Volume 163, Issue 6 
May 2015
Articles

Regulating Against Bubbles: How Mortgage Regulation Can Keep Main Street and Wall Street Safe—from Themselves

Ryan Bubb & Prasad Krishnamurthy

As the Great Recession has painfully demonstrated, housing bubbles pose an enormous threat to economic stability. However, the principal mortgage market reforms in response to the latest boom and bust—the Dodd-Frank Act's provisions on mortgage lending and securitization—are not designed to protect the economy from a housing bubble. Instead, these reforms tinker with the incentives of securitizers and lenders to prevent their exploitation of naive investors and borrowers. In particular, these changes require securitizers to retain credit risk and lenders to assess borrowers' ability to repay.

This approach misses the mark. The sine qua non of a bubble is marketwide overoptimism about future house prices. Irrational exuberance in a bubble leads parties across the entire system of housing finance to make risky bets based on rosy beliefs. It is not just investors who underprice credit risk and borrowers who overextend. Securitizers and lenders are also eager to take on dangerous levels of risk and leverage. The Dodd-Frank Act's incentive-based reforms, by relying on rational behavior by supposedly sophisticated parties, will do little to protect the economy from a bubble. They might even increase systemic risk by concentrating mortgage risk in large financial institutions.

Because indirect incentive-based regulation is ineffective in a bubble, more direct mandates should be employed. We suggest a number of direct regulations to limit mortgage leverage, debt-to-income levels, and other contractual features that enable or induce borrowers to take out larger loans. We show how such limits can curb bubbles, lower defaults, and reduce household exposure to housing risk. While such limits would undoubtedly entail costs, such as restricting access to mortgage credit and homeownership, we suggest straightforward ways to mitigate many of these concerns. Our critique of incentive-based regulation also provides an important new perspective on current legislative efforts to reform the broader architecture of housing finance.

The Dodd-Frank Act's mistargeted approach reflects in part the growing literature in behavioral law and economics that shows how sophisticated firms take advantage of biased consumers. Indeed, much of the debate over the appropriate response to the Great Recession has been about how to keep Main Street safe from Wall Street. We advance this literature by showing that the mistakes of firms have important implications for the design of regulation. Our analysis calls for a fundamental paradigm shift. The central policy challenge is to keep Main Street and Wall Street safe from themselves.


A Dose of Reality for Specialized Courts: Lessons from the VICP

Nora Freeman Engstrom

The latest in a long line of reform proposals, health courts have been called “the best option for fixing our broken system of medical justice.” And, if health courts’ supporters are to be believed, these specialized courts are poised to revolutionize medical malpractice litigation: They would offer faster compensation to far more people, while restoring faith in the reliability of legal decisionmaking. But these benefits are, as some leading supporters have acknowledged, “hoped for, but untested.” The question remains: Will health courts actually operate as effectively as proponents now predict?

The best evidence to answer that question comes, I suggest, from the Vaccine Injury Compensation Program (VICP)—a Program that employs very similar procedures to handle very similar claims and that had, at its birth, a very similar ambition. Mining nearly three decades of previously untapped material concerning the VICP’s operation, this Article analyzes how an American compensation program that wrests jurisdiction from traditional courts has, in practice, fared. Findings are discouraging. Though the VICP and health courts share many of the same procedural innovations, those innovations, in the VICP context, have largely failed to expedite adjudications and rationalize compensation decisions. This fact carries significant implications for health courts, suggesting that they won’t operate nearly as effectively as their proponents now predict. More broadly, this study of an American no-fault regime, in action and over time, enriches—and at times complicates—current understanding of the prospects, promise, and “perceived virtues” of other specialized courts and alternative compensation mechanisms.


Judicial Priorities

Bert I. Huang & Tejas N. Narechania

In an unprecedented move, the Illinois Supreme Court in the mid-1990s imposed hard caps on the state’s appeals courts, drastically reducing the number of opinions they could publish, while also narrowing the formal criteria for opinions to qualify for publication. The high court explained that the amendment’s purpose was to reduce the “avalanche of opinions emanating from [the] Appellate Court,” which was causing legal research to become “unnecessarily burdensome, difficult and costly.”

This unusual and sudden policy shift offers the chance to observe the priorities of a common law court in its production of published opinions. The method we introduce here can be seen as a sort of revealed-preferences approach: when forced to choose, which types of opinions were these courts more likely to continue publishing, and which types were they more likely to abandon?

Our method, which seems straightforward, has turned out to reveal more than we expected: it has uncovered more than the simple priorities raised in the thought experiment above. One especially surprising pattern forces us to develop new theories about how higher-level judicial priorities—such as a concern for outward appearances—compete for influence over judicial choices.


Comments

Dangerous Liaisons: Criminalization of “Relationship Hires” under the Foreign Corrupt Practices Act

Shinjini Chatterjee

On August 17, 2013, the New York Times published a front page story on JPMorgan Chase & Co. that cast the firm at the center of an international bribery scandal and sparked a media firestorm. The article reported that the U.S. Securities and Exchange Commission (SEC) had opened a bribery investigation into the firm's hiring practices in China pursuant to the Foreign Corrupt Practices Act (FCPA), a statute that regulates bribery and public corruption in foreign countries. The story continued to garner national attention in the weeks following the article's release, especially after the Department of Justice (DOJ) joined the SEC's investigation. At the center of the controversy was the unusual nature of the investigation itself: unlike most FCPA bribery investigations, which target financial payments to foreign officials in exchange for business advantages, the central issue underpinning the JPMorgan investigation was the firm's apparent practice of hiring well-connected children of Chinese business and political leaders. More specifically, the government's investigation targeted the firm's “Sons and Daughters” program in China, a hiring program that allegedly favored children of Chinese owners of state-controlled enterprises in China. JPMorgan purportedly relied on this hiring process to gain a competitive advantage in China, where state-owned enterprises dominate the economy.

Although most media reports on the JPMorgan investigation characterize it as an unusual approach for the government, probes into corporate hiring practices are part of an increasingly apparent trend in FCPA enforcement. About eight months after the JPMorgan investigation began, DOJ and the SEC sent letters to at least five other financial institutions, requesting information on their hiring practices in Asia. Federal agencies have justified these types of “relationship hire” investigations as well within the scope of the FCPA. The FCPA prohibits the exchange of “anything of value” with foreign officials for any “improper advantage”—language that appears to encompass offers of employment to relatives of foreign officials. Critics of the FCPA's application to relationship hires have questioned the government's reading of the Act's language, characterizing it as an “aggressive” interpretation.

Despite the publicity surrounding the JPMorgan scandal, very little scholarship has examined relationship hires as an issue that defines and tests the limits of future FCPA enforcement. This Comment begins this discussion by analyzing both the rationale for the government's application of the FCPA to relationship hires and the implications of this type of FCPA enforcement.


Getting Their Due (Process): Parents and Lawyers in Special Education Due Process Hearings in Pennsylvania

Kevin Hoagland-Hanson

The Individuals with Disabilities Education Act (IDEA) requires school districts to provide a free appropriate public education to all students, regardless of physical or mental disability. To that end, thousands of parents and students enter the special education due process system created by state governments under IDEA each year to compel districts to provide the services required by statute. All parents and students have the right to hire a lawyer to help them navigate the complicated administrative regime, though not all have the ability to do so. But many critics of IDEA due process argue that the presence of lawyers slows the process unnecessarily and damages the relationship between families and school districts.

Through a combination of empirical analysis of five years of Pennsylvania special education hearing officer decisions and interviews with private special education lawyers, this Comment examines the role of counsel in IDEA due process. Parents and students with counsel were significantly more likely to obtain substantive relief through due process than those proceeding pro se. Yet, at least some pro se parents still had viable claims and a few were able to successfully obtain favorable decisions from hearing officers, without the assistance of counsel.

This Comment evaluates proposed alternatives to the due process system as constructed, including alternative non-adversarial dispute resolution mechanisms, in light of the empirical data from Pennsylvania. The data suggests that special education due process, in Pennsylvania at least, is more stable and effective than many critics have argued and that greater access to counsel, not less adversarial alternatives, may be a better way to ensure compliance with the substantive requirements of IDEA.


Issues - Print Edition - PennLawReview.com