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Freedom, Revisited [Part 1]

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[ I started this intending to write a short essay on the need for liberals and the left to develop new theories of liberty. My basic view is that both for legal advocacy and to “reclaim the politics of freedom” more generally, progressives need a fuller theoretical response to the limitations of the right’s vision of freedom as a system of negative rights and economic liberty. This is the first of several posts, in which I hope to discuss theories of negative liberty, positive liberty, and civic republicanism as potential ways to revitalize common understandings of freedom that embrace the United States' tradition of democratic governance and the need for broadly inclusive economic structures. ]

I agree with Corey Robin’s conclusion in Reclaiming the Politics of Freedom. Freedom needs to be contested and understood at the level of first principles if an alternative is to emerge to counter the anti-statist, pro-private power vision that has come to dominate American discourse and aided in the dismantling of public services and the regulatory structures that limit corporate power. The need to reconceptualize liberty is particularly urgent given that the conservative members of the US Supreme Court have imported a theory of negative liberty into their interpretation of the Constitution and the First Amendment specifically. This impoverished notion of liberty has become a barrier to a variety of democratically enacted regulations and, in the 2010 Citizens United case, served as the basis for eliminating reasonable campaign finance laws. The constitutionality of the Affordable Care Act, similarly, will turn on the Court’s willingness to read this theory of negative liberty into the text of the Commerce Clause.

The theory of freedom that informs the American right’s “small government,” “get the government out of x” rhetoric is, as Charles Taylor and others have noted, a mostly negative theory of liberty. The idea being that freedom means the absence of coercion or interference, or as Ayn Rand said, “to be free, a man must be free of his brothers.” It’s important to point out that historically negative liberty has inspired leftists and liberals as intensely as it currently moves the American right. The theory of negative liberty was first described (albeit unpraisingly) by the liberal theorist and socialist Thomas Hill Green, and in the Twentieth Century, the idea moved liberals like Isaiah Berlin. In his essay Two Concepts of Liberty, Berlin described negative liberty as “the area within which a man can act unobstructed by others.”

The recent revival of interest in Ayn Rand’s writings and libertarianism more generally speaks to the level to which this notion has informed the way millions of Americans continue to understand themselves politically. I think it would be a mistake not to take such commitments seriously. Rather than entirely abandon a theory that has proven enormously inspiring and deeply rooted (at least among Americans), I think it’s worth asking what other liberals have found inspiring here and looking at where conservatives have sold their own theory short.

There is one extremely important difference between the negative liberty described by Berlin and the liberty celebrated by libertarians and the contemporary American right. Berlin’s definition of negative freedom means the absence of coercion from all others, whereas the right’s definition means only the absence of coercion from the state. As Corey Robin noted, the way conservatives managed to recast negative freedom in this way was “to locate this notion of freedom in the market.” By focusing primarily on the tension between private industry and government regulation, conservatives have advanced a view of freedom that largely ignores both the mass incarceration state and the various ways private industry can impinge on individuals’ rights.

As Bernard Harcourt’s scholarship has helped highlight, there is something enormously paradoxical about a view of negative liberty that locates freedom entirely in the market but turns a blind eye to police enforcement and national security. The United States has been gradually sacrificing civil liberties to the exigencies of law enforcement and counter-terrorism over the past decade. We have become the most incarcerating nation in world history, with more than six million people imprisoned and many of them for nonviolent offenses. As Harourt recently wrote, “The rise of neoliberal thought since the 1970s has left us with a frightening union, one in which there is both free-market ideology (which militates against universal healthcare) and mass incarceration (with the attendant excesses like generalized strip-searches).” The unwillingness of American courts to see liberty outside the economic sphere is, to quote Harcourt again, “pushing the country, inch-by-inch, in the direction of a police state.”

Beyond the paradoxes of the mass incarceration state, the problem of private power exposes another important oversight in the right’s operative theory. If negative liberty is genuinely about protecting spaces of individual autonomy, it has to mean being free to act without coercion from from private parties as well as from government and law enforcement. That means that businesses that can turn phone records over to the police, websites that sell an individual’s search history, prospective employers who ask for facebook passwords, and employers who meddle in their employees private lives are just as capable of interfering with people’s negative liberties as state agents. Private individuals unconstrained by the state provided the foundations of both slavery and debt servitude, indisputably two of the most unfree systems in human history. The failure of the right to address the excesses of corporate power and the various risks created in the private sector is precisely what is least liberating about that view — it is a vision of freedom that is willing to accept coercion and domination as long as they are committed by private actors.

In contrast to that view, a more thorough acceptance of negative liberty would be far more radical (and complicated) than simply shrinking the state at every opportunity. It would also mean liberating the spheres where individuals may act and opening up spaces for people to act democratically or collectively to shape the conditions of their own lives. To protect their own liberty, people would have to be able to resist not just coercion from the state but also to resist coercion from extractive economic structures and private actors who do not share their interests. Indeed, one might even expect the champions of negative liberty in a democracy would be far more concerned with coercion from private powers than the government, because government, arguably, is already accountable to the people through elections.

Negative theories of liberty could once again carry some emancipatory potential if expanded to embrace individuals’ authority to free of both unwanted private encroachments as well as intrusions by law enforcement and other state actors. That is not to say that a more expansive concept of negative liberty would not be without shortcomings of its own. Some of these shortcomings should become clearer when contrasted to the positive and civil republican theories of liberty [I'll save that for another post]. Nonetheless, negative liberty has been an inspiring and enduring vision of freedom that has moved millions of people across history and continues to speak to Americans’ self-understanding. For the current moment, a vision of negative liberty that takes private power into consideration still offers a powerful critique to those who think keeping the government out of the market is a sufficient guarantee of individual freedom.

Citizens United Was Just the End-Zone Dance

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This entry was originally posted at Demos’ Policy Shop.

Jeffery Clements was at Demos this morning for an event marking the New York launch of his new book, Corporations Are Not People. As a lawyer and cofounder of Free Speech for People, Clements has been one of the leading voices in the campaign for a constitutional amendment to overturn Citizens United. This book, rather than simply providing a limited guide on the harms of corporate political spending in elections, offers a much more profound reexamination of the role corporations play in American public life.

While Citizens United might look like an outlier in the Supreme Court’s First Amendment jurisprudence, Clements makes a very compelling case that the decision can be better understood as the culmination of a decades-long campaign to insulate corporate activity from democratic regulation and control.

This corporate rights agenda was first outlined in the 1971 Powell memo, a confidential memo written by former-tobacco industry lawyer and later Supreme Court Justice Lewis Powell to the Chamber of Commerce. Powell’s memo complained that corporations were under public attack by all kinds of public health and safety regulations, and he provided a decades-long strategy to construct an area of corporate rights that would no longer be subject to public laws that cut into their potential bottom lines. Powell was eventually appointed by President Nixon to the Supreme Court, where he began transforming the First Amendment into what Jedediah Purdy recently called an “anti-regulatory hammer.”

Clements also draws attention to an interesting wrinkle in the right-wing deregulatory project that often goes unrecognized: conservatives have long been conflicted about providing corporations with constitutionally recognized rights. Chief Justice William Rehnquist, another Republican Nixon appointee, was extremely influential in standing up to the invention of new corporate constitutional rights. Rehnquist has a number of eloquent dissents that reiterate the idea that corporations are a legal fiction — a creation of state law that provides a useful instrument for economic growth — and he repeatedly stood up for the position that the states are permitted to define the privileges and burdens created by the corporate form.

Justice Rehnquist dissented to Powell’s activist vision of the First Amendment as early as 1978 inFirst National Bank of Boston v. Bellotti, which recognized corporate speech rights to contribute to political campaigns, and in the 1980 case Central Hudson Gas & Electric Corp. v. Public Service Commission, which struck down a restriction on commercial advertising as a violation of the First Amendment. As recently as McConnell v. Federal Election Commission, which upheld the same campaign finance law that Citizens United eviscerated, Chief Justice Rehnquist was able to maintain a majority of the Court for the position that a democratic majority may legally limit the role of corporate money in elections. As Clements noted, it was not until Justices Alito and Roberts joined the Court that the corporate rights project of removing democratic control over corporate behavior attained its current high-water mark.

Clements was a persuasive speaker, and beyond looking forward to this book, I’m excited to see the impact he will have on the way Americans understand their relationship to corporate power. More than a call to undo Citizens United, this book makes a wide-ranging rallying cry to restore the rule of public law over those forms of concentrated wealth that are manipulating and dismantling the democratic institutions the United States was founded on.

America’s Libertarian Pendulum

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I wrote a piece for Guernica on the regular recurrence of libertarianism in America. Here’s the key idea I wanted to get across:

These tensions [between majoritarian politics and unassailable individual freedoms] are largely inherent to our political system, and as long as we have a liberal democracy, they cannot be finally resolved. Libertarian arguments will keep coming back, because majoritarian politics will always be unsatisfying or objectionable to some subset of the population. Transforming a policy dispute into constitutional or higher order debate about individual rights provides a mechanism for resisting majoritarian abuse, but it can also undermine the potential power of a political majority and make a country ungovernable. And as we are now seeing, this ability to reframe politics as a battle between the individual and the state also contains the explosive potential to escalate simple politics into a constitutional crisis. Billionaire funders and government ineptness aside, libertarianism is in the air because the line between private power and public accountability is being redrawn.

A Good Man

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A friend and I were talking about Bertolt Brecht the other night, and he mentioned a poem I’d never read, “The Interrogation of the Good,” which Slavov Zizek quotes in Violence to mock the neoliberalism of American progressives and professionals. Brecht’s poem goes far beyond Hannah Arendt in blaming the average person who thinks he’s apolitical, ‘just doing his job,’ for enabling political and societal breakdowns through complacence. I can’t help from thinking that the poem is something of a joke, but there’s also an unmistakable hint at the absolute hatred that people bear against one another when things fall apart. It has to be one of the most scathing condemnations of political apathy and shallow philanthropic liberalism ever written.

“The Interrogation of the Good”

Step forward: we hear
That you are a good man.

You cannot be bought, but the lightning
Which strikes the house, also
Cannot be bought.
You hold to what you said.
But what did you say?
You are honest, you say your opinion.
Which opinion?
You are brave.
Against whom?
You are wise.
For whom?
You do not consider your personal advantages.
Whose advantages do you consider then?
You are a good friend.
Are you also a good friend of the good people?

Hear us then: we know.
You are our enemy. This is why we shall
Now put you in front of a wall. But in consideration
of your merits and good qualities
We shall put you in front of a good wall and shoot you
With a good bullet from a good gun and bury you
With a good shovel in the good earth.

Reimagining the Corporate Form: Toward a More Democratic System of Corporate Governance

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This entry was also posted at the HLPR Blog: Notice & Comment.

Occupy Wall Street has, in the words of John Paul Rollert, “come to embody a common sense that something is wrong with American capitalism.” The problem Rollert points to is not with capitalism itself, but with a particular American version that has ceased to work for broad cross-sections of its population. Given America’s Depression-level income inequality and near-record levels of private indebtedness, it is extremely tempting to focus on bad outcomes as the problem. But the real issue is that many of the economic and political structures that we take for granted repeatedly produce unequal, undesirable outcomes. If reformers seek to make American capitalism more inclusive, the focus needs to be on fixing these structures and getting the rules right.

It has been a steady mantra of Occupy Wall Street not to make demands of existing political leaders and institutions. But as Matt Langer explained, “the reasoning behind not making demands most certainly does not preclude making demands of our collective imagination.” Whether people prefer to work within existing structures or not, the next essential step is to understand how broken institutions and flawed incentives created this mess and to start imagining what structures can be built in their place. Where better to start than with corporations?

Current Governance Structures and Their Shortcomings

Consider the role that our system of corporate governance has played in producing some of our current imbalances. Excessive risk-taking, stagnating wages, and the spike in executive compensation can all be linked back to a system of corporate governance that privileges management’s interests at the expense of other actors.

It’s by no means an original observation to say that boards are under the sway of management. Indeed, the US is something of a global outlier in allowing a business’ president/CEO to appoint its board of directors, and in some cases the president/CEO actually serves dually as the chair of the board. Not only is the composition of the board not reflective of its owners, employees, or investors, boards are only subjected to a relatively relaxed legal standard. As a result, directors often find that their interests (i.e. staying on the board) are best served by taking a passive role and letting management make most of the choices. In light of this structural failure to limit conflicts-of-interest, it should be unsurprising then that the interests of employees, shareholders, and other stakeholders are, at best, secondary to those of executives. As Harvard Law Professor Mark Roe succinctly phrased it, “the US is managerialist, not capitalist.”

Current governance arrangements have had an enormous impact on the larger economy and on the distributive features of American capitalism. To begin with, the existing corporate governance system (in conjunction with other regulatory failings) has proven inadequate to keep excessive managerial risk-taking under control. Despite the Enron disaster, the fall of Bear Sterns and Lehman Brothers, and the near-collapse of many of America’s overleveraged financial firms in 2008, we appear to have done nothing to address this issue. These risk-induced failures were repeated last week in the near-overnight fall of MF Global. As though nothing was learned, the star-studded MF Global board sat by and, in Steven Davidoff’s words, “gave executives []free rein to take tremendously risky bets that brought the house down.”

In 2008, Martin Lipton and his colleagues at Wachtell prepared an excellent memoranda on boards’ responsibility over risk-management which was posted at the HLS Forum on Corporate Governance. In discussing the legal framework for risk-management, they advised corporate boards to go beyond the minimal requirements created by the leading state law case, In re Caremark. Nonetheless, this is how they summarized the state of the law: “These cases demonstrate that it is difficult to show a breach of fiduciary duty for failure to exercise oversight; these cases do not require the board to undertake extraordinary efforts to uncover non-compliance within the company.” Federal laws like the Sarbanes Oxley Act do require auditing and increased oversight from the board, but the overall implications remain: the decision-making center of gravity remains largely with executives, whose personal incentives to post short-term profits can fuel excessive risk-taking, and current law gives boards few incentives to keep that risk-taking in check.

The problem is not just that boards are passive and deferential, but that those who want risk limited cannot make themselves heard. These high-risk strategies often run counter to the interests of other stakeholders, including bondholders and shareholders, whose interests are not reflected in the board’s composition and thus are not sufficiently represented. The idea that the broader public or the employees whose jobs are on the line would have a say is, under current thinking, not even a remote possibility.

The resultant proximity between Boards and management has a lot to do with runaway executive pay. Board members usually have a stake in their position, and because they are appointed by management, it’s often not in a director’s interest to start ruffling the CEO’s feathers. As Lucian Bebchuk and Jesse Fried argue in their excellent book Pay Without Performance, “structural flaws in corporate governance have produced widespread distortions in executive pay.” Their argument, briefly, is that boards have too many incentives to go along with management and are therefore unable to contract with executives at arm’s length. This broken feedback loop is at the root of the ridiculous pay packages, bonuses, and golden parachutes we’ve seen over the past decade.

The wage stagnation that’s affected the remainder of the workforce shares a common origin: all stakeholders other than executives are systematically excluded from decisions that determine compensation. The fact that corporate profits remain at near record highs suggests that the problem is indeed structural and not attributable simply to changes in the labor market. The absence of a voice for employees either in management or on the board of directors, in conjunction with weakening collective bargaining rights, means that the record profits businesses have been posting get funneled mostly to executives and do not translate into gains for the average American worker. The rules that determine who gets to cut the pie, in other words, have a lot to do with the fact that CEOs went from making 24 times what the average worker did in 1965 to making 185 times as much in 2009.

http://www.stanford.edu/group/scspi/cgi-bin/fact2.php

Ratio of CEO compensation to of average worker’s compensation.
Source: Economic Policy Institute, 2011, via SCSPI.

More Inclusive Alternatives to Minority-Rule Governance

Corporations do not have to be organized in this way in order for the private sector to prosper or for the economy to grow. Recent events should make it clear that keeping down transaction costs is not the only concern here. A number of compelling alternatives exist. I start with the more moderate reform proposals and conclude by proposing that we look to the German corporate model or other structures that afford investors and employees a role in a company’s management.

Calls are frequently made to enhance the role of shareholders in decisions involving executive compensation and risk-management that happen at shareholders’ expense. Bebchuk and Fried have argued that it’s possible to improve transparency and accountability by giving shareholders a greater say on pay, by strengthening shareholders’ ability to unseat and replace directors, or by increasing the number of independent directors (i.e. directors not employed by or doing business with the company). Another proposal they describe would allow shareholders the ability to amend the corporation’s charter. Any long-term solution to these agency problems entails providing investors and owners with a permanent vote or some structural role in decisions that affect them.

An increased role for employees is also necessary to prevent some of imbalances that have arisen between management and the average member of the workforce. Randall Thomas and Kendell Martin, for example, have argued that labor unions and related entities should be allowed to make shareholder proposals. It would be possible to go even further by affording both investors and labor a role on the board and a larger say in major decisions that affect a company’s future. This is precisely what the German corporate governance system does. The German Codetermination (Mitbestimmung) system provides employees a role in the company’s management and has proven remarkably successful across a number of economic sectors. And although German income inequality has grown in recent years, “income inequality in Germany is a long way from reaching US proportions.”

I point these out not to advocate any particular corporate form, but to observe that there are alternatives that can address failings of the existing system. It’s important also to observe that things were not always this way. The internet has fostered an explosion in new forms of social organization, and cooperative membership structures are another potential source of ideas. There’s no reason that running a successful business means accepting a one-size-fits-all corporate model, particularly when that model marginalizes a company’s most committed participants—its investors and its employees.

Capitalism isn’t a single thing or a system of natural laws. It is a system whose rules are shaped by political—and ideally democratic—choices. Nowhere is this more obvious than in the reified legal fiction of the modern corporation. The absence of democracy within corporations is a central reason that the US has seen such a proliferation of high-risk investment strategies, and an unprecedented divergence in incomes. The concerns of both investors and employees have been systematically subordinated to the interests of America’s managerial class. The failure to create an inclusive economy is fundamentally a failure to build inclusive institutions. And the first step to fixing this problem is remembering that the rules that govern institutional decisions can be different.

Debt forgiveness as economic stimulus

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This entry was originally posted at The HLPR Blog: Notice & Comment.

Following up on an earlier piece about the student loan bubble, I wanted to share two graphics that depict the over $550 billion in student loan debt carried by U.S. households. The first shows 2011 student loan debt relative to 2000 debt.

The second reveals how much faster student loan debt has grown relative to all other household debt. If you look closely, it’s possible to notice that since 2008 Americans have reduced their dependence on credit with the exception of student loans.

With default rates rising, the student loan bubble has gotten a lot of attention in the past few months. The Chronicle recently reported that students are bearing an increasing percentage of university costs. A piece at the Washington Monthly demonstrated that many of the added costs have come from increased administrative hiring. And a number of other articles have explored how the debt has impacted people in their 20s and 30s. While it’s tempting to debate how the student loan bubble is or is not like the subprime mortgage crisis, I simply want to note that it has the same potential to create political rifts when the debt proves unpayable.

During the debt ceiling debates back in July, Rep. Hansen Clarke (D-MI) proposed a resolution in the House entitled “H.Res. 365 — Expressing the sense of the House of Representatives that Congress should cut the United States’ true debt burden by reducing home mortgage balances, forgiving student loans, and bringing down overall personal debt.” While this bill is just sitting in committee, it seems noteworthy for being one of the only post-crisis bills that acknowledges what’s actually straining the global economic recovery: high levels of private debt.

The political turmoil in Europe, the subprime/foreclosure crisis, and the student loan/unemployment disaster facing the United States all boil down to the same issue. Creditors made a lot of bad, risky loans leading up to the financial crisis in 2008. But rather than take losses for those loans, what we’ve seen across Europe and the U.S. has been an attempt to use the legal system and political pressure to make sure these creditors get 100 cents on the dollar. Borrowers and, in many cases, taxpayers (in the form of austerity programs) have been tapped to make sure that debt does not get written down. In the U.S., politicians have proven more willing to see homeowners foreclosed on than ask banks to start refinancing mortgages, and student loans were made virtually unforgivable in 2005 when the bankruptcy code was amended.

These outcomes are not mandated by economic principles. Rather, they are political choices that reflect a systematic preferencing of creditors over borrowers. They also happen to be economically bad policies. After a bailout and two rounds of quantitative easing, banks have still not resumed the lending necessary to achieve sustained job growth, and politicians need to realize that policies that protect creditor interests at the expense of an over-leveraged population are postponing economic recovery.

With private debt at record high levels, debt relief (whether in mortgage writedowns, loan forgiveness, or some other form) has enormous potential as an economic stimulus. It would free a portion of people’s paychecks to start purchasing again, stimulating demand and creating jobs. And it would keep many others in their homes. As Kenneth Rogoff, a professor of economics at Harvard and former chief economist of the IMF, recently wrote, “the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.”

This deleveraging process can happen through austerity and defaults or it can happen through sensible policies that write down debt in ways that can stimulate the economy. David Graeber has written a fantastic book, Debt: The First 5000 Years, that shows how debt has been at the middle of political disputes for all of recorded history. And Bob Kuttner noted quite early in an excellent piece for the American Prospect that debtor-creditor tensions are likely to become far more pronounced and more central to our political debates.  Debt resolution is already threatening the stability of the European Union. The sooner American policymakers realize what the current phase of the financial crisis is really about, the sooner we can devise a coherent response and begin the recovery.

Now that the debt ceiling has been raised, can we get around to abolishing the debt ceiling?

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Originally posted at The HLPR Blog: Notice & Comment.

On August 2 of this week, the United States successfully—if you can call it that—raised its debt ceiling for the 10th time since 2000. Regardless of the merits or un-merits of the deal that was eventually reached, the negotiation process was overwhelmingly bad for the country’s fledgling economic recovery. America’s reputation globally has suffered as a result. China’s state run paper called the negotiations “dangerously irresponsible,” and many commentators thought the US was coming perilously close to a constitutional crisis.

The country may be suffering from a bit of debt ceiling fatigue at the moment, but given the harm that the past few weeks have done, the United States needs to get around to abolishing the debt ceiling before this situation repeats. It would be a good signal to markets and remove political uncertainty that’s likely to keep US interests rates up, and it’s important for the continued stability and civility of our political system.

In case you need persuading that the debt ceiling should be abolished, I recommend this article by James Surowiecki at the New Yorker or Annie Lowrey’s piece in Slate from back in May, where she referred to the debt ceiling a “historic relic” with a “horrific downside and negligible upside.” And on August 1, Bruce Bartlett, a former policy advisor to Presidents George H.W. Bush and Ronald Reagan, laid out a persuasive argument for the debt ceiling’s abolition, explaining that:

“Even if the Treasury avoids default on government debt this week, we will inevitably have to go through the same political drama the next time the debt limit runs out and every time thereafter. And sooner or later the shoe will be on the other foot, as Democrats hold the debt limit hostage against a Republican president.”

“Unfortunately, the option of just letting the debt limit expire is not available. It is permanent law and can be abolished only by repeal or by a ruling by the Supreme Court that it is unconstitutional.”

Given the fight that was just waged over raising the debt ceiling, I am rather skeptical that the Republican-controlled House is prepared to repeal the debt ceiling at the moment. Neither party, it seems to me, has the proper incentives to give up this political bludgeon willingly. As Michael Shear stated, “it may be impossible for Washington to put the debt ceiling genie back in the bottle.” Whether the debt ceiling statute is unconstitutional is another matter.

Bruce Bartlett has also written an excellent summary of the constitutional issue and has compiled some of the best arguments for and against the executive branch’s invoking the 14th Amendment to avoid hitting the ceiling. While most of these arguments focus on whether the President was empowered by the 14th Amendment to authorize the Treasury Secretary to continue issuing debt, the relevant question is whether the legislation establishing the debt ceiling is itself constitutional. Niel Buchanan at Dorf on Law has addressed exactly this issue and argued that the debt-limit statute is unconstitutional because it separates Congressional spending from the authorization to raise money to pay for those obligations.

Alternatively, it might be possible to argue that Congressional action that calls into question the United States’ debt might itself be unconstitutional. As Jack Balkin has written:

“Secretary Geithner does not believe that the President is allowed to violate the Constitution himself to stop congressional Republicans, but it does not follow that what the Republicans are doing is constitutional.

The press so far has been asking whether the debt ceiling is constitutional. The correct question they should ask is whether the Republican strategy of hostage taking violates the Constitution.” (emphasis in original).

As most legal commentators have recognized, standing and the political question doctrine pose hurdles to the Supreme Court ever ruling on the issue. Given the enormous damage this game of political chicken caused and how perilously close the nation came to an unprecedented constitutional conflict, however, these questions are worth exploring in more depth—and soon.


Crowdfunding a Beer Company Buyout

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I came across an interesting post in the Blog of the Legal Times yesterday about two advertising executives who attempted to raise $300 million from online investors in order to purchase Pabst Blue Ribbon. Rather than approaching large investors, they came up with a rather brilliant method for crowdsourcing the buyout. The two men, Michael Migliozzi II and Brian William Flatow, actually managed to raise $200 million before the SEC stepped in to block the purchase.

Since late 2009, the two friends operated buyabeercompany.com (now defunct) and created a facebook page and a twitter account that helped them coordinate investors. The idea was to attract investors who would pledge money, as little as $5 or as much as $250,000, and they would only be asked to pay this money if they reached the threshold $300 million. Like Kickstarter andPledgeMusic, there was no money out of pocket until the project’s target had been reached.

The SEC canned the planned takeover because the two organizers had failed to properly register what amounted to a security issuance. In effect, the website was a stock issuance that required registration and disclosures under Sec. 5(c) of the Securities and Exchange Act. Given that there were no sanctions accompanying the SEC’s “cease and desist” order, there is some chance that after properly registering and disclosing the required information, this might not be the end of this story.

Crowdfunding in its various manifestations has been spreading rapidly and there are plenty of interesting resources around the internet. But it’s curious that there haven’t been more efforts to use the internet to enable widely distributed groups of people to buy up more major companies. Beer companies and sports teams seem like obvious candidates. While SEC filings are a small hurdle, there’s no obvious reason that the broader investing public couldn’t do a targeted takeover of any number of corporations through these kind of threshold pledge plans.

Like the far more controversial Bitcoin peer-to-peer currency, crowdfunding promises to decentralize and generally transform corporate finance around the world. Perhaps as campaigns like Buy A Beer Company become more common, the SEC will develop new protocols for facilitating these kinds of online purchases while still ensuring that potential buyers and sellers are being dealt with honestly and transparently. In the meantime, there’s going to be a real need for lawfirms or other organizations willing to perform the SEC filings for the coming surge in crowdfinanced buyouts.

This entry was originally posted at The HLPR Blog: Notice and Comment.

The Ivory Bubble

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This entry was originally written for the HLPR Blog: Notice and Comment.

I should be clear: I am delighted to be graduating with my degree. But in commemoration of my final week of law school, I’d like to use this opportunity to consider the macroeconomic implications of the increasingly hard-to-deny bubble in American higher education. Pointing out this bubble’s existence has become a kind of de rigeur exercise among online commenters. The basic point is this: the cost of higher eduction continues to rise rapidly while the real risk-weighted value of a degree declines.

Nevertheless, American families, banks, and even the U.S. government continue pouring more money into this depreciating asset. There are speculative aspects to the higher education industry (like online for-profit degree mills), but what’s driving this bubble is a Hobson’s choice: even if higher education is a scam, not having a degree looks like an even worse fate. Like housing, education is almost an economic necessity in our society. That is precisely why the housing crisis has been so virulent, and it’s why an education bubble is so troubling. What many commenters have found particularly ironic about this whole situation is the complicity of our most esteemed educational institutions in translating that necessity into massive profits and ballooning endowments.

Malcom Harris’s excellent article for the most recent issue of N+1, Bad Education, explores some of the bubble’s causes and the likely economic impact of its burst. This quote provides a helpful reference point:

Since 1978, the price of tuition at US colleges has increased over 900 percent, 650 points above inflation. To put that number in perspective, housing prices, the bubble that nearly burst the US economy, then the global one, increased only fifty points above the Consumer Price Index during those years.

The comparisons to the housing bubble don’t end there. As it did with housing, the government provides massive educational subsidies and tax-incentives. The federal government also provides massive education loan guarantees to primary lenders, which encourages bad (i.e. subprime) lending. In other words, banks have no incentive to perform credit evaluations on the students receiving the loan. Because of federal programs like the recently-discontinued Federal Family Education Loan Program (FFELP), banks face little risk when lending $240,000 to an 18-year with doubtful job prospects. Harris also notes that a secondary market in education loans has developed. Like mortgage CDOs and other mortgage-backed securities, Student Loan Asset-Backed Security (SLABS) make it possible to invest in a diversified pool of education debt.

So with all the pieces in place, what would a burst in the higher education market bubble look like? As students find their degrees don’t translate into jobs, they’ll eventually default and file for bankruptcy. Federal law prevents discharge of student debt unless the student can demonstrate “undue hardship,” an extremely difficult legal standard to satisfy. The debt could plague student borrowers for much of their adult lives, making it harder to go back to school, change jobs, get loans, and buy homes. Although, given the relatively small size of the secondary market in education debt, a financial panic is far less likely, a flood of defaults could strain the whole economy for decades. And with high unemployment among recent graduates, these effects are perhaps not far off.

One major difference from the housing bubble is that a flurry of educational defaults would not trigger a comparable problem in asset pricing. That is because the federal government has already announced, in law, how it would pay lenders if default rates get too high. So while students get stuck with a lifetime of debt, lenders have, in effect, a government insurance program. In the worst case scenario the lenders still get paid at least 75 cents on the dollar. For the larger economy, that’s far better than a bottomless hole. But a 25% drop in price could still potentially call into question the real worth of major holders of education debt and cause broader economic disruptions. In terms of moral hazard, this policy still puts taxpayers and students on the line for loans that probably shouldn’t have been made.

As in the housing crisis, this bubble is primarily squeezing America’s middle class. And while consumers may have appeared greedy in taking out subprime mortgage loans, it’s much harder to blame parents for sending their kids to college. Universities, creditors, and the federal government need to reassess how higher education is priced and financed in this country. Education debt should be dischargeable in bankruptcy. The government needs to figure out how it can stop guaranteeing loans for limitless tuition hikes without disproportionately impacting poorer applicants. Universities face perhaps the most significant moral hazards here. Schools need to reign in costs, and more fundamentally, they need to confront how their business model squares with their own mission statements.

Photo Credit: Peter Vanderwarker