The Invisible Hand for Me, Not Thee

Wall Street’s defenders have no problem going after lawyers.

The problem with market fundamentalism is not so much its principles as its lack of any. Yes, yes, we’ve all heard about “the knowledge problem,” “public choice,” and “the invisible hand.” But while, miraculously, in every case some long-ago sage has already proved exactly what the fundamentalists want to believe, those insights never extend to situations where they might rather believe something else.

Policymakers cannot possibly be expected to develop reforms that would strengthen markets, you see, and even if they could, the legislative sausage-making process ensures that what comes out will make things worse. Unless the subject is tax cuts, in which case elaborate tax reform plans should definitely be Congress’s focus. Likewise, notwithstanding the boogeyman of “industrial capture,” the time is always right for another 5,000-page trade agreement.

And while the fundamentalists never cease to amaze, it will be difficult to improve upon National Review’s latest cover story, by David Bahnsen, on “The Next Supply-Side Battle.” Bahnsen, you’ll recall, delivered a 30-minute, straight-to-camera soliloquy earlier this year for a National Review podcast responding to my New York Times essay on financialization. The argument that Wall Street’s leveraged buyouts and hedge-fund speculation do not create value, or indeed are economically counterproductive, was “utter juvenile insanity,” he said, “too stupid of a view for any grown adult,” and “absolutely mind-numbingly stupid.”

Surprisingly, then, though it’s not really surprising at all, Bahnsen and his National Review editors wish to call your attention to “the greatest threat to economic productivity” in this country: a group of highly paid professionals pursuing profit in a way they consider unproductive. “Excessive legal costs, the prevalence of frivolous lawsuits, and the fear of legal action all massively impede pro-growth decision-making,” the cover story reads. “Legal reform must become the next cause of the supply-side movement. Our economic well-being depends on it.” What follows is an in-depth case for policymakers to rewrite the rules of our court system on behalf of businesses beset by frivolous litigation.

How big is the problem? “The direct costs of tort expenses can be quantified through settlements, disclosed payouts, jury awards, defense legal fees, and insurance costs. A conservative estimate places the annual cost above $500 billion.” But settlements, disclosed payouts, and jury awards are transfers of assets from one party to another, not direct economic costs. Where they are warranted, the work of defense counsel facilitates that process and improves market incentives. Insurers would create value in that context as well. It’s true that “when corporate America wastes money defending itself against predators and charlatans — money that could be put to productive use — the invisible opportunity costs are immense,” but when corporate America acts responsibly because it knows a system exists to turn back on them costs they might try to impose on others, the invisible gains are immense too.

Unfettered by the bonds of consistency, Bahnsen flips his own argument against financial regulation on its head. Before, he observed how well the American economy was performing, especially compared to peers. “Who are these countries that are out-competing us, that are more resilient than us, that are more innovative than us?” he asked on his podcast. “I want to know who’s eating our lunch.” Now, he finds much to learn from other countries, especially seeing as our economy “has fought stagnation and subpar economic growth for nearly 20 years.”

Likewise, his frustration with unproductive litigation leads him to call for “bad actors” to be “properly ostracized” as “parasites and thieves.” But that’s only for someone else’s profession. When it comes to his own, investment management, “the idea that we want to demonize those in the financial services, it has all kinds of neo-Marxian flair, but it is economically disastrous.”

Any good market fundamentalists would presumably retort that financial markets are “private,” profit-driven activities where the invisible hand can work its magic, while lawsuits involve the heavy hand of the state. But that’s not quite right. The kind of tort litigation that Bahnsen laments is a centuries-old feature of the common law, and in fact falls under the heading of “private law,” alongside disputes over contract and property. If I sue you, I am claiming that you owe me something, whether it be payment for services or a duty of care in operating your business. I demand to be made whole. The lawyer providing me the service of representation contributes to GDP just like your private equity executive charging ten times the fees for below-market performance.

Our court system is constituted by the law to adjudicate these private claims, just as our markets are so constituted to facilitate private transactions. And of course, those markets only work with the backstop of recourse to those courts. The legal proceeding is an effort to determine who owes what and, if you cannot reach agreement amongst yourselves, the final decision rests with a jury of your peers. (Ironically, one of Bahnsen’s proposals is to create panels of experts to make these decisions instead, to which one can only insert a quizzical emoji.)

An entire academic field called “law and economics” seeks to configure legal procedures and substantive norms of liability to create the most efficient incentives for all parties. Each party can inevitably claim to be a vital contributor to greater prosperity for all. The plaintiff’s lawyer, who insists that his willingness to bring any case deters unfair practices by unscrupulous businesses, precisely parallels the high-frequency trader who explains that he is “providing liquidity” and the corporate raider who is “disciplining management.”

The most obvious proof that the litigation-finance contradiction cannot be squared is the rapidly growing field of, well, “litigation finance.” Alternative asset managers now raise funds to “invest” in lawsuits, giving law firms the backing to pursue a case and claiming a share of any favorable judgment. Individual “investments” run in the tens of millions of dollars and the “asset” class as a whole is headed past $20 billion.

Is this excessive litigation (boo, squash it), productive litigation (how to tell?), or finance (yay, so much value creation)? Once everyone acknowledges that a certain kind of litigation is among the many ways to generate profit without creating value, there is no getting around the fact that the financing of litigation represents the same. Nor is ambulance chasing the singular form of unproductive economic activity.

Distressed debt investors are pursuing favorable proceedings in bankruptcy court. Paul Singer’s Elliott Management famously used legal processes to force bond payments by the Argentinian government. Private equity firms bought emergency-room staffing companies in hopes that surprise medical billing would remain legal. Hedge funds buy and sell shares in companies involved in pending mergers, betting on whether the deals will get approval. Investment banks engineer derivatives so that everyone can gamble on each other’s loans.

In the real world, even the most ardent market fundamentalist is left with two lines he must ask policymakers to draw, because the market offers no answer. First, economy-wide, which activities actually create value, and which aim merely to extract it? Second, within the courts, which cases have merit and which do not, and what legal framework best selects for one but not the other? Surprisingly, but not really a surprise at all, Bahnsen’s solution is a range of policy reforms that he has sudden confidence in himself to advocate and politicians to implement.

I should say, I agree entirely about the problem of litigation finance and the need for tort reform broadly, though my diagnosis and remedies would be somewhat more cognizant of the enormous imbalances favoring large corporations today. But the real difference is that I believe these kinds of problems are important to consider across economic contexts, while market fundamentalism is premised on insisting that they don’t exist, except when they do, and that nothing can be done, except when it must.