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Philosophy is perfectly right in saying that life must be understood backward. But then one forgets the other clause – that it must be lived forward. Soren Kierkegaard Both law students and law teachers have traditionally been drawn to conceptual projects that attempt to systematize the field of contract law. The reasons for this are easy to see: the field is doctrinally complex, few beginning students have any substantial experience with the kinds of fact patterns that arise in the cases, and the law is a locus of contestation over fundamental issues of economic liberalism that go to the heart of the capitalist system. Thus, there has long been both an appetite and a market for syntheses of the field that go beyond the usual study aids and hornbooks. A generation ago, Professor Grant Gilmore's The Death of Contract, Professor Charles Fried's Contract as Promise, and, for those with greater stamina, Professor Patrick Atiyah's The Rise and Fall of Freedom of Contract addressed this intellectual need, and all three are still unquestionably worth the attention of first-year students and their teachers. But time passes, new problems arise, case law develops, and the frontiers of political contestation shift; and a new cohort of guidebooks is needed for a new cohort of lawyers.

Guaranty arrangements, in which one person stands as surety for a second person's obligation to a third, are ubiquitous in commercial transactions and in commercial law. In recent years, however, scholarly attention to the topic has been scant; and no one has systematically analyzed this body of law and practice from an economic policy perspective. Accordingly, this Article attempts to outline the basic economic logic underlying the guaranty relationship, and applies the results to a variety of specific issues in government policy and private planning. It poses and answers three main questions: First, why would a creditor prefer to make a guaranteed loan rather than an unguaranteed one? The answer is not as obvious as might first appear, given that market competition over credit terms tends to adjust the interest rate paid by an individual borrower to reflect the specific default risk that he presents. Second, given that they bear the residual risk of debtor default, why would guarantors prefer to guarantee loans rather than make loans directly, thus forgoing the opportunity to earn interest payments that could help to compensate for the risk they bear? Third, even if it is efficient for one creditor to provide funds and another to provide insurance against default, why would the parties prefer to implement this arrangement through the triangular form of a guaranty, instead of simply having the former creditor lend to the latter and the latter lend to the ultimate borrower?

Guaranty arrangements, in which one person stands as surety for a second person's obligation to a third, are ubiquitous in commercial transactions and in commercial law. In recent years, however, scholarly attention to the topic has been scant; and there is still no theoretical treatment of this body of law or practice from a economic policy perspective. This paper, accordingly, attempts to outline the basic economic logic underlying the guaranty relationship, and applies the results to a variety of specific issues in government policy and private planning. It poses and answers three main questions: First, why would a creditor prefer to make a guaranteed loan rather than an unguaranteed one? The answer is not as obvious as might first appear, given that market competition over credit terms tends to adjust the interest rate paid by an individual borrower to reflect the specific default risk that he presents. Second, given that they bear the residual risk of debtor default, why would guarantors prefer to guarantee loans rather than make loans directly, thus foregoing the opportunity to earn interest payments that could help to compensate for the risk they bear? Third, even if it is efficient for one creditor to provide funds and another to provide insurance against default, why would the parties prefer to implement this arrangement through the triangular form of a guaranty, instead of simply having the former creditor lend to the latter and the latter lend to the ultimate borrower?

The modem field of law and economics – that is, the application of economic analysis to legal subjects other than trade and business regulation – is now over thirty years old, but it remains controversial in the legal academy and, to a lesser extent, in the profession at large. Since its beginnings in the early 1960s, the economic approach has provoked substantial opposition and antagonism. The sources of this resistance, however, are a matter of dispute. Many economists and economically influenced lawyers attribute it to more traditional lawyers' reluctance to learn a new and unfamiliar set of concepts and techniques. Critics of the economic approach offer a variety of other explanations. Some are skeptical of the utility of abstract theoretical modeling in the social sciences, others object to economics' central behavioral assumption of rational choice, still others criticize economics' supposed libertarian politics and ideological allegiance to laissez-faire. The explanation that has attracted the most attention by far is economics' commitment to the efficiency criterion: proponents of the economic approach tend to argue that more traditional lawyers have not paid enough attention to efficiency, and its detractors tend to argue that economics inappropriately focuses on efficiency to the exclusion of other normative considerations. All these explanations, however, are too narrow. As with any conflict between rival disciplines, the underlying division between law and economics is methodological and cultural. The two fields use different rhetorics, different styles of discourse, different epistemologies, and different literary forms in developing and articulating their respective accounts of the world. Resistance to interdisciplinary exchange between lawyers and economists comes partly from the fact that neither group wishes to give up its own culture in favor of the other's.5 It also comes, however, from the two sides' failure to understand each other's cultural practices in full context.