Placeholders: Engaging the Hayekian Critique of Financial Regulation

Since Friedrich Hayek, debates about the proper relationship between the state and the market, and about the optimal design of regulatory institutions, often turn on assumptions about the workings of legal expertise — and in particular about the difference between public expertise (bureaucratic knowledge) and private expertise (private law). Hayek’s central argument, adopted uncritically by a wide array of policy-makers and academics across the political spectrum, is a temporal one: bureaucratic reasoning is inherently one step behind the market, and hence effective market planning is impossible. In contrast, Hayek argues, private ordering is superior because it is of the moment, happening in real time. My research suggests that Hayek’s description of the limitations of bureaucratic planning resonates with the sense of powerlessness and frustration experienced by many government officials themselves as they attempt to manage economic fluctuations. But Hayek’s rich (and even empathetic) account of the limits of well-meaning public legal expertise is far less complete when it comes to the strengths of private legal reasoning. Public reasoning has temporal weaknesses, so private reasoning must have equivalent temporal strengths, the argument goes. This chapter from a forthcoming book, Collateral Knowledge: Legal Reasoning in the Global Financial Markets, takes on Hayekian arguments against government regulation through a detailed examination of real-world examples of how public and private legal technologies manage the temporal dimensions of risk in the over-the-counter derivatives markets. It draws upon over ten years of fieldwork conducted among regulators and market participants involved in the global derivatives markets in Japan. The specific examples are: the usage of collateral on the private law side, and the usage of “real time gross settlement” payment settlement systems on the public side. My research shows that while there is no reason to believe that either of these is actually more effective than the other as a stop-gap against future uncertainties in the market, there is nevertheless a kind of “Hayekian” perception, by market participants and government officials alike, that the private devices are more legitimate, and that the experts who deploy these are more knowledgeable, more expert. In order to understand the root of this legitimacy gap, the paper explores in detail how collateral, as a private legal technology, handles the temporal uncertainties surrounding market risk. At the heart of “collateral” is a deceptively mundane, but actually quite audacious legal trick called the legal fiction. In legal terms, a legal fiction is a statement that is consciously understood to be false, and hence is irrefutable. An example would be the statement that “a corporation is a person”. Collateral is actually just a set of legal fictions, layered one on top of another. I explain how these fictions — which are just as problematically related to market “realities” as government planning technologies — nevertheless come to be much more readily accepted predictors, and indeed creators of market realities. So does this mean that private regulation is inherently superior to public regulation? The fallacy of the Hayekian argument is the assumption that these “private” technologies can only be deployed by private actors. In fact, there is nothing inherently private or public about the legal fiction or other similar devices of private law. The paper demonstrates this by showing how financial regulators in Japan redeployed the trick of the legal fiction and hence regained legitimacy in their own eyes and in the eyes of market participants.