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The Forgotten Strand of the Anti-Monopoly Tradition in Anglo-American Law

Ben Sperry —  13 January 2021

Admirers of the late Supreme Court Justice Louis Brandeis and other antitrust populists often trace the history of American anti-monopoly sentiments from the Founding Era through the Progressive Era’s passage of laws to fight the scourge of 19th century monopolists. For example, Matt Stoller of the American Economic Liberties Project, both in his book Goliath and in other writings, frames the story of America essentially as a battle between monopolists and anti-monopolists.

According to this reading, it was in the late 20th century that powerful corporations and monied interests ultimately succeeded in winning the battle in favor of monopoly power against antitrust authorities, aided by the scholarship of the “ideological” Chicago school of economics and more moderate law & economics scholars like Herbert Hovenkamp of the University of Pennsylvania Law School.

It is a framing that leaves little room for disagreements about economic theory or evidence. One is either anti-monopoly or pro-monopoly, anti-corporate power or pro-corporate power.

What this story muddles is that the dominant anti-monopoly strain from English common law, which continued well into the late 19th century, was opposed specifically to government-granted monopoly. In contrast, today’s “anti-monopolists” focus myopically on alleged monopolies that often benefit consumers, while largely ignoring monopoly power granted by government. The real monopoly problem antitrust law fails to solve is its immunization of anticompetitive government policies. Recovering the older anti-monopoly tradition would better focus activists today.

Common Law Anti-Monopoly Tradition

Scholars like Timothy Sandefur of the Goldwater Institute have written about the right to earn a living that arose out of English common law and was inherited by the United States. This anti-monopoly stance was aimed at government-granted privileges, not at successful business ventures that gained significant size or scale.

For instance, 1602’s Darcy v. Allein, better known as the “Case of Monopolies,” dealt with a “patent” originally granted by Queen Elizabeth I in 1576 to Ralph Bowes, and later bought by Edward Darcy, to make and sell playing cards. Darcy did not innovate playing cards; he merely had permission to be the sole purveyor. Thomas Allein, who attempted to sell playing cards he created, was sued for violating Darcy’s exclusive rights. Darcy’s monopoly ultimately was held to be invalid by the court, which refused to convict Allein.

Edward Coke, who actually argued on behalf of the patent in Darcy v. Allen, wrote that the case stood for the proposition that:

All trades, as well mechanical as others, which prevent idleness (the bane of the commonwealth) and exercise men and youth in labour, for the maintenance of themselves and their families, and for the increase of their substance, to serve the Queen when occasion shall require, are profitable for the commonwealth, and therefore the grant to the plaintiff to have the sole making of them is against the common law, and the benefit and liberty of the subject. (emphasis added)

In essence, Coke’s argument was more closely linked to a “right to work” than to market structures, business efficiency, or firm conduct.

The courts largely resisted royal monopolies in 17th century England, finding such grants to violate the common law. For instance, in The Case of the Tailors of Ipswich, the court cited Darcy and found:

…at the common law, no man could be prohibited from working in any lawful trade, for the law abhors idleness, the mother of all evil… especially in young men, who ought in their youth, (which is their seed time) to learn lawful sciences and trades, which are profitable to the commonwealth, and whereof they might reap the fruit in their old age, for idle in youth, poor in age; and therefore the common law abhors all monopolies, which prohibit any from working in any lawful trade. (emphasis added)

The principles enunciated in these cases were eventually codified in the Statute of Monopolies, which prohibited the crown from granting monopolies in most circumstances. This was especially the case when the monopoly prevented the right to otherwise lawful work.

This common-law tradition also had disdain for private contracts that created monopoly by restraining the right to work. For instance, the famous Dyer’s case of 1414 held that a contract in which John Dyer promised not to practice his trade in the same town as the plaintiff was void for being an unreasonable restraint on trade.The judge is supposed to have said in response to the plaintiff’s complaint that he would have imprisoned anyone who had claimed such a monopoly on his own authority.

Over time, the common law developed analysis that looked at the reasonableness of restraints on trade, such as the extent to which they were limited in geographic reach and duration, as well as the consideration given in return. This part of the anti-monopoly tradition would later constitute the thread pulled on by the populists and progressives who created the earliest American antitrust laws.

Early American Anti-Monopoly Tradition

American law largely inherited the English common law system. It also inherited the anti-monopoly tradition the common law embodied. The founding generation of American lawyers were trained on Edward Coke’s commentary in “The Institutes of the Laws of England,” wherein he strongly opposed government-granted monopolies.

This sentiment can be found in the 1641 Massachusetts Body of Liberties, which stated: “No monopolies shall be granted or allowed amongst us, but of such new Inventions that are profitable to the Countrie, and that for a short time.” In fact, the Boston Tea Party itself was in part a protest of the monopoly granted to the East India Company, which included a special refund from duties by Parliament that no other tea importers enjoyed.

This anti-monopoly tradition also can be seen in the debates at the Constitutional Convention. A proposal to give the federal government power to grant “charters of incorporation” was voted down on fears it could lead to monopolies. Thomas Jefferson, George Mason, and several Antifederalists expressed concerns about the new national government’s ability to grant monopolies, arguing that an anti-monopoly clause should be added to the Constitution. Six states wanted to include provisions that would ban monopolies and the granting of special privileges in the Constitution.

The American anti-monopoly tradition remained largely an anti-government tradition throughout much of the 19th century, rearing its head in debates about the Bank of the United States, publicly-funded internal improvements, and government-granted monopolies over bridges and seas. Pamphleteer Lysander Spooner even tried to start a rival to the Post Office by appealing to the strong American impulse against monopoly.

Coinciding with the Industrial Revolution, liberalization of corporate law made it easier for private persons to organize firms that were not simply grants of exclusive monopoly. But discontent with industrialization and other social changes contributed to the birth of a populist movement, and later to progressives like Brandeis, who focused on private combinations and corporate power rather than government-granted privileges. This is the strand of anti-monopoly sentiment that continues to dominate the rhetoric today.

What This Means for Today

Modern anti-monopoly advocates have largely forgotten the lessons of the long Anglo-American tradition that found government is often the source of monopoly power. Indeed, American law privileges government’s ability to grant favors to businesses through licensing, the tax code, subsidies, and even regulation. The state action doctrine from Parker v. Brown exempts state and municipal authorities from antitrust lawsuits even where their policies have anticompetitive effects. And the Noerr-Pennington doctrine protects the rights of industry groups to lobby the government to pass anticompetitive laws.

As a result, government is often used to harm competition, with no remedy outside of the political process that created the monopoly. Antitrust law is used instead to target businesses built by serving consumers well in the marketplace.

Recovering this older anti-monopoly tradition would help focus the anti-monopoly movement on a serious problem modern antitrust misses. While the consumer-welfare standard that modern antitrust advocates often decry has helped to focus the law on actual harms to consumers, antitrust more broadly continues to encourage rent-seeking by immunizing state action and lobbying behavior.

In Amazon, Antitrust & Competition, Constitutional Law, Corporate & Securities Law, Economic Theory, Google, Intellectual Property, Law & Economics, Monopolization, Patent, Platforms, Truth on the Market , , , , , , , , , , , ,
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The America Invents Act, a First-to-Invent Patent System, and “Obama-Birther” Accusations

Adam Mossoff —  6 July 2016

About a month ago, I was asked by some friends about the shift from the first-to-invent patent system to a first-to-file patent system in the America Invents Act of 2011 (AIA). I was involved briefly in the policy debates in the spring of 2011 leading up to the enactment of the AIA, and so this query prompted me to share a short essay I wrote in May 2011 on this issue. In this essay, I summarized my historical scholarship I had published up to that point in law journals on the legal definition and protection of patents in the Founding Era and in the early American Republic. I concluded that a shift to a first-to-file patent system contradicted both the constitutional text and the early judicial interpretations of the patent statutes that secured patent rights to first inventors.

This legal issue will likely reach the courts one day. A constitutional challenge a couple years ago was rightly dismissed as not being justiciable, but there may yet be an appropriate case in which an inventor is denied a patent given that he or she lost the race to file first in the Patent Office. So, after sharing my essay with my friends, I thought it valuable to post it again on the Internet, because the website on which it was first published (www.noonHR1249.com) slipped into digital oblivion long ago.

I was asked to write this essay in May 2011 by the U.S. Business & Industry Council (USBIC)[1] The USBIC requested my scholarly analysis of the first-to-file provision of the AIA, which was being debated as H.R. 1249 on Capitol Hill at the time, because I had been publishing articles in law journals on the legal definition and protection of patents as property rights in the Founding Era and in the early American Republic (see here and here for two examples). In my essay, I identified the relevant text in the Constitution, which authorizes Congress to secure an exclusive right to “Inventors” in their “Discoveries” (Article 1, Section 8, Clause 8). Based on my academic research, I summarized in my essay the historical Supreme Court and lower federal court decisions, which secured patents to inventors according to the same policy justifications used in common-law cases to justify property rights to first possessors of land. Thus, I concluded that the first-to-file provision in the American Invents Act was unconstitutional, based on well-recognized arguments concerning textual analysis of the Constitution and inferences from original public meaning as reflected in the historical judicial record.

There’s more to my essay, though, than just the substantive legal argument. It also provides an insight into the nature of the legal academic debates going back many years, because at the time Professor Mark Lemley of Stanford Law School compared me to an “Obama-birther” and he called this constitutional and legal argument “fringe science.” Given concerns expressed last year in an open letter co-authored by Professor Lemley and others about inappropriate rhetoric used by academics, among other issues (see here for a news report on this letter), it bears noting for the record that this is a concern that goes back many years.

Here’s the basic story: My essay was published by the USBIC in May 2011 and I was invited to speak in congressional staffer briefings and in other venues in Capitol Hill against the AIA on this issue. At this time, I was the only legal academic writing and speaking on Capitol Hill on this issue in the AIA. In late May, the 21st Century Coalition for Patent Reform, which supported enactment of the AIA, distributed on Capitol Hill a response that it had solicited from Professor Lemley. I no longer possess this response statement that was sent out via email by the 21st Century Coalition, but I do have the response I was asked to write on June 1, 2011 in which I explicitly refer to Professor Lemley’s argument against the first-to-invent position. In response to a law professors’ letter to Congress defending the first-to-file provision in the AIA that was circulated on an IP professors listserv (IPProfs), I sent out on IPProfs on June 11 a draft letter to Congress, calling for signatures from other law professors in support of my argument first presented in my essay (the final version is here). The next day, on June 12, Professor Lemley wrote on Facebook that my constitutional and legal argument made me the same as an “Obama-birther.”[2] Although he didn’t refer directly to me, it was clear that it was directed at me given that this posting by Lemley followed the day after my email to all IP professors asking them to join my letter to Congress, and I also was the only law professor actively writing on this issue and speaking on it on Capitol Hill up until then.

The following year, in a New York Times article on the court challenge to the first-to-file provision, Professor Lemley further characterized this constitutional argument as “the legal equivalent of fringe science.”

Before the spring of 2011, my writings on legal doctrine and policy were published only in law journals, and I had never participated in a policy debate over patent legislation. In my academic articles before this time, I had critiqued Professor Lemley’s incorrect historical claims about whether U.S. patents were considered monopolies or property rights, and they reflected a purely academic tone that one should expect in a law journal article (see here). Before spring 2011, I had never addressed Professor Lemley, nor had he addressed me, about the AIA, other legislation or court cases.

Professor Lemley’s “Obama-birther” attack on me was surprising, and when I replied in the comments to his Facebook post solely on the substantive merits of the issue of policy versus law, Professor Lemley defended his accusation against me. (This is evidenced in the screen shot.)[2] At the time, I was still a relatively junior academic, and this was an object lesson about what a senior academic at a top-five-ranked law school considers acceptable in addressing a much-more junior academic with whom he disagrees. This remark in 2011 was not an outlier either, as Professor Lemley has used similar rhetoric in the ensuing years in addressing academics with whom he disagrees; for instance, a couple years ago, Professor Lemley publicly referred to an academic conference that I and other patent scholars participated in as a “Tea Party convention.”

Of course, legal and constitutional disputes consist of opposing arguments. In court cases and legislative debates, there are colorable legal and policy arguments on both sides of a dispute. Few issues are so irrational that they are not even cognizable as having a supporting argument, such as astrology and conspiracy theories like the birthers or 9-11 truthers. So, I will simply let my essay speak for itself as to whether it makes me the same as an “Obama-birther” and if my argument represents “fringe science.”

More important, if or when a good case arises in which an inventor can rightly claim an identifiable and specific harm as a result of the statutory change created by the AIA, I hope my essay will be of some value.

[1] Full disclosure: The U.S. Business & Industry Council paid me for my time in writing the essay, which I disclosed in the essay itself. Unfortunately, as recently reported by IAM Magazine, other legal academics are not always so forthcoming about their financial and legal connections to companies when publicly commenting on court cases or advocating for enactment of legislation.

[2] This is a link to a screen shot I took last year only because the Facebook post by Professor Lemley recently disappeared after I only quoted the language from it about a month ago when I shared on Facebook my essay with my friends and colleagues.

UPDATE on June 7: I added some more supporting links and some additional information after this was initially published on June 6, 2016.

In Constitutional Law, Facebook, Intellectual Property, Patent, Platforms , , , , , , ,
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Health Care Reform, Reconciliation, and the Role of the Senate: Some Wise Counsel from Key Democrats

Thom Lambert —  28 February 2010

Well, it looks like Congress is going to attempt to enact the Senate’s health care bill using the reconciliation process. President Obama certainly suggested as much in Thursday’s Health Care Summit, downplaying the significance of such a move and suggesting it may be necessary in order to “move forward.”

First, he said to Senator McCain:

You know, this issue of reconciliation has been brought up. Again, I think the American people aren’t always all that interested in procedures inside the Senate. I do think that they want a vote on how we’re going to move this forward. And, you know, I think most Americans think that a majority vote makes sense, but I also think that this is an issue that could be bridged if we can arrive at some agreement on ways to move forward.

I interpret that as, “Agree with us, or we’ll pursue this using reconciliation. Americans won’t mind.” That also was the thrust of the President’s closing remarks, where he said:

[T]he question that I’m going to ask myself and I ask of all of you is, is there enough serious effort that in a month’s time or a few weeks’ time or six weeks’ time we could actually resolve something? And if we can’t, then I think we’ve got to go ahead and make some decisions, and then that’s what elections are for. We have honest disagreements about — about the vision for the country and we’ll go ahead and test those out over the next several months till November. All right?

This is most unfortunate. Reconciliation — the process by which budget-related bills can be approved without threat of a filibuster (and thus without winning the support of at least 60 Senators) — moves the Senate away from its constitutional role as a moderating, consensus-building check on the other two entities that must approve legislation, the House of Representatives and the President. While the House and the President are designed to respond to majority impulses, the Senate is explicitly designed not to work that way; otherwise, California, with its 38 million people, wouldn’t have the same voting power as Wyoming, with its population of 540,000. If the Senate transforms itself into what is effectively a second House of Representatives for this piece of non-budget legislation (which, somewhat ironically, is actually opposed by a majority of Americans) then what’s to stop it from doing so on any future bill? The Senate will no longer be the Senate.

But don’t just take my word for it. Democratic Senator Robert Byrd, who defined the narrow contours of the reconciliation process in the so-called “Byrd Rule,” adamantly insists that the process is inappropriate for sweeping social legislation like the pending health care reform bill. On April 2, 2009, he wrote the following to his Senate colleagues:

I oppose using the budget reconciliation process to pass health care reform and climate change legislation. Such a proposal would violate the intent and spirit of the budget process, and do serious injury to the Constitutional role of the Senate.

As one of the authors of the reconciliation process, I can tell you that the ironclad parliamentary procedures it authorizes were never intended for this purpose. Reconciliation was intended to adjust revenue and spending levels in order to reduce deficits. It was not designed to cut taxes. It was not designed to create a new climate and energy regime, and certainly not to restructure the entire health care system.

Just last week, Senator Byrd reiterated his position in another “Dear Colleague” letter. In that letter, he insisted that any attempt to use reconciliation to enact health care reform would be “grossly misguided.”

Senator Byrd isn’t the only Democrat who recognizes the importance of maintaining the Senate’s supramajority rule for important social legislation. Friday afternoon, I spent several hours reading through the Congressional Record from May 10, 2005 to May 25, 2005, a period during which the then-Republican majority leadership in the Senate was threatening to eliminate the supramajority requirement for approving judicial nominees. A number of Democratic senators — including Senators Bayh, Biden, Clinton, Dodd, Durbin, Feingold, Feinstein, Harkin, Kohl, Lautenberg, Leahy, Murray, Nelson, Reid, and Schumer — spoke eloquently and passionately about the Senate’s crucial and constitutionally prescribed role as a non-majoritarian body. Their characterization of the Senate’s special role was spot on.

Here’s some of what they had to say (emphasis added, of course):

SENATOR CHUCK SCHUMER, May 10, 2005:

It is the Senate where the Founding Fathers established a repository of checks and balances. It is not like the House of Representatives where the majority leader or the Speaker can snap his fingers and get what he wants. Here we work many times by unanimous consent where you need all 100 Senators to go along. In some instances, we work where 67 votes are needed, in some with 60, and in most with 51. But the reason we don’t always work by majority rule is very simple. On important issues, the Founding Fathers wanted — and they were correct in my judgment — that the slimmest majority should not always govern. When it comes to vital issues, that is what they wanted.

The Senate is not a majoritarian body. My good friend from Utah spoke. He represents about two million people in Utah. I represent 19 million in New York State. We have the same vote. You could have 51 votes for a judge on this floor that represents 21 percent of the American people. So the bottom line is very simple. This has not always been a 50.1 to 49.9 body. It has been a body that has had to work by its rules and by the Founding Fathers’ intent. Even when you are in the majority, you have to reach out and meet not all, not most, but some of the concerns of the minority.

***

SENATOR HARRY REID, May 18, 2005:

For further analysis, let’s look at Robert Caro. He is a noted historian and Pulitzer Prize winner, and he said this at a meeting I attended. He spoke about the history of the filibuster. He made a point about its legacy that was important. He noted that when legislation is supported by the majority of Americans, it eventually overcomes a filibuster’s delay, as a public protest far outweighs any Senator’s appetite to filibuster.

But when legislation only has the support of the minority, the filibuster slows the legislation-prevents a Senator from ramming it through, and gives the American people enough time to join the opposition. Mr. President, the right to extended debate is never more important than when one party controls Congress and the White House. In these cases, the filibuster serves as a check on power and preserves our limited government. …

For 200 years, we have had the right to extended debate. It is not some ” procedural gimmick.” It is within the vision of the Founding Fathers of this country. They did it; we didn’t do it. They established a government so that no one person and no single party could have total control.

Some in this Chamber want to throw out 214 years of Senate history in the quest for absolute power. They want to do away with Mr. Smith, as depicted in that great movie, being able to come to Washington. They want to do away with the filibuster. They think they are wiser than our Founding Fathers. I doubt that is true.

***

SENATOR CHRIS DODD, May 20, 2005:

One of the reasons the extended debate rule is so important is because it forces us to sit down and negotiate with one another, not because we want to but because we have to. I have helped pass many pieces of legislation in my 24 years here, both as a majority and minority Member of this institution. I have never helped pass a single bill worth talking about that didn’t have a Republican as a lead cosponsor. I don’t know of a single piece of legislation here that didn’t have a Republican and a Democrat in the lead. We need to sit down and work with each other. The rules of this institution have required that. That is why we exist. Why have a bicameral legislative body, two Chambers? What were the Framers thinking about 218 years ago? They understood the possibility of a tyranny of the majority. And yet, they fully endorsed the idea that in a democratic process, there ought to be a legislative body where the majority would rule.

So the House of Representatives was created to guarantee the rights of the majority would prevail. But they also understood there were dangers inherent in that, and that there ought to be as part of that legislative process another institution that would serve as a cooling environment for the passions of the day. So the Framers … sat down and said: There is a danger if we don’t adopt a separate institution as part of the legislative branch where the rights of the minority will also prevail, where you must listen to the other side in a democracy, pay attention to the other side.

***

SENATOR JOE BIDEN, May 23, 2005:

At its core, the filibuster is not about stopping a nominee or a bill, it is about compromise and moderation. That is why the Founders put unlimited debate in. When you have to-and I have never conducted a filibuster-but if I did, the purpose would be that you have to deal with me as one Senator. It does not mean I get my way. It means you may have to compromise. You may have to see my side of the argument. That is what it is about, engendering compromise and moderation.

Ladies and gentlemen, the nuclear option extinguishes the power of Independents and moderates in this Senate. That is it. They are done. Moderates are important only if you need to get 60 votes to satisfy cloture. They are much less important if you need only 50 votes. I understand the frustration of our Republican colleagues. I have been here 32 years, most of the time in the majority. Whenever you are in the majority, it is frustrating to see the other side block a bill or a nominee you support. I have walked in your shoes, and I get it. …

I say to my friends on the Republican side: You may own the field right now, but you won’t own it forever. I pray God when the Democrats take back control, we don’t make the kind of naked power grab you are doing. But I am afraid you will teach my new colleagues the wrong lessons.

***

Much, much, much more below the fold. Please read it — it’s important and, well, a little fun! Continue Reading…

In Constitutional Law, Taxes , ,
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The Collected Works of Henry G. Manne

Geoffrey Manne —  29 December 2009

I’m delighted to report that the Liberty Fund has produced a three-volume collection of my dad’s oeuvre.  Fred McChesney edits, Jon Macey writes a new biography and Henry Butler, Steve Bainbridge and Jon Macey write introductions.  The collection can be ordered here.

Here’s the description:

As the founder of the Center for Law and Economics at George Mason University and dean emeritus of the George Mason School of Law, Henry G. Manne is one of the founding scholars of law and economics as a discipline. This three-volume collection includes articles, reviews, and books from more than four decades, featuring Wall Street in Transition, which redefined the commonly held view of the corporate firm.

Volume 1, The Economics of Corporations and Corporate Law, includes Manne’s seminal writings on corporate law and his landmark blend of economics and law that is today accepted as a standard discipline, showing how Manne developed a comprehensive theory of the modern corporation that has provided a framework for legal, economic, and financial analysis of the corporate firm.

Volume 2, Insider Trading, uses Manne’s ground-breaking Insider Trading and the Stock Market as a framework for many of Manne’s innovative contributions to the field, as well as a fresh context for understanding the complex world of corporate law and securities regulation.

Volume 3, Liberty and Freedom in the Economic Ordering of Society, includes selections exploring Manne’s thoughts on corporate social responsibility, on the regulation of capital markets and securities offerings, especially as examined in Wall Street in Transition, on the role of the modern university, and on the relationship among law, regulation, and the free market.

Manne’s most auspicious work in corporate law began with the two pieces from the Columbia Law Review that appear in volume 1, says general editor Fred S. McChesney. Editor Henry Butler adds: “Henry Manne was an innovator challenging the very foundations of the current learning.” “The ‘Higher Criticism’ of the Modern Corporation” was Manne’s first attempt at refuting the all too common notion that corporations were merely devices that allowed managers to plunder shareholders. Manne saw that such a view of corporations was inconsistent with the basic economic assumption that individuals either understand or soon will understand the costs and benefits of their own situations and that they respond according to rational self-interest.

My dad tells me the sample copies have arrived at his house, and I expect my review copy any day now.  But I can already tell you that the content is excellent.  Now-under-cited-but-essential-nonetheless corporate law classics like Some Theoretical Aspects of Share Voting and Our Two Corporation Systems: Law and Economics (two of his best, IMHO) should get some new life.  Among his non-corporations works, the classic and fun Parable of the Parking Lots (showing a humorous side of Henry that unfortunately rarely comes through in the innumerable joke emails he passes along to those of us lucky enough to be on “the list”) and the truly-excellent The Political Economy of Modern Universities (an updating of which forms a large part of a long-unfinished manuscript by my dad and me) are standouts.  And the content in the third volume from Wall Street in Transition has particular relevance today, and we would all do well to re-learn the lessons of those important contributions.

The full table of contents is below the fold.  Get it while it’s hot! Continue Reading…

In Administrative Law, Corporate & Securities Law, Financial Regulation, Law & Economics, Regulation, Securities , , , , , , , , , , , , , , , , , , , ,
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Easterbrook (Gregg, not Frank) Up a Creek

Robert Miller —  5 October 2008

Here’s another reason—as if you needed it—as to why getting a reasonable bailout of the mortgage-backed securities market through Congress was so difficult. Below I reproduce an analysis from Gregg Easterbrook of the Brookings Institute:

Supposing we assume the bailout is required, here is what bothers me about the plan so far: Taxpayers don’t get stock, what they get is warrants that can be exchanged for stock, and nonvoting stock to boot….  Even if the warrants are called [sic, Easterbrook means exercised], taxpayers get no voting positions…. A week ago, Warren Buffett rescued Goldman Sachs by injecting $5 billion in capital. Did Buffett bargain for warrants that can be exchanged at an unknown later date for nonvoting shares? No: He is not a fool. Buffett gave Goldman Sachs $5 billion in return for senior preferred stock, the kind that votes and also is more valuable than ordinary shares…. The United States Congress and the White House should use the public’s $700 billion to buy … senior preferred shares. Why are Congress and George W. Bush not simply following the road map laid out on this problem by the smartest investor of our era?

The problem is that this is factually mistaken from beginning to end. Easterbrook says that Buffett did not get warrants, but in fact he did—indeed, warrants to purchase $5 billion of common stock with a strike price of $115 per share and a five year term. Easterbrook says that the preferred shares Buffett received are “the kind that votes,” but they’re not. Like the six classes of preferred stock Goldman already has outstanding, Buffett’s shares do not vote in the election of directors. Like virtually all preferred shares, they have very limited voting rights that do not allow the holder any ability to control the affairs of the company. This is all set out in the press release Goldman Sachs issued to announce the transaction and in Item 303 of the Interim Report on Form 8-K it subsequently filed with the Securities and Exchange Commission.

More generally, it’s apparent from his blog that Easterbrook simply doesn’t understand what preferred stock is and how it relates to common stock. As most readers of this blog know, preferred stock is “preferred” not because it’s “more valuable than ordinary shares” but because it ranks ahead of common shares in order of payment. That makes it less risky than common shares but not generally more valuable than common stick. Indeed, since return is proportionate to risk, preferred shares generally have a lower expected return than common shares, and since control follows risk, preferred shares generally have less voting rights than common shares. The preferred shares Buffett purchased from Goldman are thus perfectly typical in these respects.

My point here is not that Easterbrook doesn’t understand what he’s talking about (though he clearly doesn’t). My point is that an intelligent person in the opinion-making class trying his honest best to inform the American public about the merits of the bailout can utterly fail to understand the issues at stake. That’s not because people like Easterbrook are fools (they certainly are not) but because the matters are so complex and technical that even informed, intelligent non-specialists can get them very badly wrong.

This is a genuine challenge for democracy. In The Federalist No. 10, Madison argued that representational republicanism is superior to direct democracy because it can “refine and enlarge the public views by passing them through the medium of a chosen body of citizens, whose wisdom may best discern the true interest of their country and whose patriotism and love of justice will be least likely to sacrifice it to temporary or partial considerations.” In other words, democratically elected representatives are on the whole likely to make better decisions than the people themselves, in part because they are better informed than the average voter. History has by and large proved Madison correct in this. Part of the problem in passing the bailout program last week, however, was that our elected representatives were dealing with issues that were often too complex and difficult even for intelligent, informed people who were trying hard to understand them. I do not for a moment suggest that anyone else should get to decide such matters except the elected representatives of the people, but I think we should realize that the world has become so complex that issues like this may begin to appear with increasing frequency.

In Constitutional Law, Securities , ,
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