The Code of Capital: How the Law Creates Wealth and Inequality

Katharina Pistor’s Code of Capital is a readable history and argument about how the law affects money—a focus revealing both the book’s strengths and weaknesses. Code of Capital functions in bravura ways as a short introduction to law and finance—that in itself makes it worthwhile. The law’s impact on what money does is a hugely underdiscussed and even less understood economic driver, and any serious investor should take a few afternoons to get a sense of it. But readers should remember no one factor explains all effects in a complex and adaptive system like the global economy, making Code of Capital’s frequent impulse to attribute all sorts of market outcomes solely to law tenuous, if not at times dubious.

Pistor approaches the book like a well-composed legal brief—eruditely argued and persuasive toward her views. That’s a real positive for readers who recognize challenging ideas as learning tools: Pistor is arguing something, not trying to come down in the middle of every issue. She covers the big criticisms of today’s system with aplomb—certainly, there is unfairness and inconsistency very much worth public awareness. And much as with politics, we should all be skeptical and alert to how the law creates winners and losers structurally—and often sneakily. Law is the “frame” dictating the bounds of what money can ostensibly do (though, what money does outside the law is an equally interesting topic).

While not the main reason to pick up Code of Capital, the book forces us to think about what capital actually is. Law is where the rubber meets the road. It provides the working definitions—however opaque they may be—for how all this finance stuff works. Stocks, bonds, corporations and all that go with it—these are human ideas, mere concepts. They become workable and real via the laws we create, which turn abstract concepts into tangible things. After all, a stock is only as good as the legal rights you can claim with it, so the laws underpinning capitalism dictate much of the action within it. You’d be amazed how many investing professionals don’t take much time at all to think about that. But underneath, financial lawyers are often as powerful as money managers themselves.

Pistor is an accomplished rhetorician, and it’s on display as she describes the complex and flat-out bizarre structures of financial instruments that often seem iterations of Frankenstein’s monster—like collateralized debt obligations (CDOs), which played a key role in the 2007 – 2009 bear market. But here the book fails to recognize that ultimately many of those same mechanisms stabilized after the true crisis phase; the vast majority did not default. Frankly, so far CDOs have held up fairly well through this wretched year of COVID, too. What may look predatory to one side may simply look like insurance to another. CDOs weren’t simply part of a murky system that protects lenders over borrowers. They also really did spread risk across a system. Such things, for all their warts, can come in handy for a society, even when few sing their benefits. Moreover, the financial crisis requires a wider lens: Laws alone didn’t trigger it—the FAS 157 accounting standard (so-called “mark-to-market” accounting) was as crucial to the ills of ’08 as any law. (Here then begs the question: what of accounting? Isn’t it a set of rules like the law? But we’ll hold that topic for another review.)

A great strength of Code of Capital is its weaving of history—revealing not only the peculiar ways laws have evolved, but also just how much of a patchwork the law is across nations and jurisdictions globally—ever more important in a world of globally operating firms. There’s a reason so many big business cases are tried in New York and a reason many companies declare the Cayman Islands their headquarters.

Those who can hold the tension of seeming paradoxes benefit most from good books, and Code of Capital is no exception: Yes, the system is vastly flawed and sometimes flat-out unfair; and also yes, it has generated huge and broad prosperity across the world. Both those propositions can be true; it’s why politics is the venue of intractable things.

Code of Capital won’t reconcile the world’s ills in your head or the wider world. But we can learn much from this readable and disciplined argument on the vital topic of law and investing. Law isn’t everything, but it deserves more attention than it gets from investors.