To the Edge: Legality, Legitimacy, and the Responses to the 2008 Financial Crisis

To the Edge: Legality, Legitimacy, and the Responses to the 2008 Financial Crisis

by Philip A. Wallach

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Were the radical steps taken by the Treasury Department and Federal Reserve to avert the financial crisis legal? When and why did political elites and the general public question the legitimacy of the government's responses to the crisis?

In To The Edge: Legality, Legitimacy, and the Responses to the 2008 Financial Crisis, Philip Wallach chronicles and examines the legal and political controversies surrounding the government's responses to the recent financial crisis. The economic devastation left behind is well-known, but some allege that even more lasting harm was inflicted on America's rule of law tradition and government legitimacy by the ambitious attempts to limit the fallout. In probing these claims, Wallach offers a searching inquiry into the meaning of the rule of law during crises.

The book provides a detailed analysis of the policies undertaken—from the rescue of Bear Stearns in March 2008 through the tumultuous events of September 2008, the passage of the TARP and its broad usage, the alphabet soup of emergency Federal Reserve programs, the bankruptcies of Chrysler and GM, and the extended public ownership of AIG, Fannie Mae, and Freddie Mac. Throughout, Wallach probes the legal bases of the government's actions and explores why concerns about the legitimacy of government actions were only sporadically grounded in concerns about legality—and sometimes ran directly against them.

The public's sense that government officials operated through ad hoc responses that favored powerful interests has helped bring the legitimacy of American governmental institutions to historic lows. Wallach's book recommends constructive and sensible reforms policymakers should take to ensure accountability and legitimacy before the government faces another crisis.

Product Details

ISBN-13: 9780815726241
Publisher: Brookings Institution Press
Publication date: 04/21/2015
Sold by: Barnes & Noble
Format: NOOK Book
Pages: 319
File size: 2 MB

About the Author

Philip A. Wallach is a fellow in Governance Studies at the Brookings Institution.

Read an Excerpt

To the Edge

Legality, Legitimacy, and the Responses to the 2008 Financial Crisis

By Philip A. Wallach

Brookings Institution Press

Copyright © 2015 The Brookings Institution
All rights reserved.
ISBN: 978-0-8157-2624-1


Introduction: Law, Legitimacy, and Crisis Government

Consider the following three descriptions of government responses to the financial crisis:

—Because they wanted access to money without having to get the legislature's approval, government officials interpreted an old statute in a fairly farfetched way to commit up to $50 billion to guarantee that private investors would bear no risk of losses.

—Pursuant to the terms of a law just passed, the government offered banks an investment of capital at fairly favorable terms.

—The government left undisturbed several contracts between a private firm and its employees, concluding that it was legally obligated to do so.

From these descriptions, you might naturally imagine that outside observers would be outraged at the first action for its twisting of the law and accepting of the second and third for their clear compliance. After all, respect for the rule of law is one of the hallmarks of our system of government.

You would be very wrong. The first action described, through which the Treasury Department made a crucial intervention to support the money market industry at the peak of the financial crisis in September 2008, occasioned almost no criticism at the time and has quickly receded into historical memory. The second action, which was the first major use of the crisis-inspired Emergency Economic Stabilization Act (EESA, better known as TARP) passed in October 2008, received scathing criticism both from those who felt the government was effectively running roughshod over private firms' rights and from those who felt that the particular nature of the action was an inappropriate use of the resources allocated by the law. Years later, neither group of critics has been much mollified; angry accusations of Godfather-style extortion and bait-and-switch deception persist, if at a lower volume. The third action, in which the government decided in March 2009 that it could take no legally valid action to stop bonus payments to employees at the mostly government-owned insurance giant AIG, inspired the most fearsome public outcry of the whole crisis. A public whose sense of fairness was deeply offended was profoundly unmoved by professions of legal limitations—though, as it turned out, elected officials were somewhat more sensitive to what the law required, ultimately leading them to step away from the most legally problematic actions under consideration.

This book attempts to shed light on this divergence between legality and legitimacy during crises. It does so by offering a comprehensive account of the government's responses to the financial crisis of 2008 and the political and legal controversies that surrounded them. Throughout, it attempts to accurately describe how the public reacted to each action and analyze why certain issues aroused so much more anger than others.

As with any exploration of recent history, the events described still inspire strong and conflicting feelings. Their place in history is in the early stages of being determined, and so partisans of various interpretations are likely to denounce those who fail to ratify their own views. In the case of the recent crisis, two polar extreme views are now vying for contention. For some, it is all but self-evident that what the government did during the crisis was outrageous and that the so-called bailouts were a fundamental betrayal of the public trust as well as a perversion of both statutory and constitutional law. At the other end of the spectrum, some will profess astonishment at the idea that the government's actions deserve further scrutiny, either in a legal or political sense. They believe everything that the government did was perfectly above board and that it is downright petty to quibble over insubstantial legal trifles at this point in time, especially given how well these programs turned out to perform.

There is little purpose in coyly hiding my own views. As the crisis unfolded in 2008 and 2009, much of what the government was doing struck me as legally unjustifiable and worrying. I was skeptical that "loans" would ever be paid back, or even that the policymakers involved believed that they would be; as a result, many of the government's actions struck me as illicit forms of spending. As those loans were paid back at levels that showed my initial thinking was mistaken, and as I learned more about the details of the responses and the history of other crisis responses, I became considerably less distressed, and more convinced that discretion ought to be welcomed, at least in limited circumstances. There are many choices that remain troubling to me, and my judgments are sure to be evident throughout the book. But the main purpose of the book is not to simply argue for a particular judgment about each of the various crisis responses. Convincing either of the two types of critics noted above of the merits of my judgments is not my priority.

Instead, my aim is to illuminate for readers of all perspectives some of the dynamics of establishing legitimacy during a financial crisis, especially the role of law in that process. Responding to crises—whether military or financial—raises several dilemmas for a country's leaders. Relying on already existing legal authorities may be insufficient to meet the challenges, and exigency may make obtaining new ones impossible. History generally esteems leaders who seize these moments and respond forcefully, whether in strict compliance with the law or not.

Some scholars thus conclude that legal constraints have come to play almost no role in shaping the legitimacy of responses to crisis, but I reject that view. Especially when leaders enjoy little public trust, bold crisis actions may be regarded as illegitimate if they flaunt the law. Although it is easy to overestimate the importance of the rule of law in crises, complying with the law remains one important factor for legitimacy. And achieving legitimacy is often a necessary prerequisite to successfully responding to a crisis.

I argue that legality is neither necessary nor sufficient to establish an action's legitimacy during a crisis. If "it's against the law" is the only argument against an action, then this legalistic point will be little impediment to establishing legitimacy. From the other direction, if an action lacks legitimacy for various reasons, declaring that it is consistent with the law (or even legally mandatory) will not always confer legitimacy on it. Indeed, I argue that there is no single factor that can reliably secure legitimacy for a crisis response. Obedience to established law, democratic support, trust in crisis leaders, and a widespread sense that those leaders will be held accountable for any abuses will all contribute to legitimacy, but none of these factors is indispensable. Looking to the future, I recommend both a greater investment in clear legal limitations and a realistic acceptance of law's limitations as embodied by a limited but substantial discretionary fund to be used at the executive branch's disposal to combat financial crises.

To begin to explain these claims, the concept of legitimacy I employ demands some clarification at the outset.

What Is Legitimacy?

There are two ways of thinking about legitimacy: normatively or as a positive social fact. Academic political theorists and armchair moralists alike most often engage in the normative enterprise: developing standards of legitimacy that government actions must meet and evaluating particular actions with regard to these standards. (Lawyers focus on the somewhat unusual normative standard of legality, to which I return shortly.) To anyone who has ever argued about the legitimacy of government actions in normative terms, it should be obvious that judgments about legitimacy are often sharply conflicting. This is true even when discussions clearly distinguish between "actions that are legitimate" and "actions that I approve of," which many do not.

Treating legitimacy as a social fact, as I do in this book, is somewhat more conceptually difficult. Following Max Weber's empirical approach, this approach does not deny normativity but says that the social scientist interested in legitimacy ought to understand its emergence as it happens, rather than as the practitioners of "legal dogmatics" say it ought to.

In a sense, legitimacy as a social fact can be understood as the aggregate product of all of the normative arguments—including arguments that never actually happen and that people perhaps are not even prepared to have. That statement requires some unpacking.

Legitimacy as a social fact is necessarily a collective phenomenon. If every person were an independent-minded political theorist and a perfect observer of every government action, then political legitimacy writ large could probably be fairly characterized as an aggregated sum of all citizens' judgments about legitimacy. As long as time and attention are scarce, however, a real citizenry can never approach this (rather dystopian-sounding) ideal. Rather, certain shared ideas about legitimacy shape widespread perceptions, both because citizens apply them in similar ways and because elite opinion leaders apply them and have others adopt their judgments as authoritative. This application of ideas to particular instances is hardly ever a matter of applying well-defined logic, though. Instead, opinion at every level of engagement is shaped by a contest of rhetorical framings, selective attention to facts, and group affinity; opinion leaders seeking audiences for their own views about legitimacy are sensitive to which arguments gain currency and thus are also followers of broad sensibilities.

Legitimacy for the whole polity is thus an emergent and path-dependent phenomenon, characterized by dozens of feedback mechanisms that involve those who develop criticisms, those who rebut them, and those who determine their own judgments about these debates and determine their own level of engagement with them. Predicting social legitimacy in advance is generally a fool's errand, as so much depends on how arguments play out in real time; that said, it is far from random, and there are characteristics of actions that usually contribute or detract from their legitimacy in predictable ways. These characteristics correspond to normative conceptions of legitimacy held by many people—but I must emphasize that I do not prejudge whether people will actually apply those factors in every case (let alone whether they should). Indeed, one of the book's contributions is to show how missing certain legitimating factors often thought of as absolutely crucial—including legality—can turn out not to create legitimacy problems.

By studying at what points a lack of legitimacy produced political strife during the recent crisis, I draw useful lessons about what policymakers can do to improve the legitimacy of their future actions. But I have no illusion that these lessons will be anything other than helpful heuristics: probabilistically useful but by no means a recipe for certain success. Politics, in its most universal sense, is about determining what collective actions are legitimate, and nobody should imagine that it can be reduced to a simple science—it is, after all, properly thought of as the art of the possible.

That I offer no scientifically rigorous way of ascertaining legitimacy after the fact will undoubtedly worry those who crave certainty. In part to satisfy such worries, I frequently make use of public opinion data obtained through polling, and it can often provide a useful indicator. But the questions asked by pollsters are generally too vague and haphazardly deployed to give a clear sense of reactions to specific policies; and even if I had been able to conduct my own polls consistently, I would not argue that legitimacy is equivalent to public opinion. This is because polling obscures the huge variations in the intensity of people's investments in understanding political developments. This is well understood, but little dwelt upon, by students of political behavior, who nevertheless often confine themselves to the kinds of questions that polling data are able to speak to more or less adequately.

In studying the debates surrounding the responses to the financial crisis, it is important to emphasize several facts that are rarely acknowledged, perhaps because doing so seems unscholarly: that it is difficult, time consuming, confusing, and often boring to penetrate the mass of information about these complicated events. This is true even for those of us who invest large parts of our lives poring over particulars. (Indeed, there are a few matters that probably deserve treatment in this book but managed to evade coverage because of their technical slipperiness.) Treating these features of our political life as merely incidental unnecessarily renders scholarly discussions less realistic.

This book frankly acknowledges that lack of attention and ignorance are the defining features of most people's relationship to particular governmental actions. These actions' legitimacy will be a function of the interaction of underlying attitudes about government with (generally unfocused) exposure to the playing out of arguments among a small elite. The most common underlying attitudes are blanket cynicism, blanket trust (quite uncommon today), and blanket indifference, each of which has the power to wipe out the impact of any debate. More consequential for determining society-wide legitimacy are those people more able to adjust their judgments about a policy's legitimacy in response to ongoing elite debates, at least some of the time, and therefore to vary their levels of "specific support" from one policy action to another. The relevant elite is one of knowledge and opinion; especially in the age of the Internet, it is open to those who decide to invest their time and energy—at least in part. Our national conversations are still disproportionately centered in a few newspapers, and those who have access to the opinion pages of the New York Times and the Wall Street Journal have greater ability than the rest of us to affect judgments about legitimacy.

To make this at least a little more concrete: The median citizen, or even the median voter, probably understands little about the role played by the Treasury or the Federal Reserve in responding to the financial crisis. The median engaged citizen has never heard of Maiden Lane LLC, let alone pondered its legal justification. Even the median member of Congress must find a great deal about the government's response to the crisis quite obscure. Policies such as "the auto bailouts" are far more widely opined about—although many of those most willing to stake out a position on the legitimacy of a policy like that one, the politics of which ended up polarized along partisan lines, may be unable to say with any specificity what the intervention consisted of. But it would be wrong to infer that there is no there there when it comes to determining legitimacy: as chapter 5 shows, the contentious debates among experts about the legitimacy of the Chrysler bankruptcy are extremely substantive and illuminating, and the hard-hitting legal criticisms offered at the elite level manifested themselves as a greater willingness among Republicans to pound the table about the issue.

Although not formally systematized, the book's approach to legitimacy nevertheless attempts to distinguish levels of critical reactions. Legitimacy is clearly not a binary variable, though it is sometimes discussed in that way. Instead, there is a spectrum, with actions inspiring violent revolution on one end and actions hailed with unanimous acclamation on the other. Intermediate cases are not so easily deemed to possess or lack legitimacy: if a substantial minority angrily complains that an action is illegitimate but is not angry or well mobilized enough to effectively oppose it; if most people raise their eyebrows when learning of an action but then reluctantly acquiesce; if a few people are upset by an action but most are not even aware of it. To place different actions on this spectrum, I consult a variety of sources, gauging the intensity of the reaction among journalistic commentators, blogging academics, and angry commenters across the web. Activity in Congress is a crucial barometer: if an issue is never raised by some legislator hoping to make a name for himself through hard-hitting oversight, it probably failed to make much of an impression on the broader public. If it inspires table-pounding hearings or the introduction or even passage of bills, then worries about legitimacy were more consequential.


Excerpted from To the Edge by Philip A. Wallach. Copyright © 2015 The Brookings Institution. Excerpted by permission of Brookings Institution Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents


Acknowledgments, ix,
1 Introduction: Law, Legitimacy, and Crisis Government, 1,
2 When Legality and Legitimacy Diverge, 21,
3 Embracing Adhocracy, 43,
4 Laying Out a Broad TARP, 79,
5 Adhocracy Continued in the Obama Administration, 119,
6 Accountability Mechanisms, 158,
7 Taking Stock and Looking Ahead, 186,
Glossary of Crisis Laws and Programs, 219,
Notes, 223,
Index, 307,

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