While there are behavioral biases in entrepreneurial finance – e.g., entrepreneurs are overconfident and VCs fall prey to the availability heuristic – they don’t seem as prevalent as in public securities markets, or at least don’t lend themselves to the same calls for regulatory reform. Still, with recent notable works like Nudge and thought-provoking posts like this one from Josh Wright (on Jones v. Harris), it’s hard not to spend some time figuring out into which camp – rational choice or behavioral law and economics – you more firmly plant your flag.

The behavioral camp has much to offer. But several observations made by others persuade me not to dip my toes too deep into the behavioral waters. Here’s a quick list:

--Regulatory responses are challenging because different individuals have different biases, and even the same individual may have competing biases that negate each other;

--While individuals have biases, so do regulators (see Choi & Pritchard comparing the biases of investors with those at the SEC);

--The rational choice model works pretty well most of the time (and critics sometimes seem to forget that it’s only meant as a model, not a full-on reflection of the real world); and

--Taking into account behavioral biases in policy prescriptions removes incentives for correction. Tom Ulen has a nice discussion of this in a short article at 10 Lewis & Clark L. Rev. 177, 179-80 (2006) (it doesn’t appear to be on SSRN). There he differentiates between our “software” biases that can be corrected, including the entertaining Monty Hall three-door problem, and our “hardware” biases that are much harder to correct. Regulatory responses seem more appropriate for hardware biases, education for software biases.

There are also persuasive critiques of the rational choice model, and they get a lot of play these days. But regulatory responses based on the behavioral model are far from easy or perfect, and rational choice has proved highly instructive in my work on sophisticated entrepreneurial parties. I for one am not ready to toss it out just yet.

UPDATE: I should put this post in context, since the topic is like so 2005 (or whenever). I just finished Nudge (where have I been, I know!) and had sort of a negative gut reaction to it. To me the paternalism part overwhelmed any mitigating libertarian influence. I'm not a raging libertarian or anything, but I find myself uncomfortable with paternalism in many contexts. I'll get a chance to flesh out the issue more when Todd Henderson visits my class in a couple of weeks to talk about his provocative new paper The Nanny Corporation. Todd's paper first argues that paternalism for corporate employees is inevitable because stakeholders will demand it (e.g., to cut health care costs), then engages in a comparative analysis of who should supply it, markets or the state. I have doubts about the premise, but assuming its validity, I agree with Todd that markets are the preferential provider.

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[Update: I've added two additional amici who filed for Harris yesterday, the Chamber of Commerce and the Investment Company Institute.]

Today was the deadline for all amici supporting Harris Associates to file their briefs in the Supreme Court case of Jones v. Harris.  Neither the official Supreme Court docket nor the SCOTUSwiki for the case reflects today's filings yet, but I've seen a number of briefs distributed throughout the day.  So here is a preliminary list of amici, together with their counsel:

• Securities Industry and Financial Markets Association, represented by Carter Phillips of Sidley Austin
• Mutual Fund Directors Forum, represented by G. Eric Brunstad of Dechert
• Cato Institute, represented by Ilya Shapiro & Timothy Sandefur
• Fidelity Management & Research, represented by Jim Benedict of Milbank and Stephen Shapiro of Mayer Brown
• Independent Directors Council, represented by Ted Olson of Gibson Dunn 
• Law and Finance Professors, represented by Frances S. Cohen of Bingham McCutchen (Specifically, the professors are William Baumol, Michael Bradley, William Carney, Stephen Choi, Robert Clark, John Coates, Allen Ferrell, Joseph Grundfest, Ehud Kamar, Steven Kaplan, Edmund Kitch, Kate Litvak, Thomas Lys, Jonathan Macey, Fred McChesney, Adam Pritchard, Mark Ramseyer, Larry Ribstein, Eric Roiter, Steven Schwarcz, Kenneth Scott, J.W. Verret, Sunil Wahal, and Roman Weil.)
• Chamber of Commerce, represented by Richard Bernstein and Barry Barbash of Willkie Farr
• Investment Company Institute, represented by Seth Waxman of WilmerHale

Last month, the following amici filed in support of the petitioners Jones, et al.:

• Law Professors (specifically, the professors are Barbara Aldave, myself, Barbara Black, Douglas Branson, Jim Cox, Steven Davidoff, Lisa Fairfax, Jim Fanto, Jesse Fried, Theresa Gabaldon, Joan MacLeod Heminway, Don Langevoort, David Millon, Larry Mitchell, Bud Murdock, Donna Nagy, Liz Nowicki, Alan Palmiter, Frank Partnoy, Margaret V. Sachs, Bill Sjostrom, Marc Steinberg, Ahmed Taha, Steven Thel, Randall Thomas, and Manning Warren.)
• John Bogle
• AARP & Consumer Federation of America
• National Association of Shareholder and Consumer Attorneys
• North American Securities Administrators Association
• Professors Deborah DeMott and Mark Ascher
• Professors Robert Litan, Robert Mason, and Ian Ayres
• The United States

Even by Supreme Court standards, this collection appears to be a large, impressive, and remarkable array of contending forces for a business law case. 

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My friend and colleague Paul Heald has just posted a typically iconoclastic piece that's generating some buzz.  Ever heard a birkenstock-wearing, tofu-eater deplore the tyranny of modern agribusiness? Has the replacement of myriad heirloom varieties with supermarket pablum got you down?  Apparently the science behind foodie nostalgia hinges on one study that compared seed catalogs from 1903 to ones from 1983 and found a stunning 97% loss rate in number of available varieties. 

According to Paul, the numbers are wrong.  Quoting from the abstract:

Our study of 2004 commercial seed catalogs shows twice as many 1903 crop varieties surviving as previously reported in the iconic 1983 study on vegetable crop diversity. More important, we find that growers in 2004 had as many varieties to choose from (approximately 7100 varieties among 48 crops) as did their predecessors in 1903 (approximately 7262 varieties among the same 48 crops). In addition, we cast doubt on the number of distinct varieties actually available in 1903 by examining historical sources that expose the systematic practice of multiple naming.

Of extra interest to lawyers, it doesn't seem like whether a type of produce could be patented increases the number of available varieties.  Food innovation occurs with or without legal protection.

Don't get me wrong, I'm a big fan of locally grown food and heirloom varietals. I belong to a CSA.  Our Saturday morning farmer's market visit is a weekend ritual.  And it's a wrench for me to pass up a roadside produce stand, no matter how sketchy.  Paul's research just suggests that the cornucopia of fruits and veggies available to us now is varied as it ever was.  Something to chew on.

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All the big investment banks failed over the course of six months - or would have, if the Fed hadn't intervened.  And hedge funds and other shadow institutions also got killed, while insurance companies went for TARP funds, they were so pressed for solvency.

These institutions suffered something of a bank run during this period, as counterparties refused to trade with them.  Why?  No deposit insurance is a precondition, of course, but I'm not sure there is agreement about the precise form of the bank run, though it is pretty clear that there was one.  Repo market, commercial paper, CDSes, or just fire sales of assets due to asset depreciation....all of these funding mechanisms (CDSes may not be funding mechanisms, but humor me) dried up at roughly the same time.  At any rate, the investment banks and special investment vehciles borrow short and lend long, and they found that they couldn't borrow short from their counterparites all at the same time, meaning that they all started to go down at once.  There's a lot to say about timing here - when did everything go south?  Lehman, the start of the subprime meltdown, or what?  All of this, however, threatened the financial intermediaries so much because they were highly leveraged, and what capital they had was tied up in risky assets. 

You and I, simple depositors, don't have to worry about the solvency of our bank.  I don't care - and I wouldn't care even my credit union said that it had had a terrible quarter, or was putting all of my money into big bets at the dog track.  But the counterparties of the shadow banks had to worry about the solvency of their trading partners.  And they all lost confidence in the shadow banks at the same time, who, since they depend on short term money quickly fell apart.

The problem with sorting out what cased the loss of confidence in September, when things really went kerblooey (though they weren't easy before then), is that the month is overdetermined.  You could to an event study on the VIX or LIBOR, but it is hard to separate the Lehman news from the AIG news, from the "we're going to Capitol Hill" news from the "deposit window is open" news from the WaMu news from the Reserve Primary news.  I wonder if we'll ever know what really triggered the collapse - of course, it is possible to spook people with a range of bad news events that come close together, and perhaps that is what happened here.

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As a first timer on the appointments committee, I wanted to add my two cents to the great advice for candidates already out there in the blogosphere. Please take it with the caveat that it’s just me talking, not my appointments committee, and that my wealth of experience is all of four years in academia (which does include one lateral move). But, while I may not know as much as others, I am in the throes of the selection process right now, so maybe some of this will be helpful.

--To entry-level candidates, write directly to schools you’re interested in. I seem to recall one blog post saying it might not matter, but for candidates on the borderline for a DC interview, I definitely think it helps.

--To lateral candidates, do not write directly to schools you’re interested in, and do not go through the AALS process. You do not want to appear anxious to escape your current situation, even if you are. The best way to get the word out that you’re open to a move is to let your well-respected friends at other schools know that. These folks will inevitably be contacted by appointments committees looking for people who might be moveable. Also, the standard advice about going to conferences, publicizing your papers all holds true. If you’re doing good work, getting yourself out there, and are at a school from which one would reasonably assume you are extractable, you’ll get calls.

--To entry-level candidates, I predict that the whole process is on its way to mirroring the lateral process. It started with the rise of the VAP, which has produced far more sophisticated entry-levels, but now it’s more than that. You should not only do a VAP, but also go to conferences, especially those like the Big Ten Aspiring Scholars Conference and similar venues where you can present your work and mingle with those already in the academy. I like the idea of guest blogging somewhere too, but really take some care in your posts – it will likely be your first impression on the academic world. I recommend taking these extra steps because great candidates might not be picked up by a FAR search for any number of reasons. Also, there’s obviously a right way to go about all this without overdoing it. But it never hurts to have those of us on this side of the table know your name, think that your work has promise, and be able to pass it along to friends at other schools.

Good luck to all!

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Sunday I met a woman who works for an organization that provides social services for the city of Philadelphia and has not gotten paid since June.  Moreover, she said that the last time she was paid the check bounced, and the government had to take steps to cover the fees resulting from the bounced check.  She concluded her story by telling me that her oldest son was starting college, noting that the bills were still coming even though she was not getting paid. 

Her story prompted me to look again at the budget woes impacting Philadelphia.  Indeed, Pennsylvania has been without a budget since its new fiscal year began July 1, and the stalemate at the state level has repercussion for cities and government workers.  Indeed, it has meant that many workers and contractors stopped receiving a full paycheck at the end of June, and while a bridge budget was passed in early August that covered many workers, others were left out.  And it is not clear when a budget will be passed.  In fact, apparently Pennsylvania may soon become the only state in the nation doing business without a budget.  What does this mean for Philadelphia?  According to the city's mayor, the state's inaction could force Philadelphia to institute a plan that not only would shrink the municipal workforce by 13%, but also would require the closing of all of its recreation centers and all branch and regional libraries while reducing trash pickup to a bi-monthly schedule.  One group called the plan "the largest lay off of Philadelphia public servants in history."  To be sure, it is not clear if the plan will be implemented.  Indeed, on a somewhat brighter note, yesterday the mayor of Philadelphia announced that the city would be getting a $275 million loan from JP Morgan Chase.  The loan obviously provides much needed cash for the city, enabling it to finally pay the salaries of thousands of contractors.  Not sure if this would include the woman I met, but I certainly hope so.  Needless to say, even if a state budget is finally passed and Philadelphia is able to avoid such large layoffs, its budget woes have had a tremendous impact on its citizens, reminding us that the financial crisis has very real and personal repercussions. And that the bills keep coming.

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Financial intermediaries usually put investors together with opportunities.  But one reason why they fared so badly in the crisis was that they retained so many risky assets on their books, rather than selling them on to sleepy pension funds and insurance companies who tend to be super long only, and very long term, investors.  This is something that can be shown, and it is a basic insight about the cause of the crisis; capital adequacy collapsed, and intermediaries could no longer roll their obligations by posting the bad assets as collateral.  Without repo or commercial paper, the intermediaries went insolvent quickly, because they borrow short and lend long.  Why did they keep these bad assets?

I haven't heard a great story, whether it was to chase alpha, because they thought they had a government guarantee, or because they were running doomed insurance schemes, picking up nickels in front of steam rollers, on the assumption that they (or the employees making the asset purchase decisions) would get out before the collapse and retire to the Vineyard or whatever. 

Or maybe intermediaries were just dumb, though economists don't like the "dumb" explanation much, especially since intermediaries are supposed to be smarter than most market participants, and have always transferred risk to dumb people who don't mind holding it, rather than keep it on their own balance sheets.

There's lots to unpack here.  Jimmy Cayne, the Bear Stearns CEO, had almost all of his net worth tied up in company stock.  Why didn't he do something about "securitize and hold"?  The corporate governance of financials, btw, couldn't be better, loads of outside directors, plenty of M&A, and few poison pills, etc.

Whatever the case, it was a widely shared strategy that didn't work. 

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A stimulating conference on the performance of financial intermediaries (that's banks and shadow banks) during the crisis reminded me that a number of finance scholars largely agree on some of the basics of what happened.  Legal scholars and bloggers have expressed no such consensus, perhaps because we are focused on institutions and laws, such as was it compensation practices?  Regulators asleep on the job?  Credit rating agencies?  And so on.

All of these institutions probably played a role, of course, but many economists would probably put much of the blame where, it seems to me, it must belong: in the markets.  And in those markets, banks and shadow banks kept risky assets on their books, rather than selling them on to the greater fool.  When the asset values collapsed, there was an old-fashioned run on the shadow banks, and a serious impact on the solvency of the banks.

So I thought I'd do a couple of posts on this, ventriloquizing what I've heard - there's no creativity here - so that the wise readers of this here website can consider these issues. But the market failures raise three questions.  First, why did the banks keep the risky assets?  Second, why was there a bank run in the shadow banking sector?  And third, what should be done to prevent these sorts of market failures from happening again?

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I've been busy with semester-starting, Glom Master-organizing, FAR-form-reading, home remodeling, etc., so the flash-trading ruckus has been lurking on the periphery of my consciousness.  Yesterday's WSJ article intrigued me, though.

What's flash trading?  According to the article it's "a particular variety of high-frequency trading that briefly previews some orders to a few dozen market participants and trading platforms in hopes of finding a match."  Huh? 

Last week flash-trading proponents Chris Hynes and Donald Luskin described it this way:

 ...it is simply a way for one customer to query other customers to see if they will take the other side of a trade.

Let's say that among all the exchanges, the highest bid for stock XYZ is 10, and the lowest offer is 10.5. Bob enters a flash order to buy 500 shares in between, at 10.25. This order exists in Direct Edge's system for mere milliseconds, but in that time the high-speed computers of other participants might decide to sell Bob the 500 shares he wants to buy. So Bob gets a price better than the best offer, and the seller gets a price better than the best bid. If a trade can't be executed, then Bob can try other markets.

In this example, because the flash trade comes in between the best bid and the best offer, it does not contribute to market volatility. Buyer and seller have entered into a trade in which they both feel they have achieved the best possible deal, or they wouldn't have traded. And the flash order created an opportunity for new liquidity to enter the market.

Flash trading is definitely a big deal. A NYT article says:

An explosion of computerized trading has helped drive volume on the New York Stock Exchange alone up by 164 percent since 2005. Stock exchanges say that more than half of all trades are now executed by just a handful of high-frequency traders, who use rapid-fire computers to essentially force slower investors to give up profits, then disappear before anyone knows what happened.

I'm still not quite sure I get exactly how flash trading works.  But I do get the stories. 

N.Y. Sen. Charles Schumer claims these deals create:"a two-tiered system where a privileged group of insiders receives preferential treatment." He wants the SEC to ban them.  Basically the story goes that it's unfair to the rest of us that these insiders get to make these special trades.  It's the "rich people get access we don't" story.

Hynes and Luskin tell a story of Direct Edge as scrappy little guys trying to buck the establishment (NYSE), taking too much market share, and being unfairly picked on.  With Direct Edge accounting for 12% of U.S.-listed stock trading, it's a plausible David-vs.-Goliath story: NYSE sees a threat to its turf, and sics the SEC on the plucky upstart. 

Who's right?  I don't feel like I understand enough of the mechanics to say.  But look for SEC rules on flash trading and "dark pools" this fall.

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Thanks to Gordon for his nice words about my new paper on venture debt, and for his great help whipping it into present form (a new version just went up on SSRN). When I started the paper, I remember a friend warning me that “debt is not sexy.” Worse, the financial crisis has given debt a bad rap. Yes, consumers may take on too much debt, but don’t believe all the naysayers. Debt is awesome. It is extremely important in financial markets. Even in the start-up world my paper explores, where equity from angel investors and venture capitalists dominates, the use of debt makes for a fascinating story. Start-up companies have no track records, no positive cash flows, no tangible collateral, and no personal guarantees from entrepreneurs, yet are able to attract billions of dollars in loans each year. How is that possible? Read the paper to find out. Long live debt!

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An increasing number of British news reports -- such as this one in yesterday's Guardian -- suggest that the roiling Scottish-Libyan kerfuffle over the release of Abdelbaset al-Megrahi is best understood as a story about international business in addition to criminal justice.  Such an evolution might make business law professors generally more interested.  For my part, the particular facts are also coming closer to home.

Evidently, a centerpiece involves details regarding how the Anglo-Dutch oil concern, Shell, bested American Exxon for rights to massive natural gas fields in Libya.  The Guardian claims that high-ranking British ministers met with Libyan officials as many as 26 times to win access and control of "one of the world's key energy terminals": Marsa el-Brega.

Marsa el-Brega was "once a tiny fishing village on the most southerly tip of the Mediterranean" but now features a massive liquefied natural gas facility.  Brega, as it happens, was also once my home.  For the best part of my first eight years of life, I lived in a tiny expatriate compound there.  Then came the "line-of-death" US-Libyan brouhaha and we were all evacuated, with Americans banned for about a quarter of a century.  How profoundly odd it is to see one's puny, sand-strewn childhood village loom large in international intrigue.

By the way, if you're ever visiting, we lived at 1169 Cyrene.  (A fairly grandiose address, I confess, since there were only about 300 houses.)

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Thanks to Gordon and everyone at the Glom for having me back to visit. It’s a real pleasure to be back! With my securities regulation class starting this week, I wanted to begin there. While I really enjoy teaching the course, I can’t help but wonder whether it should be retooled in light of today’s financial markets.

My course is a standard survey of the disclosure process for public offerings and public corporations. As a combined securities regulation and securities litigation course, we spend a good bit of time on the liability provisions that the litigators look to when the transactional lawyers screw up the disclosures. But several important topics that seem to warrant coverage are hard to place within that traditional framework. For example, where does the financial crisis and systemic risk come in? Or the appropriate regulatory balance between the SEC and the Fed? What about Madoff and broker-dealer regulation? And perhaps most troubling of all – and this is a critique of the law as much as the course – we’re still studying retail investor rules in an institutional investor world. If mutual funds are such important financial intermediaries in today’s markets, why does the course not spend some time on them and their regulation? There is really interesting scholarly work in the area (e.g., William Birdthistle’s), but I fear that students leave the basic securities course knowing little to nothing about the vehicle through which most of them will invest, if not counsel as clients.

SEC Commissioner (and former Glom guest) Troy Paredes beat the same drum at this summer’s AALS Mid-Year Conference on Business Associations, so others might share these concerns. Perhaps there’s a market opportunity to write an innovative casebook that shakes up how we think about and teach this material. Any takers?

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Paul Caron has the collected links. This is a great resource for people wanting to make their way into the profession.

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Darian Ibrahim is a familiar name to many Glom readers. He is back for another stint at guest blogging, and will be discussing, among other things, his excellent new paper on venture debt. Welcome back, Darian!

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So, the last two weekends have found us at the movies, and as the blockbuster summer season wanes, we went to see two "small" movies that we liked very much.

500 Days of Summer.  We were going to see the "Time Traveler's Wife," but made a game time decision to see this movie after a neighbor recommended it to us on our way out the door.  It's a really simple movie, but captures what it's like when you are in your 20s and you really think that someone is "the one."  You know, when two people are holding hands at the IKEA and pretending they are married and live in the furniture "serving suggestions," and one person is like "Oh my gosh, they must want to marry me because we're pretending we're married in the IKEA" and the other person is like "The IKEA is such a fun place to joke around.  Let's go get some meatballs."  I've been there.  Anyway, the male lead, Joseph Gordon-Levitt, completely makes the movie.  He was the "boy" alien on 3rd Rock From the Sun and the little boy in Angels in the Outfield, but now he's a male lead, which somehow adds to the affection that you have for this naive young man falling in love so hard, so hard.  Very sweet movie.  It's set in modern day, but it feels sort of retro (the music, the clothes) somehow, which help us old people remember. . . .

Taking Woodstock.  We sort of just wandered into this one at the art theater downtown without knowing what it was going to be.  I think our lack of preconceived notions helped a lot.  Again, it's a really sweet movie about another early 20s male trying to find his way in the world, navigating between his immigrant parents who run a (run-down) motel in the Catskills and his desire to be a designer and go to San Francisco with his New York friends.  And, he's gay, but his parents don't know.  So, with this backdrop, Elliot becomes the driving force for getting the Woodstock music festival to come to his Catskills town when the "hippies" are kicked out of Wallkill, NY.  The movie is based on the memoirs of Elliot Teichberg, now Tiber.  Woodstock is the backdrop -- the real story is Elliot's journey separating from his parents and becoming his own person. 

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