Working Paper: CEPR ID: DP9235
Authors: Katharina Pistor
Abstract: This paper develops the building blocks for a legal theory of finance. LTF holds that financial markets are legally constructed and as such occupy an essentially hybrid place between state and market, public and private. At the same time, financial markets exhibit dynamics that frequently put them in direct tension with commitments enshrined in law or contracts. This is the case especially in times of financial crises when the full enforcement of legal commitments would result in the self-destruction of the financial system. This law-finance paradox tends to be resolved by suspending the full force of law where the survival of the system is at stake; that is, at its core. Here, power becomes salient. This helps explain why finance is concentrated around ultimate lenders of last resort and why regulating finance?s core has become so elusive. It also holds lessons for future reforms.
Keywords: finance; financial crisis; financial regulation; law; political economy; power
JEL Codes: F5; G01; G2; K0; K22; N20; P1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial markets are legally constructed (G10) | Financial markets exhibit inherent instability (D53) |
| Fundamental uncertainty and liquidity constraints (D89) | Financial markets trigger systemic crises (E44) |
| Predetermined legal commitments (K12) | Self-destructive outcomes for the financial system (F65) |
| Rigid legal obligations conflict with the need for flexibility (D45) | Self-destructive outcomes for the financial system during crises (F65) |
| Legal elasticity of financial commitments is inversely related to the hierarchy of finance (G39) | Core financial actors enjoy more flexible legal treatment than peripheral ones (F65) |
| Legal obligations (G38) | Exacerbate systemic risks (F65) |