 All things can be coded as capital with the right legal coding. We have seen a lot of examples for how capital is coded in law, how we use a simple object, a promise to future payment or an idea, and turn it into a wealth-generating asset or an asset that can protect wealth that we have generated in the past for future purposes. I want to now take a closer look into the institutions that make this possible. Give me any asset and I take the legal code and by grafting the legal code onto these different types of assets I create a new capital asset. So what does the law really do? I identify four attributes of capital. The first is priority. If you have stronger rights, you have better rights than everybody else. If you own the asset, if you have a legal title to the asset, you can claim it and you can ask everybody else to step aside. Think of a situation where a debtor can no longer fulfill all the claims that creditors might have against her. So you are an insolvent debtor by definition if your asset is no longer enough to satisfy all creditors. If somebody lent you her car, you are now insolvent. This friend can come and take her car out of the pool of assets and all the other creditors have to stand aside because she has a better title. It's her property, she can take it out. Other creditors who might have secured some of the interest, maybe a bank that had a mortgage on the house or maybe you have a security interest in the car or in other assets that the debtor has, they can take out these assets and sell them and satisfy themselves from these assets. Those who are unsecured creditors, they only get the leftovers. So here you can see how ranking different rights makes it relatively easy in times of insolvency to determine who gets what. You just look at the priority rules in bankruptcy and they reflect typically the other rights that we have created. So property rights are always a very powerful right. Secured interest is powerful. Just to contract your claim, less so. Priority is key. The second attribute is durability and durability extends rights over time by basically creating separate pools of assets like trusts and corporations and thereby ensures that not all creditors can potentially put their hands on these assets. Why not? Because the creditor of a shareholder cannot get to the assets of the corporation. We already said that the shareholder can't put her hands on the assets of the corporation because they're owned by the corporation and conversely, the creditors of the corporation cannot just take the assets of the shareholder because the shareholder is protected by limited liability. By creating such legal mechanisms, we're basically making sure that pools of assets stay together like a little incubator and they can incubate more wealth over time because only few people who have a specific right against this particular asset can enforce against the debtor. So that's what I call durability. The third attribute is universality, which basically says these kind of legal interests will be enforceable against the world, not only between two parties who talked about this but also against people who had no idea that these transactions were created that don't even know what a corporation is. They don't know whether you have title. You might not even have possession over a thing but you still might have title and if you have title, a court will enforce this title against others. Universality is absolutely critical. This also explains again why law is so important because once the state through its courts and other enforcement agencies has recognized a particular interest as legally protected as having a legal title, it will enforce it against anybody, erga omnis as we say in Latinese, which basically means against the world. And then last but not least, I use convertibility to show how financial assets attain durability. For financial assets, you don't want to just lock them in but for financial assets, you want to be able to convert them into safer assets whenever you want to. Most financial assets that are traded, of course, are privately issued assets. All of them can lose their value. If you find yourself at a time when you hold assets and they lose value, what do you want to do? You want to sell them. Why do you want to sell them? Because when you get money, the money retains its nominal value because of the state issued and the state stands in for it that the nominal value is protected now not necessarily the real value but in times of financial crisis, protecting the nominal value is absolutely key. You basically lock in your past gains by selling your assets now. And if you have a right to convert your assets into cash, either against another private entity or preferably at the central bank because that issues the money after all, then you are better protected than anybody else. So as you can see, these attributes basically say, how can we create legal entitlements that give me a better right than anybody else if I have these kind of legal protections, I have a better chance to survive and to expand and to create wealth and protect this wealth over time. So that's why that's so important. How do we create these things? It's kind of astonishing that they have been, let's say a handful, legal institutions that have coded assets as capital for about 400 years or so pretty consistently. We've seen this with land. You take the old land that was held in Commons, you enclose it first physically, then you enclose it legally by saying somebody has the better title. Collateral law is a kind of a property law. Slightly lower effect, but it's still similar because I have a claim not only against you as a debtor to pay me back, but I can take your asset that I have secured. I have to be relatively specific, but I can secure your asset, your home or your car or some other asset that has some meaningful market value and I can take it if you don't pay back your loan and I can sell it on the market. The trust is an invention of the English common law, which is kind of a funny creature. It started actually back in the 13th century or even earlier when there was a mandatory inheritance rule that said that the fathers have to give all their property to the first born son. So if the father also had a second born son or maybe a daughter to whom he wanted to leave some property, he couldn't do this by writing a will because that wasn't allowed at the time. You had a mandatory inheritance law. So lawyer said the idea to create a legal device by which the father would still be in possession of the land but would transfer title to a particular plot of land to his younger brother, hoping that the younger brother would survive him and say, you are now formally holding this title. I can still use it, but you're holding this title no longer for me, but you're holding this title for my daughter. And upon my death, you transfer this land to my daughter. At the time, in the early days, it was called a use, a similar structure we call nowadays the trust. Again, from the worst, of course, to trust. If you just come back and think again about our securitization structures, when I said new century originates a lot of mortgages and then packages them all up and goes to city group and says, city group, here are the mortgages. What does city group do or its affiliate? It creates a trust and transfers all the mortgages to it because the trust is a legal shield that separates all these mortgages and the cash flows that go into the mortgages and have to be paid out to the investors. It separates them from city group itself so that none of the investors has to think about whether city group will ever survive. They only have to think about the special purpose vehicle, which is now a separate entity floating out there in the world and a little bit of an orphan in the storm governed only by a trustee. The fourth element is corporate law. Corporate law because, again, you create a new legal entity. You create a corporate entity that has a legal person that has the right and the power to own its own assets, can contract in its own name, sue and be sued in its own name, has its own governance structure, is its own body entity that can operate economically separate from its shareholders and not necessarily dictated by the shareholders. And then, of course, as we have seen in the case of Lehman Brothers, you can also use the corporate form by combining it in many different ways to create new wealth because you can separate all these pools of assets and lever up their assets to get more credit finance and then use this to produce profit for your shareholders. Doesn't always end well as the case of Lehman Brothers suggests, but in the meantime, people can make a lot of money. Bankruptcy law is another legal device that is typically mandatory law. It doesn't squarely fit into the private law institutions that I'm mentioning here, but it's interesting because it can create its own priority rules such as property law by saying if there's insolvency and we have to distribute the leftovers of the debtor, we follow a certain rank order and here it is. We try to follow typically what has been negotiated before in the markets, but the bankruptcy law can create its own priority rules and sometimes does this simply by saying, oh, we exempt some asset holders from the normal operation of the bankruptcy law. We call this bankruptcy safe harbors, and prior to 2008, actually still today largely, asset holders who had complex derivatives or swaps were exempt from the ordinary operation of the bankruptcy code. If somebody defaulted, the idea was these people should still be able to settle their rights against each other because otherwise the entire market would collapse and so we created exemptions from bankruptcy law, effectively privileging holders of derivatives over other creditors and giving them a priority right, akin to a property right. And last but not least, we have contract law. Contract law, again, we think about this as just an agreement between you and me, but contract law, if you follow the basic principles of the law and you follow the requirements to create a legally binding agreement that will be enforceable in a court of law, then you have created something that can be protected against others and you actually have a claim that you can enforce against me and as I suggested earlier, you can also then take this claim and sell it because it's enforceable in a court of law which makes it much more likely that people will buy it from you. Perhaps as a discount, if they don't think me to be very credit worthy but they will nonetheless buy it, which they wouldn't if you didn't have a binding contract. So let's step one step further back and think about when we look at these modules, these are all legal institutions, sometimes they're written up in a code but very often they evolve over time in case law. Many of you might think law is mostly like something vertical that the state controls and Max Weber and many others have of course said that the modern nation state has centralized the means of coercion and you can think of law as the institutionalization of access to these means of coercion. Centralizing the means of coercion however does not mean that we only have centralized access to the means of coercion because if you litigate your claim, if you go to court and say I want to hold somebody else liable for what they've done to me, maybe I was run over by a car, I won't have liability. Then I basically harness the collective resource, the centralized means of coercion to enforce my own claims and if I'm right, if I have the better claim and the other party doesn't yield, I can actually ask the court to tell the bailiff to go and seize a bank account or seize an asset and give it to me. So we can mobilize the means of coercion in a highly decentralized fashion. Otherwise our economic system wouldn't work in the way it does. What the law then ultimately does, it not only creates the rights through the legal modules, it creates the priority rights, the durability, the universality, the convertibility, it also creates the conditions under which rights holders can harness and access the means of coercion to enforce these rights. Who can do it? Individuals or collectives? How? For what purposes? How expensive it's going to be? That's all ways in which it can be easier for some and more difficult for others to access the means of coercion. So there are different access channels. If you think about criminal law, you think about a prosecutor, the police, it's hierarchicals from the state to the individual who has committed a crime. Similarly in administrative processes, if you want to have a permit, even just a driver's license, or maybe let's say a tax, you have a tax issue with the tax authorities, again it's vertical. The tax authorities will typically tell you've got to pay first and if you want to dispute this then we can talk about this later. We might also end up in court but in principle I have the power to actually put a lien on your property rights if you don't pay your taxes. What is very often forgotten at least amongst lay people that we also harness the same power, the centralized means of coercion for organizing our horizontal relations with one another. If I enter a contract with you and you can enforce it against me by going to a court and getting the bailiff, then you're also using access to the means of coercion to do so. So we have decentralized access mechanisms for the means of coercion and that's a powerful device. Now let me say a few words about the conditions that many rules, now we're entering something called the civil procedure codes or laws of different countries, the rules that they establish for who might access the means of coercion. So do you have standing as a classic question? Do you have a right that is enforceable in a court of law? If you don't you're out. We always think that natural persons should have a right, always sort of naturally standing in a court of law. Natural persons of course attain their legal status with birth according to most legal systems. It's also interesting, we basically graft onto natural persons their ability to also act as legal subjects in our legal system and then we create these additional creatures, artificial persons, legal persons. Can legal persons sue? Yes they can, be sued in their own name, their own property they can contract. So again we don't have to do this, but once we give legal persons a right to sue, then they have the ability to access the means of coercion to enforce their rights. What kind of claims can you bring? Property rights almost goes without saying, that's always been something that certainly in modern times, once we have individualized property rights, they were protected by the law. Not only by civil law, by private law, you can go and litigate and make sure that trespassers are removed from your property, but also by criminal law. So England enacted statutes that made it capital punishment if you trespassed on property and then hanged people if they did so. This is a process that is ongoing constantly. So we're not only having sometimes formal legal change, but this can also happen in the private sphere. Some rules might be overturned, some precedences might be overturned. That's a formal legal change. What I'm almost more interested in, certainly very interested in, are the processes of incremental change that happen by interpreting and applying rules to new types of cases and not necessarily in the court but also outside the court, because most cases, also most disputes never ever make it to court. Most people settle in the shadow of how they understand the law. But in doing that, in forging a common understanding of the law, they also very often reinterpret it. So if two powerful private financial institutions get into a conflict, in most cases nowadays they would rather settle than go to a court because they're afraid that a court might make a ruling that could overturn a lot of the practices that they had built into thousands and thousands of contacts of the same kind. But through this process of renegotiating what the meaning of the law is, we're actually changing the law because a couple of years down the line a court might hear a case and then say, oh, in the practice of the parties the law has changed and we think now that we want to adapt the law accordingly. A good way to think about the law is what Thorsten Weblen has said. Law is the working rules of society. So the working rules of society are not static, they change. And then for financial assets nowadays you could say we're actually talking no longer just about expectations but about a probability, even very often a small probability of realizing these expectations. And these different ideas of property go hand in hand with a kind of things, objects, organizations, promises to future pay that we have coded in the law of property. Land, tangible, business, expected returns and financial assets probability that we might realize some return in the future and still these assets are treated almost like tangible assets. That's a change in the law that happened over time. We didn't get together in a social contract, format said now let's just do this, but it was a much more incremental process. But that was driven, of course, by interested parties either in the courts or through legislatures or regulators. At the same time we've also changed the kind of assets that we use to create wealth. Until 1880 roughly most of the source of wealth was in rural land and then it collapsed because of a depression in agriculture and because of a legal change that said we actually allow creditors to now take the land from the landlords and no longer protect them and all of a sudden the durability of rural land which was protected by legal devices was stripped off rural land and it ceased to be one of the most important sources of wealth. What came in instead? Well shares and corporations, interests and trusts, financial assets that can be coded in law itself and of course intellectual property rights. Financial assets and intellectual property rights also the corporate form are all creatures in the law. The beauty of these creatures of the law is you can create as many as you want. Hyman Minsky once said anybody can issue money but not all money will find takers. We can proliferate these institutions as long as there is enough demand and as long as others believe there's enough value behind them so that they will buy them hoping to find another buyer in the future but these are creatures of social resources of the legal system. And last but not least we also have expanded the ability of private agents to mobilize the means of coercion and not necessarily of the state that gave them the law to code their assets a capital but sometimes even of any state that they choose to use to enforce against some asset. So what has happened in particular over the last three or four decades is we have allowed private parties to much more freely pick and choose the laws by which they wish their private transactions to be governed. Most jurisdictions allow relatively free choice in contract law for private parties because they say well the private parties know best what they want and so they should be able to choose the law by which they wish to be governed. But then we have made the leap from contract law to corporate law. So now we're basically saying if you incorporated your entity let's say in the Cayman Island, if you followed the rules of the Cayman Island we in the United States or the United Kingdom or in Germany will respect this creature as a legal entity with all the bells and whistles that it was grafted on by the laws of Cayman but we will respect it as a legal entity in our jurisdiction as well. Creature of the law, creature of foreign law but still a creature that can live in the law of foreign states as well. That's powerful. There was an alternative way to think about the cooperation. Germany was one of the countries that still trying to hold on to it to some extent but basically said if you operate a company in my country if you run a corporation here and you have your headquarters here and most of your business operations here you've got to be incorporated under German law because we want to govern you. That's the so-called seed theory which basically means if you want to move headquarters you have to reincorporate. Next moving headquarters rather expensive which is why the European Court of Justice struck down that rule but by allowing corporations to pick and choose you basically lose control over the corporate law and which legal creatures are created that can still do business in your own territory. It diminishes the scope of democratic self-governance. In addition, parties can also choose the courts. International associations that have drafted the contract forms, master agreements that are used to create derivatives and swaps of other financial assets they basically tell people to choose not only the law but also the courts and basically pick and choose and put your own menu together and then if you don't like courts you can also say actually I don't want to go to a court I want to have private dispute resolution I want to have arbitration. Just put this into your contract with another party and you say once we have a dispute you pick one arbiter I pick one arbiter those two pick the third arbiter they issue a ruling. What happens with this ruling? Maybe it's not worth the paper that it is written on but actually it is because what we can also do is we can enforce an arbitral award in a court of law. How does that work? Well, most countries have laws and we actually have an international convention that says that foreign international arbitral awards have to be enforced by a domestic court of law without checking its merits. So just because we have the form of an award and we make sure that both parties had their due hearing this minimum due process we will basically stamp it and hand it over to the bailiff to execute it if necessary. No domestic court will oversee it basically creating the conditions for courts to be leased out for the execution of private arbitral awards done outside the country and outside even the legal profession because they don't even have to be judges necessarily these can be experts in some field. There are reasons to like that but it's also reasons to be a little bit nervous about this because we're basically allowing to use our centralized means of coercion to enforce principles against which our legal order might not stand but we are not policing them unless there's a dramatic conflict with our own fundamental principles. And then last but not least once we have created all these mechanisms we will get execution. So you might be here in the United States choose foreign law choose a foreign court still get US courts to execute the tribunals ruling or the courts rulings against the asset of your counterpart in a court of law. That of course putting all this together has greatly expanded the ability to code capital and who does that and how this is done is something I will come back into the next session when we're talking about the masters of the code.