Katharina Pistor

Katharina Pistor

Diretora do Center on Global Legal Transformation, Columbia University, Nova Iorque Director of the Center on Global Legal Transformation, Columbia University, New York

My core argument is that the source code for wealth creation is actually the law — the law being a public good, not a private good —, a legal system that ensures people, holders of assets, interests and claims, that they can enforce a claim against others. It is somewhat intuitive to say the legal system is supposed to enforce property rights and contracts, assuming that people just enter into these arrangements and then all the law does is enforce whatever arrangements they make. I am arguing that the private law institutions used for several centuries to code capital are much more malleable than is very often assumed, especially amongst economists. They can be used to create a hierarchy of rights, create stronger rights versus weaker rights, protect some interests over time, while leaving others to deal with the fluctuation of business cycles or major crises, like the one we are currently experiencing. The legal system allows you to put your assets on “legal steroids”. Suppose we are ranking assets: somebody has a property right, others might have a collateral interest, others only have an unsecured interest. We are extending these rights over time and making them durable by ensuring that we can protect assets against too many claimants in the future. We are also ensuring that these arrangements are enforceable not only between the parties to that arrangement but against the world erga omnes, which means they are universally valid, at least as far as a particular legal regime goes, as we have conflict of law rules by which other states commit to enforcing the private law arrangements of foreign states.

Last but not least, a critical aspect for our current age and also for the Covid-19 crisis, is convertibility, which means that asset holders, especially of financial assets, can attain the durability of the wealth they have already created in the past by converting them into safer assets, ideally into cash. The only financial asset that does not lose its nominal value in a crisis is state-issued legal tender. All privately issued financial assets can lose their value in a financial crisis.

The law can be used to create structural inequalities, and that is the purpose of private law: to create stronger and weaker rights. We also have to understand that we are creating these rights, typically, under conditions of great uncertainty. We don’t really know how this pans out in the future. The parties with the better bargaining powers will try to use the legal devices — with the help of sophisticated lawyers, whom I call the masters of the code — to shift the risk of dealing with the future uncertainty to the other side, typically to the weaker side.

The law can be used to create structural inequalities, and that is the purpose of private law: to create stronger and weaker rights.

Our entire economic and financial systems are coded in law — in legal arrangements — and in order to scale these systems to size, we have made these commitments rather rigid, so that we can enforce them at a future date, or so that we don’t even have to enforce them because people trust that they would be enforceable. When rigid legal commitments meet crises, we can see how deeply hierarchical the system we live in really is. In a system that is coded in credible and rigid legal commitment, when the world changes after these commitments were made, the system can self-destroy because when everybody enforces their legal commitment at the same time when the circumstances have changed radically, there will not be enough money to go around . Too many people will go bankrupt, bringing others down with them. We have seen this play out exactly in the 2008 financial crisis.

We have created far too many enforceable legal commitments on a flimsy base, on the assumption that housing prices would go up forever. That has created wealth and some equality for some time, but when the system crashed the question was: how do we avoid the full self-destruction of the system?

In times of crisis, you often see the state intervene in different disguises. Central banks are one type of disguise. In 2008 and again this year, 2020, they intervened to put a floor underneath the losses that private asset holders might experience, by offering liquidity when no liquidity was legally owed. They not only offered liquidity to the banks, that paid in terms of regulatory cost to the central bank to have access to it, but they also relaxed or suspended the legal rules of the game for other players in financial markets. The central bank tries to rescue the system from self-destruction by suspending or relaxing the full force of the legal commitment that the parties have made ex-ante to build the system to size. Systems are scalable only on the basis of these credible commitments.

The Covid-19 crisis has exposed everybody — asset holders and financial markets, but also simple households — to the problem of dealing with rigid legal commitments that they have made in the past. The mechanisms that we use to scale systems also deal with inequality problems by making sure that even poorer people have access to the legal system to make credible commitments: to give a mortgage, to pledge their property to have access to credit. When the system crashes, when there is an exogenous shock like we have seen in Covid-19, we can also see who is most caught in the problem of dealing with rigid commitments from which they cannot suspend themselves.

One possible solution is for people to anticipate the possibility of future uncertainty by including some provisions in their contracts to address that force majeure. Provisions are relatively common, but force majeure provisions do not always cover a pandemic, and they are not in all contracts. That is why you have to have a sophisticated lawyer on your side, to make sure that you can put this in. With the Covid-19 crisis, many people felt the pinch and governments intervened to some extent by putting a moratorium on evictions or paying the wages for private companies' employees. However, most of the interventions for people at the lower-income level are temporary and are also constrained by the ability of states to sustain these payments, which, in turn, are constrained by the monetary regimes that they have adopted, whether they have their own currency or not, can do

monetary financing or not, by state aid rules in the European Union or by political issues. You can see that play out in the US Congress right now and in other parts of the world as well.

At the top of the financial system, where the core operates and is being protected against self-destruction, we have seen the central banks intervene once more by offering liquidity and support on an unprecedented scale and speed. It was very effective, but what is critical to understand the degree of structural inequality in our system is to compare the interventions that we make for those at the bottom and those at the top. Those at the top had much more flexibility. They remain open-ended because the central banks are standing by to offer additional support if needed. They are tinkering with their collateral guidelines, offering liquidity support, and buying assets they have never bought before. Whereas, at the bottom of the system, we are using mostly temporary measures.