The University of Chicago Law School Faculty Blog

Audio/Video: Lee Fennell, "Risk Reversals"

This week's episode of the Faculty Podcast is a recording of Lee Fennell's October 22nd Chicago's Best Ideas lecture on "Risk Reversals" (video has also been added to Bryan Hart's writeup of the talk).

As a refresher, here's Prof. Fennell's description of the talk:

Law often allocates risk, as through tort doctrines. Should people be able to undo or "reverse" such risk allocations by, for example, selling their rights to any claims that may later develop? Scholars have interestingly examined this question, as well as many other innovative ideas for rearranging risk outside of traditional insurance markets. This talk focuses attention on some related but underexplored questions surrounding risk reversibility itself—such as the optimal amount of stickiness in society's default risk allocations, the effects of heterogeneity in risk arrangements, and the implications (cognitive and otherwise) of starting from one risk baseline rather than another.

Student Blogger - Chicago’s Best Ideas: Lee Fennell, “Risk Reversals”

Update: Video of Prof. Fennell's talk is now embedded below the jump, or you may download an .mp3 or .mov file.

Suppose I am a utility-maximizing, risk-averse trophy husband/wife. Currently I have a generous monthly allowance, but due to a lack of foresight (or the blindness of love), I do not have a prenuptial agreement. There has been no trouble in the marriage yet, but what if things go south? Perhaps I should put part of my allowance toward premiums on divorce insurance, which one company now claims to offer. Previously, the initial allocation of divorce risk could not be altered; now, perhaps, it can. Whether risk can be reallocated is an issue that is present in far less tawdry situations than this example; in fact, it is everywhere.

On Wednesday, October 22, Professor Lee Fennell gave a talk entitled "Risk Reversals" as part of the Chicago's Best Ideas lecture series. (The first CBI presentation on October 1 was a fascinating talk by Mary Anne Case about "Why Evangelical Protestants are Right When They Say that State Recognition of Same-Sex Marriages Threatens Their Marriages and What the Law Should Do About It.")

The "stickiness" of risk allocations motivates Fennell's analysis. Many scholars have proposed new mechanisms for shifting risk. Fennell's investigation, however, tackles the analysis at a different level; rather than ask whether any particular risk-shifting scheme is desirable, she asks how easy or difficult, given an initial allocation of risk, transacting away from that allocation should be. Buying life insurance is easy, but selling my ability to bring a tort claim if my spouse dies in an industrial accident is difficult. I must buy car insurance, but I cannot insure against damage claims from accidents that have already occurred (although settlement is a form of insurance). How close are we to a world of Coasean risk shifting, and how close should we be?

Homeownership 2.0 Debate -- Wrapping Up

This week, Rich Schragger and I have been debating my forthcoming piece, Homeownership 2.0. Rich has made a number of excellent points.  In this last post, I want to respond to Rich's most recent post and say a little more about the broader case for H2.0. 

Rich argues that a large fraction of whites prefer racially homogeneous neighborhoods, and that H2.0 investors will respond to consumer demand by resisting integration and engaging in discriminatory practices.  I agree that H2.0 investors (like anyone else) will take measures to avoid bearing financial losses.  I also grant that if enough people hold bigoted housing preferences, whoever holds the offsite investment component for housing will have an incentive to discriminate.  It is interesting, though, that Rich's preferred approach would be to expand leaseholding, which just as surely as H2.0 pushes the investment component to someone other than the home's occupant.  One might think he would similarly worry that landlords will become (in  his words) "a large and powerful class of absentee owners who will have every incentive to intervene in local government to secure their fungible property interests."  Animus-based discrimination requires government intervention regardless of who holds the investment interest, and I see no reason to think that investors will be harder to regulate than homeowners or landlords. 

It is worth asking, however, whether outright prejudice is really the full story.  Suppose that many white homeowners resist integration not because they dislike living near people of another race, but because they fear the reactions of prospective buyers to an integrated community (or because they fear the reactions that prospective buyers will fear that their prospective buyers will have).  These layers of speculation, when coupled with the extreme risk aversion of the undiversified individual homeowner, may result in resistance to changes that actually have a positive expected value for most homeowners.  If homeowners were able to offload risk to investors, they might well stop acting so fearfully.  This, in turn, would alter the signal that investors get about what will or will not subtract value.  In other words, homeowner preferences may end up looking a lot different when we take away the element of investment risk, and investors should be expected to respond accordingly.

I want to emphasize that these potentially salutary effects on homeowner behavior are only one of several reasons why a move to H2.0 might make sense. Affordability is another:  Allowing people to alienate upside potential in their homes can allow  low-income, credit-constrained families greater access to homeownership.  With homeownership comes a stable option to remain in the neighborhood, which encourages site-specific investments in social capital.  Downside protection can also serve important values by ensuring that moves are made for the right reasons.  No longer will people feel that they must sell quickly to avoid a coming drop in home values, or delay transferring to a new job in order to avoid realizing a loss on a home. 

As with any new innovation, H2.0 would carry some risk of unwanted consequences.  I am very grateful to have had this exchange with Rich, because it has usefully fleshed out some of those worries and some possible responses to them. A number of other potential concerns are raised and addressed in the paper.  Certainly, H2.0 would not be ideal for everyone.  Consumers and regulators would confront a learning curve in adapting to it..  But, on balance, adding a new alternative to the slate of tenure choices seems worth a shot. 

H2.0 -- Fennell Response, Part II

Now for some thoughts on the third and fourth points in Rich's post. 

Rich worries that giving investors stakes in home values will lead to a cascade of damaging consequences:  exclusionary zoning, racial segregation, and the perpetuation and privileging of homogeneous white suburban enclaves.  Such consequences might come about either through investor pressures on the local political process or through private business practices such as "redlining." These are serious concerns, and ones that I share.  However, I think H2.0 would lead to fewer of these problems than the present homeowner-driven system of local control. 

First, investors are likely to be better bearers of risk than the homeowners who would choose H2.0.  Not only are investors likely to be more diversified, they will have affirmatively self-selected into the investment rather than falling into it simply because they wanted to own a home.  As Bill Fischel has argued in The Homevoter Hypothesis, homeowners tend to be extremely risk averse about their home values, given the importance of the home in their portfolios, and they vote accordingly.  They may, therefore, oppose changes that actually have positive expected values, simply because they are unable to bear any significant variance in outcomes.   Second, the fact that investors are often at a remove from the neighborhood (both physically and emotionally) may make them less likely to be swayed by inflammatory rhetoric about the purportedly negative impacts of what are in fact benign or beneficial land use proposals.  Third, investors are more likely than individual homeowners to hold offsetting interests in other properties or entities, including those in neighboring localities.  Having a stake in many communities rather than just one is likely to rein in the NIMBY impulse to push externalities onto outsiders. 

Of course, it would be unrealistic to imagine that self-interest alone will always cause investors to act in socially optimal ways. Law will need to play a role. Just as discriminatory practices carried out by landlords, mortgage companies, and insurers are prohibited, so too law must prohibit discriminatory practices carried out by investors.  We can do other things as well:  for example, if we worry that big investors will capture local political processes, we can restrict the concentration of investment in a given locale.  This points to another advantage of H2.0:  where curtailing exclusion-minded homeowners has often proved politically difficult, regulating investors should be comparatively easy. 

Finally, the subprime crisis should make us more interested, not less interested, in innovative adjustments to the mix of risks that homeowners accept.  Protection against downside risk is likely to be of increasing interest to both homeowners and lenders, and tightening credit standards are likely to trigger new interest in the sale of upside potential as an affordability tool.  And, while I've focused primarily on distant, diversified investors, the H2.0 model is sufficiently open-ended to accommodate local actors and institutions that would like to invest, quite literally, in their communities. 

H2.0-Fennell Response, Part I

Thanks so much, Rich, for these very insightful comments. In this first post, I'll take on your first two comments. I'll post later on your other points.

So why not just build a better leasehold? First, let me put labels aside and briefly cheer—if I've convinced you that there's a gap on the current tenure spectrum, that's much more than half the battle. Now let's consider what attributes that missing entry should have. I think we agree on at least two things: a long-term option to remain in the home at a fixed price, and tax advantages similar to those available to homeowners. If a tenure form is to provide consumption benefits that rival those of homeownership, it would also need to offer access to a wide array of housing choices (including plenty of single-family housing stock in good condition), and some reasonable measure of freedom with respect to matters like occupants, pets, and decorating. How to get there? First, we'd need Congress to remove the tax advantages for homeowners (I'm all in favor of that, by the way, as I've written elsewhere). That indispensable step probably already shifts us into the realm of the impossible. Still, let's forge ahead.

Next, we must get landlords to make available a lot more (and a lot better-maintained) rental housing than is presently available, with fewer restrictions on tenant behavior, and much, much, longer terms (even 30 or 40 years might be too short). Note that, as a practical matter, these long terms would have to be asymmetric—fully binding the landlord, but terminable on perhaps a half-year's notice by the tenant. It is difficult to imagine many landlords leaping to offer such deals. Of course, the law could force them to do it. But the law cannot force people to be landlords, and if the terms are unfavorable enough, landlords may stop landlording. Perhaps a system of subsidies could be developed to entice people into offering these idealized leaseholds. Still, serious moral hazard problems remain regarding the upkeep of the property (landlords will be tempted to shirk on factors that primarily affect consumption, while tenants will be tempted to shirk on factors that primarily affect the long-term value of the property). We can try to address these problems by letting tenants internalize the gains and losses associated with their own choices on the property and by giving them greater latitude to address on-site matters. But as we continue down that path, we begin to reach something very like H2.0, with landlords serving in place of investors. If a tenure form with these attributes sounds sensible as a matter of substance, scaling down traditional homeownership to generate it seems like a much more psychologically attractive and politically feasible approach.

I don't disagree with your second point, but I don't see how it's an argument against H2.0. Suppose onsite factors had absolutely no effect on the home's investment value or on the consumption value that residents could derive from living there (imagine all homes are identical, indestructible, self-cleaning stainless steel cubes). This would eliminate the moral hazard problems associated with leaseholds, and (tax issues aside) there would be no reason for the person who lived in the cube to also invest in the cube (because nothing she does to the cube will matter, either to her own comfort or to the cube's resale value). H2.0 merely translates that lesson to the messier world in which onsite actions do matter to some degree, by suggesting that the person who owns the rights to gains and losses associated with onsite activities need not also own the rights to the gains and losses associated with offsite occurrences.

I'll be back soon with more.  Thanks again for giving me so much to think about!

Next Week: Debate on Homeownership 2.0

Buying a home means accepting a large dose of undiversified risk, much of it stemming from factors outside of the purchased parcel and out of the homeowner’s personal control. In this article, forthcoming in the Northwestern University Law Review, Chicago's Lee Fennell presents a new tenure form, Homeownership 2.0 (“H2.0”), that reconfigures the default homeownership bundle. Central to H2.0 is a distinction between parcel-specific influences on home values, like remodeling and maintenance choices (“onsite factors”), and influences on home values that emanate from beyond the four corners of the parcel, such as neighborhood changes and larger housing market trends (“offsite factors”). Fennell argues that investment in onsite factors is essential to homeownership, but that requiring homebuyers to invest in offsite factors as a matter of course is no more sensible than forcing them to invest in some other random, localized venture with variable returns. Indeed, scholars and innovators have already explored a variety of ways to slice, dice, hedge, and trade housing market risk. Using the H2.0 proposal as a focal point for analysis, Lee’s piece steps back to examine how a reduced-risk version of homeownership would fit together with property theory, human cognition, and the social dynamics of neighborhoods and metropolitan areas.

Rich Schragger of UVA School of Law will debate Lee’s paper next week on the Faculty Blog. We hope you’ll join us!

Conference: "Torture, Law, and War"

On February 29 and March 1, the Law School hosted an extraordinary conference devoted to the topic “Torture, Law, and War: What are the moral and legal boundaries on the use of coercion in interrogation?” The conference, which was sponsored by the Law and Philosophy Workshop with assistance from the Center for Comparative Constitutionalism, showcased the interdisciplinarity for which a Chicago legal education is renowned. Participants looked at the central question from the perspective of a wide range of fields, from law and public policy to psychology and history. Speakers included scholars from a dozen universities as well as the Law School's own Adam Samaha, Susan Bandes, Richard McAdams, Martha Nussbaum, Geoffrey Stone, Scott Anderson, and Eric Posner.

The conference keynote speaker was Justice Albie Sachs of the Constitutional Court of South Africa (pictured above). His talk, “Four tales of terrorism,” gave a first-hand account of his own torture by South African security forces and his brush with death when they attempted to assassinate him with a car bomb. It also described the principles behind the rejection of torture and capital punishment by the ANC, both before and after coming to power in South Africa. His talk discussed at some length four instances of terrorism, and the responses that courts and political leaders in South Africa made to them. Through these, he argued for the importance of adhering to the rule of law, including a refusal to resort to capital punishment, and also for the possibility of reconciliation with those who have previously used torture and terrorism against oneself and one’s own side in political struggles.

Audio and video of the keynote address, along with the  other panels of the conference, are now available on the conference web page.

Audio/Video: Lee Fennell, "Slices and Lumps"

On February 19, Professor of Law Lee Fennell presented the 2008 Coase Lecture on Law and Economics. Problems involving the aggregation and division of entitlements, she noted, are ubiquitous in law and in everyday life. Fragments held by multiple parties—such as parcels of land, effort, or segments of a bridge—often must be assembled together to be worth much. Conversely, a presently unified entitlement may be more valuable if it can be split into separate pieces held by different parties. The lecture examined these "lumping" and "slicing" problems (which turn out to be two sides of the same coin), showed how they turn up in both interpersonal and intrapersonal contexts, and offered some tools for addressing them.

Video of the lecture is embedded below, or you may download the .mov file. Just want to listen? Then download the .mp3 file here.

UPDATE: Prof. Fennell's paper based on this talk is now available from SSRN.

Fennell's Comments [Mobblog: The New Servitudes]

Thanks for this fascinating article, Molly.  I assigned an excerpt from it to my 1L property students long before I knew this mobblog would take place, and due to a fortuitous alignment of the syllabus, we had a chance to begin discussing it on Friday (along with an excerpt from Glen Robinson's Chicago Law Review piece).   So my students will be reading along and, I hope, chiming in.

I think you are exactly right to draw distinctions among different flavors of "new servitudes" and to distinguish among problematic features of those servitudes (in your taxonomy, "notice and information costs," "the problem of the future," and "harmful externalities"). I just have a couple of suggestions on how you might go even further on those fronts.

First, I wonder if you could gain even more traction from land servitude analogies by considering which of these servitude forms most closely resembles each of the "new servitudes" you discuss. For example, the Microsoft EULA sounds like a negative easement in gross that benefits Microsoft and burdens the end user and her successors.  It works much like a conservation easement, in that everyone who comes into contact with the property is foreclosed from doing certain things with or to it, and may present some of the same concerns.  The Creative Commons and GPL examples, in contrast, look much more like the covenants in common interest communities (CICs) that reciprocally burden and benefit each parcel-holder.  Each person enmeshed in the overall scheme receives a benefit (access to the products of others) but also is subjected to a burden (giving reciprocal access to others).  The large number of benefited parties who must release each burdened party creates the anticommons-like dynamic you describe; similar problems have arisen in CICs.  So there may be more to learn by looking at the problems and solutions that are associated with the closest analogues for each "new servitude" type.

Second, although your taxonomy does this to some extent, it may be helpful to distinguish more sharply between two kinds of concerns about servitudes:  problems that are uniquely presented by servitudes "running" to other users (who may be remote in time and space), and public policy concerns that exist independent of these concerns about running.  With land servitudes, the first category of problems are tackled through running requirements and doctrines that provide, under certain circumstances, for modification or nonenforcement (or damages-only remedies, as Stewart Sterk notes in his comment).  Broader-based measures are used to address the second category of problems.  For example, the Fair Housing Act places side constraints on servitudes that run with the land, but it would also limit in exactly the same fashion and for exactly the same reasons non-running discriminatory agreements among individual neighbors.

Running itself may be an issue in the case of servitudes attached to Creative Commons and GPL licenses, in that it expands the web of reciprocally-bound parties.  And at least one concern that you raise about EULAs implicates running as such: the worry that restrictions affixed to obsolete software will hamper its use for education and research long after the software has ceased to hold significant commercial value.  [A quick aside on this point:  Might one possibility be a sunset on the enforceability of licensing agreements once the software in question is no longer available for purchase from the manufacturer or its successors? As long as the manufacturer continues to offer the product for sale, the use of servitudes could actually advance educational and research uses, for a reason noted by Glen Robinson:  servitudes make it feasible for manufacturers to engage in price discrimination].

Other concerns with EULAs seem conceptually removed from questions of "running."  For example, the possibility that EULAs will interfere with fair use rights seems like a substantive objection to the limits themselves, even as applied to the first purchasers of the product.  If our real objection is to the limitation itself and not to the fact that it runs, we need a different (and broader-based) response.  Otherwise, manufacturers could shift to non-running substitutes with the same substantive effects.  Consider what Glen Robinson terms "hardwired servitudes" – electronic products that self-destruct after some number of days or uses, or otherwise directly prevent any user from breaking the original license agreement.  These built-in constraints might be viewed as problematic, but not because of the time and remoteness concerns we would typically associate with running servitudes.

An analogy may help here.  Suppose a buffet restaurant rations access to its food with tickets that are issued only after a purchaser agrees to the following:  (1) the ticket can be used for no more than five separate trips through the buffet line; (2) no containers for carrying food may be used other than the plates supplied by the restaurant; and (3) these restrictions "run with the ticket"; if a ticket is transferred, the trip count does not reset, and the "no outside container" rule remains in force.  After observing the buffet's operation, we might well conclude that the customers are getting an unfair deal.  Perhaps the supplied plates feature a clever dome-like surface that precludes the efficient piling of food, or the restocking of the buffet is strategically staggered so that people can access only a small fraction of the ostensibly available foods on each trip through the line.  But because these are not, fundamentally, problems with the restrictions running to other diners, any response to them should be direct and broad-based (say, though prohibitions on deceptive buffet practices).  The running feature is indeed essential to the restaurant's current business model, but that business model (and the running servitudes necessary to sustain it) may turn out to be socially valuable once the substantive problems with the buffet's serving practices are addressed.

Thanks again for the paper, Molly, and for participating in this online event!

Lee Fennell: "Order With Outlaws?"

Over at the Penn Law Review PENNUmbra, Lee Fennell has published a response to an article in which Eduardo Peñalver and Sonia Katyal "provocatively argue that the violation of property laws can enhance the social order." In her response, Lee suggests a "way to distinguish socially valuable boundary crossings from socially destructive ones." You can read the full response here.