Schwarcz scholarship finds novel solutions to large-scale economic problems
Professor Steven L. Schwarcz has focused much of his recent research and scholarship on developing novel solutions to two complex problems plaguing the global economy: systemic risk and sovereign debt crises.
The past seven years have seen five separate sovereign debt crises arise in Europe alone, each one depressing local and regional economies and affecting global markets still reeling from the financial crisis. Even though Argentina recently reached a deal with certain of its creditors over its 2001 default on $95 billion in debt, other nations continue to face unsustainable debt burdens. And the ongoing debates over big banks and other financial entities, whose collapse could trigger another global financial meltdown, signal dissatisfaction and disagreement over the policies enacted to prevent such an occurrence after the financial crisis’ bank bailouts.
Both sovereign debt crises and the collapse of systemically important firms can cause financial hardship for millions of people, says Schwarcz, the Stanley A. Star Professor of Law & Business and founding director of Duke’s Global Financial Markets Center. “Addressing these problems is a humanitarian concern.”
Addressing sovereign debt from Albany
Schwarcz points to New York State law as a possible solution to many international sovereign debt crises.
Because about half of the world’s sovereign debt contracts are currently governed by New York law, the state legislature could pass domestic legislation that makes it more realistic to resolve debt crises, Schwarcz says. For instance, changing the voting requirements in those contracts to allow supermajority voting of creditors — rather than the unanimous vote often currently required, which encourages holdout behavior —could make the debt restructuring process much more rational and predictable for both nations and their creditors, he says.
“Equitable sovereign debt restructuring would be to everyone’s benefit. And it would reduce the chance of a debt crisis triggering another systemic economic collapse.”
Schwarcz has written about his proposal in a recently published article, “Sovereign Debt Restructuring: A Model-Law Approach”, as well as in a policy paper for the Center for International Governance Innovation (CIGI) where he is a senior fellow, and in news commentary.
Encouraging corporate responsibility without dulling profitability
In his forthcoming article “Misalignment: Corporate Risk-Taking and Public Duty”, Schwarcz argues that corporate governance is the key to controlling excessive risk-taking by systemically important firms. Excessive risk-taking has been a focus for regulators since the financial crisis, but settling on a policy that ensures public safety without restricting the kinds of risk-taking that can allow firms to thrive has been a sticking point.
Although governments worldwide, including the United States, have issued an array of regulations to attempt to curb that risk-taking by aligning director and shareholder interests, those regulations implicitly assume that shareholders would oppose excessively risky business ventures. That leaves a critical misalignment, Schwarcz says: because much of the harm from a systemically important firm’s failure would be externalized onto the public, endangering the larger economy, such a firm can engage in risk-taking ventures that are expected to benefit shareholders but to harm the public.
To reduce that harm, Schwarcz proposes a “public governance duty” which, he says, would help to control excessive risk-taking without stemming profit potential. Under this proposal, corporate managers deciding on certain types of risky projects would have to assess risk using a simplified cost-benefit analysis to ensure that the shareholder benefits are expected to considerably outweigh any systemic costs to the public. Schwarcz’s proposal would enable managers to realistically make this risk assessment, while being protected by the business judgment rule.
“Some risk-taking is necessary, even desirable,” he says. “But the financial crisis showed that we need some way to protect the public from the kinds of risks that could drastically harm the economy.”
Schwarcz has also written about the public governance duty on Harvard’s Corporate Governance and Financial Regulation blog, and spoken about it in lectures at universities in the United States and abroad. He also is working on another article, “Rethinking Corporate Governance for a Bondholder Financed, Systemically Risky World”, which argues that bondholders, who are more risk averse than shareholders, should be included in the governance of systemically important firms. The inclusion of bondholders not only could help to reduce systemic risk, he contends, but also is merited by two crucial changes in the bond markets: that bonds have dwarfed equity shares as the source of corporate financing, and that bondholders now typically trade their securities instead of holding them to maturity, giving bondholders (like shareholders) a vested interest in their firm’s performance. He also shows how bondholders could be included in the governance of systemically important firms without impairing legitimate corporate profit-making.