therefore, sustain a fiction by dressing up claims and placing them in opaque asset-backed legal entities and applying an alphabet soup of labels—SPVs, MBS, CDOs. But, Pistor insists, there is a basic constraint on this exercise in the nature of the assets that underlie such entities: “At the other end of the deal, there are still the same little old houses, which their owners can barely afford and that may not hold their value once the funding machine that helps fuel prices in real estate dries up.” The fantasy that a subprime mortgage could be turned into a AAA-rated security collapses, just like the alchemical promise to turn lead into gold.

Pistor thus lays out a double indictment of the law. On the one hand, the law codes the original violence of enclosure, such that something that was everyone’s becomes one person’s legally protected private property in perpetuity. On the other hand, the law is the conjurer of a delusion. By creating securities out of debt, the law preys on our desire to believe that something is ours that is not real at all, that value can be created ex nihilo.

This is a powerful polemic. But is it enough to deliver on Pistor’s subtitle, to account for the structure of wealth and inequality in modern society? What about the more routine drivers of growth and inequality, such as the unequal rewards to labor and capital and the extreme divergence between different types of managerial and routine labor? Once we pose the question this way, what is remarkable is how little space Pistor gives to what was once the central terrain of critiques of capitalism, namely production, labor, and accumulation. Once upon a time, if the question was how law created wealth and inequality, the focus would have been on labor law and how the state and the courts systematically favor the employer over the employed. But the only mention that labor law receives in The Code of Capital is a brief discussion of the role of noncompete clauses in distorting competition in Silicon Valley.

In seeking to mark her position off against Marxist arguments that the capitalist state creates inequality by sanctioning “primitive accumulation” and exploitative labor practices, Pistor claims that her focus on the process through which private law is used to code capital allows her to “explain the political economy of capitalism without having to construct class identities, as Marxists feel compelled to do.” But any Marxist would surely reply that this is a sleight of hand. If one confines the thrust of one’s analysis to issues like derivatives regulation and intellectual property, class identities are, indeed, unlikely to play an important part. What is at stake in those deals is the distribution of surplus within the capitalist class. When that goes wrong, it can have a disastrous impact on the entire economic system. As we saw in 2008, it can even cause an enormous financial heart attack.

But no one ever claimed that markets for interbank lending were the main arena in which the line between the haves and the have-nots is drawn. In the modern world, in which so much production has been outsourced, the main arena for class conflict in the classic sense is probably in the factories of East Asia, and the function of law in that struggle is far from obvious. Where Pistor does address important areas of distributional struggle, notably with regard to land enclosure, she unhesitatingly invokes distinctions between landlords and peasants—precisely the kind of class categories she claims to be able to do without. The violence of that moment of early modern enclosure and expropriation no doubt echoes down to the present, but that can explain only part of modern-day inequality.

The closest that Pistor comes in The Code of Capital to analyzing what might be called a site of production is in her interesting discussion of intellectual property. Once again, she gives us fascinating insights into the role of legal lobbyists in the construction of the global intellectual property rights regime. The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) secures extraordinary protections for large Western firms in their dealings all over the world, on the pain of sanctions by the United States.

In Pistor’s reading, it is a classic instance of “modern particularism” writ large, the “feudal calculus” extending to the very cutting edge of modern science, as in the case of patents on synthetic cDNA molecules. Fittingly, her chapter title “Enclosing Nature’s Code” harks back to the struggles that founded agrarian capitalism in early modern England. Yet there is a subtle but crucial shift. In manipulating the patent system and applying it to parts of the human genome, lawyers are up to their usual tricks. They are repurposing the modules of their code to create new capital. But what creates the opportunity for profit in this case is neither the conquest of someone’s ancestral grazing ground nor legal artifice of the type on display in the construction of derivatives contracts and asset-backed securities. What creates the opportunity for profit is a major scientific innovation, backed by the industrial infrastructure of labs and hospitals that generate the value of the discoveries by manufacturing and selling them.

And here the oldest defense of the law enters back in. It can hardly be denied that the search for profit does fire a large part of research and development, on which productivity growth across the economy depends. Of course, that is not the only motivation for research. Pistor highlights the explosion of scientific creativity in molecular biology since Crick and Watson’s discovery of the double helix. And public funding on both sides of the Atlantic helped keep the human genome in the public realm. But precisely because the goal of this research was not profit but scientific discovery, the human genome is hardly a typical case of research and development. Especially given the decline of publicly funded science, most research is now done by universities and corporations and directed from the outset toward the generation of profit, for which the legal protection of patents or the shroud of trade secrecy is essential.

But Pistor waves that kind of argument aside. We have seen, after all, how the doctrine of improvement has been implicated in the brutal process of dispossession and enclosure all over the world. The self-serving justifications of the pharmaceutical industry for their excessive drug pricing have gone a long way toward discrediting the patent system altogether. As Pistor says, we need no more such “fairy tales” to justify the privatization of common property. That is certainly true. But when one treats biotech patents as equivalent to Elizabethan land enclosure and equates modern finance to alchemy, and when one gives pride of place to these as opposed to accumulation and labor as modes of producing and distributing wealth, one is engaged in one’s own kind of storytelling. The question must surely be what purpose that storytelling serves.

The work that the apologetic discourse of law and economics does in justifying the status quo has been starkly revealed by the crises of the last decades. In the name of efficiency, high-powered legal academia justified both dangerous financial practices and the creation of monopoly. If instead, like Pistor, we attribute the production and distribution of wealth to a combination of legalized theft and an elaborately veiled ponzi scheme that moves money around without creating anything of real value, we are certainly speaking the language of the left, but it is a language with a distinctly populist tinge. A true Marxist would at this point interject that only a politics that grasps exploitation at its root, not in the sphere of distribution but in the sphere of production itself, can really offer any escape from prevailing conditions of inequality. But Pistor holds Marxism at a distance both analytically and politically. Understandably enough, she dismisses any prospect of a Marxist revolution against capitalism. Leftist populism, on the other hand, is enjoying a substantial vogue both in Europe and the Americas. And perhaps the best way to read Pistor is as offering a highly sophisticated program for a leftist economic populism.

Pistor concludes her powerful book with a list of practical policy suggestions. Their basic aim is to make clear and visible the ultimate dependence of private assets on public legitimation, to subject private coding of property rights to public scrutiny, and to undercut the monopoly of “big law” on legal coding. Specifically, she argues that there should be a clear rule banning any further extensions of capitalist legal privilege in legislation and treaties. There should be obstacles put in the way of corporations choosing the jurisdiction of greatest convenience. The role of private arbitration in settling disputes between corporations and consumers should be curbed in order to assert the sovereignty of state courts. Private legal arrangements that generate large externalities—costs borne by others, such as environmental damage—for the public should be subject to restraint. The outsized influence of lobbyists should be redressed. Old limits on coding capital such as the nonenforceability of purely speculative contracts should be revived, however hard it may be to draw such a line.

These are technical suggestions. But their ultimate aim is political—to offer an effective answer to right-wing populism. As Pistor says, in recent years we have seen “rampant attacks on independent judiciaries and the free press, not only in relatively young democracies, such as Poland or Hungary, but in countries with a long tradition of democracy and the rule of law, such as the United Kingdom and the United States.” These, in Pistor’s view, are political responses by electorates “desperately trying to regain control over [their] own destiny.” The nightmare she invokes is Karl Polanyi’s diagnosis of the interwar backlash against the predominance of capital that in his view spawned both fascism and communism.

But the promises this right-wing populism makes of “taking back control” are dishonest, since power usually ends up concentrated in few hands and with little oversight from the people. The best response to the appeal of this kind of populism, Pistor suggests, would be a real demonstration of popular sovereignty. And what prevents that demonstration are not the bugbears of national populists: international treaties, the EU, or an influx of foreigners. The main limitation is capital. What is required, therefore, is a “rolling back” of laws favorable to wealthy corporations and individuals, and a forceful demonstration that “the power to determine the contents of law lies ultimately with the people as the sovereign.” That is the ultimate purpose of her technical recommendations, which have no chance of realization without a dramatic assertion of popular will. The proper responsibility of a reformed and self-critical legal profession, reorganized around a new model both for funding law schools and determining professional compensation, would be to support this assertion of popular sovereignty. The result, Pistor hopes, will be nothing less than a “true transformation, not an elimination, of rights and of law.”

Pistor’s proposals are surely worthy of applause. But one is left wondering whether her emphasis on the clash between capital and the people, with the legal profession as the crucial mediator, does justice to the third party in her story: the administrative state. Again and again, the state is invoked in Pistor’s analysis as the ultimate enforcer of the law. As she says, “Without power, law is at best fleeting and at worst ineffective.” But as crucial as the state is to Pistor’s account, it remains a shadowy and abstract presence, as if to reflect a sad reality: the administrative state, particularly in the US, has withered away in the face of decades of political and fiscal assault, and through the insidious work of the “private coders of capital,” their clients, and their cheerleaders in the mainstream legal academy.

If a rebalancing of public interest and private right is essential, if what we need is a reassertion of political sovereignty, then one of its central prerequisites is a reconstruction of state capacity. This, too, is a project in which the law and lawyers have a crucial part to play.