Blog Ipsa Loquitur

Published on under Legal Theory

While all the morning talk(ing heads’) shows were focusing on last night’s self-congratulatory industry awards for excellence in the field of excellent filmmaking results, I’ve been catching up on Depression Watch 2009. As proof that law school irredeemably changes the way you think, I offer my train of thought.

I keep reading about the people in charge of investing all kinds of money into what the media continues to call “toxic assets” - securities that aren’t worth nearly what investors were betting they’d be worth. This bit from today’s New York Times struck me:

Still, the big banks say they remain relatively healthy and that, with time and support from the government, they will regain their footing. But many economists, Wall Street analysts and even some bank executives contend that some of the banks are already effectively insolvent.

Even though banks have reported billions of dollars of losses from bad loans, these critics say, the major institutions still carry trillions of dollars in additional toxic assets and are too damaged to resume normal lending.

Trillions? With a T? When we the taxpayers floated Citigroup $50 billion, that was less than 2% of the market’s total toxic assets? At this point, incompetence can’t hope to explain this mess. The banks who made these investment decisions inflated short-term profits (and short-term bonuses) so much that the people responsible can retire today in comfort for the rest of their lives.

I’ve had this vague sense of how horrible this situation is; I understand that we haven’t hit bottom just yet; I know that $50 billion is a mind boggling amount of money, and I can’t imagine that there are trillions of dollars of these assets that just aren’t worth trillions of dollars.

At this point, I started thinking about one of the fundamental concepts of my criminal law class from last year: the culpable mental state. While doing something bad (actus reus), you have to have something happening in your brain (mens rea) that makes you responsible in some capacity for your action.

sidebar: Were I still in college, I’d probably diverge into a long and perilously drawn out discussion of how difficult or impossible it can be to discern the subjective mental state of another person. The law makes certain allowances for this. I’ll satisfy my urge to be the Socratic gadfly to my own monologue with a link to the wonderful Stanford Encyclopedia of Philosophy’s entry for philosophical zombies, and pose the question: can we ever see what (if anything) goes on inside someone’s head?

The two relevant mental states with regard to the banks are negligence and recklessness.

Negligence in the criminal sense is characterized in part by the failure to perceive a substantial and unjustifiable risk that a certain result will occur, or a certain circumstance does exist. As always, I’m oversimplifying - the full text of the law is available on Justia here. The part of the definition I want to focus on is the existence of a substantial risk that the actor fails to perceive.

In the case of the bankers, I gave them the benefit of the doubt. When word came out about the toxicity of the banks’ assets, I knew I had heard relatively few details and I assumed that these people are good at what they do. It’s clear that there was a risk that mortgage-backed securities would burst into flames and plunge the country into a second Great Depression, but the bankers were probably ignorant, right? Why would you take a risk that will kill your 150 year old investment firm? It seemed to be an irrational action against self interest that no rational actor would take.

But I’m starting to see the behavior of the banks as less negligent and more reckless. Recklessness is different from negligence in that the actor perceives the substantial risk before he goes ahead with his action anyway. It seems baffling that bankers could think there was no risk in having over 30 times as much debt as assets, with so many of their “assets” in the form of mortgage-backed securities that the government has $4.6 trillion tied up in shoring up the market.

It’s obvious now that there was a risk: perhaps it wasn’t certain that the gross overvaluation of assets like mortgage-backed securities would cripple the economy exactly when it did, but there was clearly an ongoing risk. It’s a multi-trillion liability, and it seems impossible that people who were paid to assess risk didn’t see this possibility.

So where I assumed simple negligence had caused this problem, now it’s hard to believe that this is anything but recklessness.

Similarly, it’s hard to believe that my train of thought wanders into legal definitions. Halfway to getting my J.D., law school has broken my brain.