American Finance and American Democracy: Towards an Institutionalist 'Law and Economics'

This article reconsiders the financial and economic crisis of 2007-2009 and the present debate about the regulation of finance in the light of a vision of how finance can better serve the American economy and American democracy. The central claim is that regulation as conventionally understood cannot adequately redress the problems, and seize the opportunities, revealed by the crisis. We should approach financial regulation as the first step in a series of institutional innovations designed to put finance more effectively at the service of the real economy (financial deepening) while broadening economic opportunity in the country (financial democratization). I develop and defend this thesis by arguing for four subsidiary claims. A first subsidiary claim is that a major part of the causal background to the crisis was an inconclusive hollowing out of the New Deal regime for the governance of finance. That regime failed to be replaced by an alternative coherent scheme. Instead, it gave way to a ramshackle compromise -- powerful, opaque, recalcitrant, and damaging. Such a situation -- I argue -- represents the rule rather than the exception in the history of law and institutions. The outcome of the hollowing out in the United States was a weakening of the links of finance to the real economy, paradoxically accompanied by the hypertrophy of the financial sector. A second subsidiary claim is that the New Deal critics and reformers of finance, such as Louis Brandeis and William Douglas, were right in their intuition that a strong link exists between the legal and institutional requirements of financial deepening and of financial democratization. A third subsidiary claim is that to make good on this intuition in today's circumstances we need a new agenda of reform with an explicit and ambitious institutional content. Such an agenda includes the transfer of sophisticated financial capabilities to the country's remarkable network of local banks as well as a vast expansion and popularization of financial services, channeling long-term saving into long-term productive investment. A fourth subsidiary claim is that law and legal thought provide the chief storehouse of the ideas and methods needed to conceive and to implement such innovations. Prevailing styles of economic theory, including those underlying the dominant practice of “law and economics,” remain largely bereft of institutional imagination. This article illustrates how a revised practice of legal and institutional analysis can help fill this lacuna. In so doing, this piece takes "law and economics" in another direction.