Part Three of my book will have the heading "Some Policy Consequences."
Some transitional material. In chapter 10 we asked ourselves: what keeps those hungry piranha alive in the liquid marketplace? After all, they can't perform their function of continuing to eat up raw meat (profitable inefficiencies) unless there is a fresh supply of raw meat. We identified some of the sources of inefficiency. One of these is bankruptcy law, and the opportunity it affords to those willing to buy up distressed debt and maneuver their way through the system.
But of course it is not the job of public policy to make life easy for such piranha. Indeed, I propose in the following four chapters to work on the presump-tion that it is the job of public policy to make their life more difficult, to narrow the ecological niche that piranha fill.
Its first chapter, 13, concerns "Bankruptcies and Rescues."
Within US laws that now govern corporate bankruptcies, there are at least two great sources of inefficiency. The first is the degree of secrecy the system allows, and the second is the skewed incentives that it creates for trustees. We'll look at those in that order, and then we'll ask a broader question: does the U.S. really need a voluntary system of corporate reorganization at all? What might happen if the only corporate bankruptcies were the involuntary sort sought by creditors?
The Federal Rules of Bankruptcy Procedure in their current form [though amendments are scheduled to take effect this December], prescribe disclosure by an "entity or committee representing more than one credit" of the identity of the creditor involved, the nature and amount of its interest, the dates on which the separate interests were acquired, and even the amounts paid for them. If rigorously enforced, that would make life rather difficult for speculators, who depend upon the opacity of the proprietary strategies. They have resisted rigorous enforcement of that rule, creating committees that aren't really committees, for example.
In the case of Northwest Airlines (2007), this technical-sounding issue received a burst of publicity. The condition of the US airlines industry made this bankruptcy of especial interest to a broad public.
Showing posts with label bankruptcy. Show all posts
Showing posts with label bankruptcy. Show all posts
29 April 2011
27 January 2011
Equity and Prop Desks
Below is a brief passage from what may become the third chapter of my proposed book as represented in the table of contents I provided on December 10, 2010.
This complements materials I've provided for the two previous chapters, and we will continue our march in a measured pace.
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3. Equity and Prop Desks
The distinction between equity and debt is critical to any serious discussion of modern finance. It is also, not coincidentally, critical to the understanding of corporate liquidations or reorganizations. We will begin there, and soon enough we’ll be discussing corporate governance, government regulation, and the mysteries of federalism.
Think of a newly bankrupt corporation as a see-saw with a much heavier weight on the left and a lighter weight on the right. The right end, then, is up in the air. The left end (the equity) sits on the ground. The fulcrum is in the middle.
In terms of the right to receive a payoff, the most senior debt has first dibs. This is the airiest part of the see-saw. After those debts are paid off, payments follow in a sequence defined by contract and law. In time, the liquidators of the estate come to the fulcrum – the point at which what remains to be distributed is the good will of the ongoing enterprise.
Let’s assume that there is some such value (if not, we’d be dealing with a liquidation rather than a reorganization). On this assumption, the holders of the “fulcrum security” will be reimbursed by the transformation of their securities into the equity of the reorganized company. The classes of security that are lower than the fulcrum security, including the holders of the old equity, will get nothing.
One quick way of expressing all of this is to say that the holders of the equity of a company are the ones who bear the “residual risk.” They are the ones most certain to lose out in the event of liquidation. Thus, their interests are aligned with the interests of the corporation as a continuing, sustainable, entity.
To use a serious maritime image rather than the frivolous playground imagery above, we might say this: it is because the captain would go down with the ship, in accord with maritime tradition, that the captain is the best one to entrust with the task of steering the ship safely. Passengers with secure access to a rowboat in the event of a mishap are less suitable for the task.
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A footnote in there may refer to “Chapter 11 Reorganization Cases and the Delaware Myth” by Harvey R. Miller (2002), an article that sought to rebut the widespread impression, the “myth” that “there is something fundamentally wrong, even reckless, with the reorganization process as it is practiced” in the federal bankruptcy court in bellwether Delaware.
A further theme of the chapter as it develops will be the critical role of speculation in uncovering the real value of assets. Specifically, the equity markets (and their speculators) reveal the value of an ongoing enterprise as its market cap. The difficulties caused by regulations that obscure that process, thus hiding the true value. Prices as data. Leonard Read’s pencil.
From there to the role of shorts, a return to the Enron scandal, what Skilling called a certain short. Hedge funds and the prop desks of banks.
This complements materials I've provided for the two previous chapters, and we will continue our march in a measured pace.
--------------
3. Equity and Prop Desks
The distinction between equity and debt is critical to any serious discussion of modern finance. It is also, not coincidentally, critical to the understanding of corporate liquidations or reorganizations. We will begin there, and soon enough we’ll be discussing corporate governance, government regulation, and the mysteries of federalism.
Think of a newly bankrupt corporation as a see-saw with a much heavier weight on the left and a lighter weight on the right. The right end, then, is up in the air. The left end (the equity) sits on the ground. The fulcrum is in the middle.
In terms of the right to receive a payoff, the most senior debt has first dibs. This is the airiest part of the see-saw. After those debts are paid off, payments follow in a sequence defined by contract and law. In time, the liquidators of the estate come to the fulcrum – the point at which what remains to be distributed is the good will of the ongoing enterprise.
Let’s assume that there is some such value (if not, we’d be dealing with a liquidation rather than a reorganization). On this assumption, the holders of the “fulcrum security” will be reimbursed by the transformation of their securities into the equity of the reorganized company. The classes of security that are lower than the fulcrum security, including the holders of the old equity, will get nothing.
One quick way of expressing all of this is to say that the holders of the equity of a company are the ones who bear the “residual risk.” They are the ones most certain to lose out in the event of liquidation. Thus, their interests are aligned with the interests of the corporation as a continuing, sustainable, entity.
To use a serious maritime image rather than the frivolous playground imagery above, we might say this: it is because the captain would go down with the ship, in accord with maritime tradition, that the captain is the best one to entrust with the task of steering the ship safely. Passengers with secure access to a rowboat in the event of a mishap are less suitable for the task.
--------
A footnote in there may refer to “Chapter 11 Reorganization Cases and the Delaware Myth” by Harvey R. Miller (2002), an article that sought to rebut the widespread impression, the “myth” that “there is something fundamentally wrong, even reckless, with the reorganization process as it is practiced” in the federal bankruptcy court in bellwether Delaware.
A further theme of the chapter as it develops will be the critical role of speculation in uncovering the real value of assets. Specifically, the equity markets (and their speculators) reveal the value of an ongoing enterprise as its market cap. The difficulties caused by regulations that obscure that process, thus hiding the true value. Prices as data. Leonard Read’s pencil.
From there to the role of shorts, a return to the Enron scandal, what Skilling called a certain short. Hedge funds and the prop desks of banks.
25 September 2010
Bankruptcy and Transparency
A controversy about the rules of bankruptcy procedure, specifically rule 2019, has bubbled along for three years now and may be about to make a big change in the way corporate bankruptcies are handled in the U.S.
It all began in February 2007 with a "seemingly innocuous opinion" by Judge Gropper of the Manhattan bankruptcy court in the Northwest Airlines case.
Gropper held that under rule 2019, hedge funds that were a member of one of the ad hoc groups that form for the purposes of negotiating/arguing out the terms of a debtor company's reorganization have to turn over to their court information that hedge funds as such like to keep close to their vests -- information amount about interest held and the price at which that interest was purchased.
The funds tried to mitigate the harm to their traditional trading strategies that this threatened, by asking for permission to provide this information under seal. But Gropper, a few days later, shot that down, too.
Several other bankruptcy courts have considered the matter since then. No consensus has developed among them as to what 2019 means.
In August 2009, the Advisory Committee on the Federal Rules of Bankruptcy Procedure (Advisory Committee) proposed a significant revision of the rule In part, this came about because of the need for legal certainty. As important, though, it came about because many well-placed people think Gropper was right on policy grounds, and that it would be good to have a rule that is very clear about that.
The proposed rule revision would change the bankruptcy investing game in three principal ways: (1) it would widen the scope of who must disclose under Rule 2019; (2) it would widen the scope of what must be disclosed; and (3) it would give bankruptcy courts wider discretion to relieve or abridge disclosure obligations, especially disclosure regarding the prices of assets purchased in secondary market trading. This article discusses the proposed revision in depth, focusing on the potential consequences for hedge funds that invest in and around bankruptcies.
There is now a widespread expectation that there will be reform, that it will be in place by the end of 2011, and that the results will demand more transparency than anyone would have expected before Gropper put this ball in play.
For the possible significance of this, I refer you back to my explanation at the time of Gropper's stance.
It all began in February 2007 with a "seemingly innocuous opinion" by Judge Gropper of the Manhattan bankruptcy court in the Northwest Airlines case.
Gropper held that under rule 2019, hedge funds that were a member of one of the ad hoc groups that form for the purposes of negotiating/arguing out the terms of a debtor company's reorganization have to turn over to their court information that hedge funds as such like to keep close to their vests -- information amount about interest held and the price at which that interest was purchased.
The funds tried to mitigate the harm to their traditional trading strategies that this threatened, by asking for permission to provide this information under seal. But Gropper, a few days later, shot that down, too.
Several other bankruptcy courts have considered the matter since then. No consensus has developed among them as to what 2019 means.
In August 2009, the Advisory Committee on the Federal Rules of Bankruptcy Procedure (Advisory Committee) proposed a significant revision of the rule In part, this came about because of the need for legal certainty. As important, though, it came about because many well-placed people think Gropper was right on policy grounds, and that it would be good to have a rule that is very clear about that.
The proposed rule revision would change the bankruptcy investing game in three principal ways: (1) it would widen the scope of who must disclose under Rule 2019; (2) it would widen the scope of what must be disclosed; and (3) it would give bankruptcy courts wider discretion to relieve or abridge disclosure obligations, especially disclosure regarding the prices of assets purchased in secondary market trading. This article discusses the proposed revision in depth, focusing on the potential consequences for hedge funds that invest in and around bankruptcies.
There is now a widespread expectation that there will be reform, that it will be in place by the end of 2011, and that the results will demand more transparency than anyone would have expected before Gropper put this ball in play.
For the possible significance of this, I refer you back to my explanation at the time of Gropper's stance.
17 October 2009
Vampire Squid v. Old Greenmailer
A lending unit of the Goldman Sachs Group has filed a lawsuit against the High River Limited Partnership -- an investment vehicle controlled by Carl Icahn -- alleging that High River breached contract by failing to complete a transaction in bank debt.
This lawsuit is the latest bit of shrapnel from the long complicated bankruptcy proceedings over auto-parts maker Delphi Corp. During the pendency of that bankruptcy, banks holding IOUs from Delphi were in the market to make deals, to sell that paper and whatever it might get them via the reorganization for cash.
In principle of course this makes possible some middleman profits. Icahn could have bought the paper from banks desperate to get rid of it, turned around and sold it to Goldman which (on this hypothesis) was taking a longer-term view and was willing to build up its position in Delphi debt.
But Goldman alleges that isn't quite what Icahn did. Instead, he sold them bank debt he didn't own (naked shorting it, so to speak) and then, when the time came for the deal to close, pulled out. Presumably he was hoping that the value of this paper would fall between the time he made the deal and the closing date, so he could buy it for less than Goldman had promised. That didn't happen, so he was faced with the choice of pulling out of the deal, or of buying high to sell low.
That scenario, if true, would certainly seem to be a contractual liability, if not worse. It could be fraud if he led them to believe he was in possession of the instruments.
High River says it has done nothing wrong, and I haven't even seen the complaint. I'm retailing this to you second hand. I do think it may be intriguing to watch this one develop, though.
This lawsuit is the latest bit of shrapnel from the long complicated bankruptcy proceedings over auto-parts maker Delphi Corp. During the pendency of that bankruptcy, banks holding IOUs from Delphi were in the market to make deals, to sell that paper and whatever it might get them via the reorganization for cash.
In principle of course this makes possible some middleman profits. Icahn could have bought the paper from banks desperate to get rid of it, turned around and sold it to Goldman which (on this hypothesis) was taking a longer-term view and was willing to build up its position in Delphi debt.
But Goldman alleges that isn't quite what Icahn did. Instead, he sold them bank debt he didn't own (naked shorting it, so to speak) and then, when the time came for the deal to close, pulled out. Presumably he was hoping that the value of this paper would fall between the time he made the deal and the closing date, so he could buy it for less than Goldman had promised. That didn't happen, so he was faced with the choice of pulling out of the deal, or of buying high to sell low.
That scenario, if true, would certainly seem to be a contractual liability, if not worse. It could be fraud if he led them to believe he was in possession of the instruments.
High River says it has done nothing wrong, and I haven't even seen the complaint. I'm retailing this to you second hand. I do think it may be intriguing to watch this one develop, though.
22 May 2009
Serial bankruptcies, six figures
Edmund Andrews, who has been an economics reporter with The New York Times for several years, has written a book entitled BUSTED: Life Inside the Great Mortgage Meltdown.
Here is the amazon entry for the book.
From what I understand -- and I admit upfront I haven't read the book, so of course I stand open to correction -- Andrews treats his and his wife's experiences as a homeowning couple as a microcosm of the broader meltdown, and although he acknowledges that they were imprudent in some financial decisions, the general premise of the book is that this is anyone's story -- it could have been you, etc.
Commendable research by Megan McArdle at The Atlantic indicates that they aren't a very good microcosm for everyone. She could have done a routine review, but chose instead to do some digging. Nothing dramatic -- no meetings in a dark garage -- just some study of publicly available records of bankruptcy filings and the like. But very revealing.
The serial bankruptcies of an individual making six-figure incomes -- with the second bankruptcy coming almost as soon as lawfully possible -- is hardly an "everyman" type of situation. And treating it as a microcosm of our broader economic difficulties is not the path to clarity on the subject of the latter.
Here is the amazon entry for the book.
From what I understand -- and I admit upfront I haven't read the book, so of course I stand open to correction -- Andrews treats his and his wife's experiences as a homeowning couple as a microcosm of the broader meltdown, and although he acknowledges that they were imprudent in some financial decisions, the general premise of the book is that this is anyone's story -- it could have been you, etc.
Commendable research by Megan McArdle at The Atlantic indicates that they aren't a very good microcosm for everyone. She could have done a routine review, but chose instead to do some digging. Nothing dramatic -- no meetings in a dark garage -- just some study of publicly available records of bankruptcy filings and the like. But very revealing.
The serial bankruptcies of an individual making six-figure incomes -- with the second bankruptcy coming almost as soon as lawfully possible -- is hardly an "everyman" type of situation. And treating it as a microcosm of our broader economic difficulties is not the path to clarity on the subject of the latter.
01 May 2009
25 years ago today in music
On May 1, 1984, Mick Fleetwood, the drummer of "Fleetwood Mac" fame, filed for bankruptcy. How could that have happened? After the huge success of the band's self-titled album in 1975, and of its follow-up Rumors, in 1977? Rumors remains one of the 20 best selling albums of all time. And the drummer filed for bankruptcy court protection seven years later?
Well ... how could one of the famed "Big Three" of Detroit, automaker Chrysler, have been brought to the point of filing for bankruptcy, as happened yesterday? How could General Motors be teetering on that brink? Fame is fleeting, and wealth is more so.
There's the off-the-moment spending to which rock stars feel entitled, of course. Not just entitled ... obligated. There's an entourage to maintain. There were, in Fleetwood's case, impulsive purchases of both real estate and restaurants to disastrous effect.
As for Chrysler and GM, you'll be reading much about them in the days to come.
17 October 2008
Corporate bankruptcy and the little guy
Here's the text of a letter written by a businessman in Whitney, Texas, to a bankruptcy judge in Kansas City. MO, in October 2006.
The reference is to the Interstate Bakeries Corp., which had filed for chapter 11 protection two years before. The IBC, which is the company behind such famous brands as Twinkees and Wonder Bread, failed to adapt in time to the low-carb diet craze and went under.
The letter gives an idea of how that affects ordinary folk. After all, a corporate entity on IBC's scale is general one of several inter-related corporations, a family in which it isn't clear to outsider who is a subsidiary of whom.
"My name is ***** *****. I am the landlord for Dolly Madison Bakeries located at 584 S. -------- Rd., ------, Texas....
"The Attorneys for Interstate Bakeries are asking you to disallow my claim in the amount of $5,230.75 due to IBC being the improper Corporation.
"I was told in 2004 to request payment from IBC and did so. Interestate Bakeries made payment in the amount of $1,993.61 (copy of check attached) which was for the 2004 taxes prior to the filing of bankruptcy. The total amount of the taxes for that year was $7,224.36. They still owe $5,230.75. Their lease states that they are to pay their pro-rata share of the property taxes each year.
"I respectfully request Interstate Bakeries Corporation debt to me not be demolished."
---
I was looking to develop some story ideas recently, rummaging (in a cyberspatial sense) through the years-old file for interesting legal issues. Not much luck.
But I did find the above letter, which I consider very poignant and in its own sociological way, fascinating.
The usual mental habit is to think of the landlord as the 'upper hand,' the tenant as the one fearing, and often experiencing, oppressionor ill treatment.
But here the landlord is one guy, a natural person not a corporation. And not enough of a big shot to have a lawyer write a letter for him. He writes it himself. Not even a lawyer friend who can give him a once-over and some free advice. Or that strange use of the word "demolished" wouldn't have made the cut.
I hope he ends up with something out of the re-organized entity. Some stock in the new version of IBC when it emerges from the court's protection, perhaps. Let's root for that.
The reference is to the Interstate Bakeries Corp., which had filed for chapter 11 protection two years before. The IBC, which is the company behind such famous brands as Twinkees and Wonder Bread, failed to adapt in time to the low-carb diet craze and went under.
The letter gives an idea of how that affects ordinary folk. After all, a corporate entity on IBC's scale is general one of several inter-related corporations, a family in which it isn't clear to outsider who is a subsidiary of whom.
"My name is ***** *****. I am the landlord for Dolly Madison Bakeries located at 584 S. -------- Rd., ------, Texas....
"The Attorneys for Interstate Bakeries are asking you to disallow my claim in the amount of $5,230.75 due to IBC being the improper Corporation.
"I was told in 2004 to request payment from IBC and did so. Interestate Bakeries made payment in the amount of $1,993.61 (copy of check attached) which was for the 2004 taxes prior to the filing of bankruptcy. The total amount of the taxes for that year was $7,224.36. They still owe $5,230.75. Their lease states that they are to pay their pro-rata share of the property taxes each year.
"I respectfully request Interstate Bakeries Corporation debt to me not be demolished."
---
I was looking to develop some story ideas recently, rummaging (in a cyberspatial sense) through the years-old file for interesting legal issues. Not much luck.
But I did find the above letter, which I consider very poignant and in its own sociological way, fascinating.
The usual mental habit is to think of the landlord as the 'upper hand,' the tenant as the one fearing, and often experiencing, oppressionor ill treatment.
But here the landlord is one guy, a natural person not a corporation. And not enough of a big shot to have a lawyer write a letter for him. He writes it himself. Not even a lawyer friend who can give him a once-over and some free advice. Or that strange use of the word "demolished" wouldn't have made the cut.
I hope he ends up with something out of the re-organized entity. Some stock in the new version of IBC when it emerges from the court's protection, perhaps. Let's root for that.
18 July 2008
Dysfunctional system discounted
We may be at a bottom for the present Dow-index bull market.
Keep the confetti in storage, please. I'm merely suggesting that the upward bounce this week [the chart alongside this text shows you yesterday's contribution] might not be a trap, just the Dow's tricky way of tempting you into renewed exposure. It might, rather, mean that a process of discounting the value of a (previously) overvalued system has run its course.
My theory, FWIW, is that much of this drop has been the consequence of a dysfunctional bankruptcy system.
People have become afraid of owning equity in finance corporations because those corporations so frequently and easily become the target of lawsuits by trustees or DiP on the slightest of pretexts -- consider the fall-out from Manhattan Investment Fund, or Refco, and the institutions that are targeted in such cases.
Anyway, the stock market swoon caused by such factors has reached its natural end. All the discounting that our dysfunctional bankruptcy system requires has been accomplished. So we've found a bottom of sorts.
BTW, nothing I say is to be understood as investment advice. This is a blog dammit! You're reading this for free and its worth every penny.
That said ... suppose I'm right. If the Dow has found its bottom, discounting everythig that needed to be discounted as a result of the revelations of last year ... does that automatically means we're going up now?
No. As the saying goes, if you throw a dead cat out of a skyscraper window, it will bounce a bit when it hits the sidewalk. That won't mean it's come back to life. We might simply be seeing the dead cat bounce after the discovery of a bottom. If there is no other animating force that enters the scene at this point, we could have a period of meaningless zig-zags around a horizontal line.
24 April 2008
Bankruptcy
Dysfunction of the corporate bankruptcy system in the US is, I feel certain, a good part of what ails us inboth micro and macro terms.
In a recent reveiw of Alan Greenspan's memoir, which I contributed to The Federal Lawyer, I said that debtor/creditor relations are a central theme in US history. That was the issue behind the fights over the first and second national banks. Regional disputes over debt and credit helped ignite a civil war, and the subsequent west-versus-east character of American populism. This was the issue behind the Bretton Woods negotiations of 1944, the subsequent unravelling of the system created there, and Greenspan's own present notoriety.
I didn't reference bankruptcy law in that review, but it is a branch on the same conceptual tree.
The kerfuffle over Bear Stearns last month renewed my interest in the whole subject. I suspect that the reason Bear melted down as quickly and unexpectedly as it did has a lot to do with contemporary bankruptcy laws, and the fact that Bear's counter-parties had to act in anticipation of the very possibility, even the mere rumor, that Bear might make such a filing.
I discussed related points in a blog entry here last August, and for today I'll just link you to that.
On a personal note: I'm going to be doing some travelling. You probably won't see another entry here for a week. I hope to see lots of comments when I return.
In a recent reveiw of Alan Greenspan's memoir, which I contributed to The Federal Lawyer, I said that debtor/creditor relations are a central theme in US history. That was the issue behind the fights over the first and second national banks. Regional disputes over debt and credit helped ignite a civil war, and the subsequent west-versus-east character of American populism. This was the issue behind the Bretton Woods negotiations of 1944, the subsequent unravelling of the system created there, and Greenspan's own present notoriety.
I didn't reference bankruptcy law in that review, but it is a branch on the same conceptual tree.
The kerfuffle over Bear Stearns last month renewed my interest in the whole subject. I suspect that the reason Bear melted down as quickly and unexpectedly as it did has a lot to do with contemporary bankruptcy laws, and the fact that Bear's counter-parties had to act in anticipation of the very possibility, even the mere rumor, that Bear might make such a filing.
I discussed related points in a blog entry here last August, and for today I'll just link you to that.
On a personal note: I'm going to be doing some travelling. You probably won't see another entry here for a week. I hope to see lots of comments when I return.
17 August 2007
Auto Parts, and the Whole Auto, Too
Don't lets all panic. People paying too much attention to biz news lately may feel a bit frazzled, but that means this is a time to look for signs of hope.
There may be such signs, even in the fractured North American auto industry. Here are three:
1. The auto parts company, Dana Corp., which filed for bankruptcy in March 2006, says it plans to exit bankruptcy by the end of this year.
That isn't just an optimistic rosy-tinted sayso, either. Dana's reorganization plan has been picking up some support. The company's bondholders formally approved it earlier this week.
2. Ford Motor Company has set a new land speed record. Its Ford Fusion Hydrogen 999 reached 207.28 miles per hour on the Bonneville Salt Flats. The reports I've seen aren't clear about the date, but it appears to be something of a breakthrough for the fuel cell technology involved.
http://www.autocar.co.uk/News/NewsArticle/Ford-Concepts/227307/
3. GM, too, is making a "green push" and seems ready to show off the results at the upcoming auto show in Frankfurt, Germany.
http://www.autobloggreen.com/2007/08/16/frankfurt-preview-lots-of-debuts-and-a-green-push-for-gm/
So ... think good thoughts!
There may be such signs, even in the fractured North American auto industry. Here are three:
1. The auto parts company, Dana Corp., which filed for bankruptcy in March 2006, says it plans to exit bankruptcy by the end of this year.
That isn't just an optimistic rosy-tinted sayso, either. Dana's reorganization plan has been picking up some support. The company's bondholders formally approved it earlier this week.
2. Ford Motor Company has set a new land speed record. Its Ford Fusion Hydrogen 999 reached 207.28 miles per hour on the Bonneville Salt Flats. The reports I've seen aren't clear about the date, but it appears to be something of a breakthrough for the fuel cell technology involved.
http://www.autocar.co.uk/News/NewsArticle/Ford-Concepts/227307/
3. GM, too, is making a "green push" and seems ready to show off the results at the upcoming auto show in Frankfurt, Germany.
http://www.autobloggreen.com/2007/08/16/frankfurt-preview-lots-of-debuts-and-a-green-push-for-gm/
So ... think good thoughts!
11 August 2007
Corporate (Voluntary) Bankruptcies
On June 23 I wrote in this blog about corporate bankruptcies, chiefly to make the point that the chapter 11 "process is and should be a very public, very transparent one."
But today I'm wondering why that piece was so timid. Maybe I should've called for the abolution of any such process, insofar as it can as now be voluntarily chosen by the debtor.
There should be a procedure for the orderly liquidation of chronically insolvent corporations. I concede that. But wouldn't it make more sense to expect that the creditors themselves would initiate the process in the normative situation? If the creditors decide there is no other way they'll get much of their money back, they'll be the ones to petition for an orderly wrap-up.
The company management represents the owners of equity. In principle they should always care more about seeing to it that the stock retains some value than they care about anything else -- even the payment of their bonds. They aren't working in the first instance for the bondholders. Bondholders don't have proxies.
If a corporation's management is the party that initiates a bankruptcy proceeding, there is already a prima facie case that they think it possible they'll survive, to be the managers of the re-organized company. As, often. they are. They can do this either while assuring that the original stockholders still get some share of the new company, or despite their failure to ensure that. Logically there is no third choice.
So, logically, it seems that whenever a corporate voluntarily files for bankruptcy either the decision-making management is hoping to help the stockholders cheat the bondholders, creditors, etc., or it is planning to cheat those stockholders. Neither is a good thing, or even a policy-defensible thing.
So ... down with voluntary bankruptcies and re-organizations! That is my new view of the matter until something or someone persuades me otherwise.
But today I'm wondering why that piece was so timid. Maybe I should've called for the abolution of any such process, insofar as it can as now be voluntarily chosen by the debtor.
There should be a procedure for the orderly liquidation of chronically insolvent corporations. I concede that. But wouldn't it make more sense to expect that the creditors themselves would initiate the process in the normative situation? If the creditors decide there is no other way they'll get much of their money back, they'll be the ones to petition for an orderly wrap-up.
The company management represents the owners of equity. In principle they should always care more about seeing to it that the stock retains some value than they care about anything else -- even the payment of their bonds. They aren't working in the first instance for the bondholders. Bondholders don't have proxies.
If a corporation's management is the party that initiates a bankruptcy proceeding, there is already a prima facie case that they think it possible they'll survive, to be the managers of the re-organized company. As, often. they are. They can do this either while assuring that the original stockholders still get some share of the new company, or despite their failure to ensure that. Logically there is no third choice.
So, logically, it seems that whenever a corporate voluntarily files for bankruptcy either the decision-making management is hoping to help the stockholders cheat the bondholders, creditors, etc., or it is planning to cheat those stockholders. Neither is a good thing, or even a policy-defensible thing.
So ... down with voluntary bankruptcies and re-organizations! That is my new view of the matter until something or someone persuades me otherwise.
23 June 2007
Bankruptcy as education
The chapter 11 process is and should be a very public, very transparent one. There shouldn't be any secrets about what goes on when a company asks a court to protect it from its creditors, then re-structures its debt and in time, if all goes well, re-emerges from into the marketplace from outside the court's protective wings.
There shouldn't be any secrets for a couple of good reasons. The most obvious is that many of the parties interested in the proceedings are likely to get cheated to the extent back-room deals can be cut. They'll be cheated anyway, in a sense (it is the whole point of the process to cheat somebody!), but the distribution of the losses always shifts to the disadvantage of those who don't have the pull in those back rooms.
That, then, is enough: don't let the players step into the back rooms. Keep everything in the arena.
Still, there's another and a better reason for openness. Corporate bankruptcy proceedings can be a medium whence the public can learn about the nature of the business cycle, and can in time perhaps be roused to do something about these boom and busts that so dislocate our lives.
In boom time, when credit is easy, when the banks not only lower their interest rates and compete with each other but are eager to give away their money, then times are so good for business that managerial sloppiness goes unpunished. People who have no aptitude for business end up running large ones, and they can fool themselves into thinking they have a calling for it so long as the money stays easy.
The problem, of course, is that while they’re fooling themselves and working through these loans, other people come to depend on them: employees, suppliers, creditors. The marginal and the sloppy work themselves into the social fabric. The goodness of such ‘good times’ is deceiving, because rot is building up.
At some point the lenders have to stop being so generous. Whether this takes place with the prodding of a central bank is another question, but a turn will take place.
The more liquid institutions are among the first victims of a turn. As the expansion crawls to a stop, every trader, every brokers, everyone who hangs casually around an exchange building, knows the turn is coming. Somebody will call in a margin that will force somebody else to liquidate. Nobody wants to be the liquidate, so they all become very cautious at the same time, and as counter-parties they all become demanding at the same time.
Long-Term Capital Management goes down before Enron does. Why? Because Enron had assets other than cash – assets that couldn’t be marked immediately to market – pipelines and generators. For the same reason, Enron with its “asset lite” philosophy, had to seek bankruptcy protection before a necessarily asset-heavy firm such as Delphi did.
(Delphi is an auto parts manufacturer that sought chapter 11 refuge in the autumn of 2005 and remains there still.)
The bankruptcy system is the best public forum for the documentation of the boom-bust cycle. Immersion there in could teach people painlessly that the way up is the way down, that the cheap credit that allows for the build-up of the rot is the real cause of the subsequent collapse, even that “irrational enthusiasm” is a central banker’s term for the sort of dislocation that central banking can cause.
There shouldn't be any secrets for a couple of good reasons. The most obvious is that many of the parties interested in the proceedings are likely to get cheated to the extent back-room deals can be cut. They'll be cheated anyway, in a sense (it is the whole point of the process to cheat somebody!), but the distribution of the losses always shifts to the disadvantage of those who don't have the pull in those back rooms.
That, then, is enough: don't let the players step into the back rooms. Keep everything in the arena.
Still, there's another and a better reason for openness. Corporate bankruptcy proceedings can be a medium whence the public can learn about the nature of the business cycle, and can in time perhaps be roused to do something about these boom and busts that so dislocate our lives.
In boom time, when credit is easy, when the banks not only lower their interest rates and compete with each other but are eager to give away their money, then times are so good for business that managerial sloppiness goes unpunished. People who have no aptitude for business end up running large ones, and they can fool themselves into thinking they have a calling for it so long as the money stays easy.
The problem, of course, is that while they’re fooling themselves and working through these loans, other people come to depend on them: employees, suppliers, creditors. The marginal and the sloppy work themselves into the social fabric. The goodness of such ‘good times’ is deceiving, because rot is building up.
At some point the lenders have to stop being so generous. Whether this takes place with the prodding of a central bank is another question, but a turn will take place.
The more liquid institutions are among the first victims of a turn. As the expansion crawls to a stop, every trader, every brokers, everyone who hangs casually around an exchange building, knows the turn is coming. Somebody will call in a margin that will force somebody else to liquidate. Nobody wants to be the liquidate, so they all become very cautious at the same time, and as counter-parties they all become demanding at the same time.
Long-Term Capital Management goes down before Enron does. Why? Because Enron had assets other than cash – assets that couldn’t be marked immediately to market – pipelines and generators. For the same reason, Enron with its “asset lite” philosophy, had to seek bankruptcy protection before a necessarily asset-heavy firm such as Delphi did.
(Delphi is an auto parts manufacturer that sought chapter 11 refuge in the autumn of 2005 and remains there still.)
The bankruptcy system is the best public forum for the documentation of the boom-bust cycle. Immersion there in could teach people painlessly that the way up is the way down, that the cheap credit that allows for the build-up of the rot is the real cause of the subsequent collapse, even that “irrational enthusiasm” is a central banker’s term for the sort of dislocation that central banking can cause.
19 May 2007
Northwest plan
A bankruptcy court judge in New York this week gave Northwest Airlines permission to emerge from chapter 11. The company's reorganization plan drew a rare show of support ... more than 97% of the creditors eligible to vote on the plan have approved it.
The airline said in a statement that it expects to re-emerge formally on May 31.
According to the plan, NW's secured creditors will be paid in full. Most unsecured creditors will be paid subject to a discount, which will vary in size depending on the nature of their claim. They'll get as much as 83% of what they were owed, as little as 66%.
The old stockholders will get nothing. The new company will raise its initial round of operating cash by selling new shares, which will trade on the NYSE under the symbol NWA.
This is as it should be. I don't mean that the re-emergence of the airline is a good thing. My view has long been that the airline industry desperately needs consolidation, and that the revolving-door bankruptcies are part of the problem, not part of the solution. If Northwest were actually liquidated, and its fleet melted down into scrap so that none of those planes would ever serve passengers again, the remaining airlines would face that much less competition, and the industry would be closer to a sustainable equilibrium.
This would mean higher costs to passengers -- but then, passengers aren't entitled to an endless future of below-cost pricing.
What is as it should be about the plan is that the old equity owners are zeroed out. THAT will be a disincentive for them to ever invest in an airline again, and the punishment meted upon them may serve the goal of consolidation, too.
More generally, the system of corporate law in most of the world these days, a system with Anglo-American roots, links the "residual risk" borne by equity holders to their dominance as decision makers. The board of directors of any company is supposed to represent the holders of equity, precisely because they represent the folks who have no contractual interest, who stand to lose everything if the operation fails.
There is an intuitive force to this connection of ideas and it is good to see the "loss" part of the profit-and-loss equation coming to fruition.
The airline said in a statement that it expects to re-emerge formally on May 31.
According to the plan, NW's secured creditors will be paid in full. Most unsecured creditors will be paid subject to a discount, which will vary in size depending on the nature of their claim. They'll get as much as 83% of what they were owed, as little as 66%.
The old stockholders will get nothing. The new company will raise its initial round of operating cash by selling new shares, which will trade on the NYSE under the symbol NWA.
This is as it should be. I don't mean that the re-emergence of the airline is a good thing. My view has long been that the airline industry desperately needs consolidation, and that the revolving-door bankruptcies are part of the problem, not part of the solution. If Northwest were actually liquidated, and its fleet melted down into scrap so that none of those planes would ever serve passengers again, the remaining airlines would face that much less competition, and the industry would be closer to a sustainable equilibrium.
This would mean higher costs to passengers -- but then, passengers aren't entitled to an endless future of below-cost pricing.
What is as it should be about the plan is that the old equity owners are zeroed out. THAT will be a disincentive for them to ever invest in an airline again, and the punishment meted upon them may serve the goal of consolidation, too.
More generally, the system of corporate law in most of the world these days, a system with Anglo-American roots, links the "residual risk" borne by equity holders to their dominance as decision makers. The board of directors of any company is supposed to represent the holders of equity, precisely because they represent the folks who have no contractual interest, who stand to lose everything if the operation fails.
There is an intuitive force to this connection of ideas and it is good to see the "loss" part of the profit-and-loss equation coming to fruition.
17 March 2007
The Forces of Secrecy Gather
My entry one week ago was entitled "A Cheer for Bloomberg News." I want to return to the subject I discussed there, because there's been a new development.
A bit about corporate bankruptcies, though, as filler here. Whether it takes the form of liquidation or re-organization, there is a well establish order of precedence.
Imagine a newly bankrupt corporation as a see-saw with a much heavier weight at one end than at the other. The lighter end, accordingly, is up in the air. The heavy end on the ground.
In terms of the right to receive a payoff, the most senior or best secured debt instruments have first dibs, and after that payments follow in legally defined sequence with the owners of equity sitting on the ground. At some point, moving down the lever/see-saw, the tangible assets of the estate run out. But, if we're assuming that there is some good will for the ongoing enterprise, there is still some value to be distributed. The instruments that represent that point are, accordingly, sometimes called the "fulcrum securities."
A lot of jockeying goes into determining the placement of the teeter-tooter. Some interests don't want their own securities to be too high on the lever. They'd rather get equity in the re-organized company, in the hope of course that it'll prove more valuable. On the other hand, if you have a high position on the lever, and jockey to lower it in search of the fulcrum, you might miscalculate, end up below the fulcrum, and get ... nothing.
It's a very high stakes game. Further, its a game with consequences for the rest of us, because the system is supposed to work in a way that lets a productive corporation re-emerge into the higgle-haggle of the market again ready to serve customers, treat employees fairly, and otherwise embody quaint ideas of productivity. Since the public interest is involved, the process is supposed to have some transparency. Anyone ready to look through the court records (which are available on line through the wonderful PACER system) can figure out who ismaking what motion, and what they have at stake in it.
All that said: in the ongoing Northwest Airlines bankruptcy proceedings, certain Wall Street speculators have tried to operate an "ad hoc committee" to jockey for position without disclosing anything -- or very little -- about their own stakes. They want such information to the "under seal," which means that it won't be on PACER, it won't be available in paper form to somebody asking at the court clerk's desk, and the other parties to the action who do see this information will be sworn to secrecy.
As I observed last week, Bloomberg News and its counsels, to their undying credit, are fighting the good fight here, trying to obtain and make public information about the Northwest Airlines proceedings.
Unfortunately, the forces of secrecy are gathering. Two industry groups that between them represent much of Wall Street have joined in assisting the speculators in their efforts to (a) persuade the bankruptcy judge to reconsider his pro-disclosure ruling, and (b) appeal over his head if they can't.
In a memo they said that such disclosure of "proprietary and highly confidential information" will quite probably "erect a substantial obstacle to the participation of many stakeholders—in particular, those sophisticated stakeholders that are most likely to have the means and the experience to make a positive contribution toward reorganization."
Get that? The speculators want to keep their secrets because keeping secrets helps them win. They should be allowed to keep their secrets because they are so "sophisticated" that they can help the court in its goal of re-organizing.
Um, sorry. No sale. This is sounding a lot like military procurement. The bankruptcy court is like a little Pentagon, the "sophisticated" speculators are like contractors selling it weapons, uniforms, vehicles, or whatever. The greater the transparency, the less the threat that the rest of the country is being ripped off by cronyism, double-dealing, and other earmarks of the sophisticates of every age since record-keeping began.
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_pauly&sid=alsJTc7wcqFA
Do you, dear reader, want to do something in the service of such transparecy? Okay. Write to judge Allan Gropper, of the U.S. Bankruptcy Court, Southern District of Manhattan. Tell him you approve of the stand he has taken, and he should stick with it, however many Wall Street purchased amicus briefs he receives the other way.
A bit about corporate bankruptcies, though, as filler here. Whether it takes the form of liquidation or re-organization, there is a well establish order of precedence.
Imagine a newly bankrupt corporation as a see-saw with a much heavier weight at one end than at the other. The lighter end, accordingly, is up in the air. The heavy end on the ground.
In terms of the right to receive a payoff, the most senior or best secured debt instruments have first dibs, and after that payments follow in legally defined sequence with the owners of equity sitting on the ground. At some point, moving down the lever/see-saw, the tangible assets of the estate run out. But, if we're assuming that there is some good will for the ongoing enterprise, there is still some value to be distributed. The instruments that represent that point are, accordingly, sometimes called the "fulcrum securities."
A lot of jockeying goes into determining the placement of the teeter-tooter. Some interests don't want their own securities to be too high on the lever. They'd rather get equity in the re-organized company, in the hope of course that it'll prove more valuable. On the other hand, if you have a high position on the lever, and jockey to lower it in search of the fulcrum, you might miscalculate, end up below the fulcrum, and get ... nothing.
It's a very high stakes game. Further, its a game with consequences for the rest of us, because the system is supposed to work in a way that lets a productive corporation re-emerge into the higgle-haggle of the market again ready to serve customers, treat employees fairly, and otherwise embody quaint ideas of productivity. Since the public interest is involved, the process is supposed to have some transparency. Anyone ready to look through the court records (which are available on line through the wonderful PACER system) can figure out who ismaking what motion, and what they have at stake in it.
All that said: in the ongoing Northwest Airlines bankruptcy proceedings, certain Wall Street speculators have tried to operate an "ad hoc committee" to jockey for position without disclosing anything -- or very little -- about their own stakes. They want such information to the "under seal," which means that it won't be on PACER, it won't be available in paper form to somebody asking at the court clerk's desk, and the other parties to the action who do see this information will be sworn to secrecy.
As I observed last week, Bloomberg News and its counsels, to their undying credit, are fighting the good fight here, trying to obtain and make public information about the Northwest Airlines proceedings.
Unfortunately, the forces of secrecy are gathering. Two industry groups that between them represent much of Wall Street have joined in assisting the speculators in their efforts to (a) persuade the bankruptcy judge to reconsider his pro-disclosure ruling, and (b) appeal over his head if they can't.
In a memo they said that such disclosure of "proprietary and highly confidential information" will quite probably "erect a substantial obstacle to the participation of many stakeholders—in particular, those sophisticated stakeholders that are most likely to have the means and the experience to make a positive contribution toward reorganization."
Get that? The speculators want to keep their secrets because keeping secrets helps them win. They should be allowed to keep their secrets because they are so "sophisticated" that they can help the court in its goal of re-organizing.
Um, sorry. No sale. This is sounding a lot like military procurement. The bankruptcy court is like a little Pentagon, the "sophisticated" speculators are like contractors selling it weapons, uniforms, vehicles, or whatever. The greater the transparency, the less the threat that the rest of the country is being ripped off by cronyism, double-dealing, and other earmarks of the sophisticates of every age since record-keeping began.
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_pauly&sid=alsJTc7wcqFA
Do you, dear reader, want to do something in the service of such transparecy? Okay. Write to judge Allan Gropper, of the U.S. Bankruptcy Court, Southern District of Manhattan. Tell him you approve of the stand he has taken, and he should stick with it, however many Wall Street purchased amicus briefs he receives the other way.
10 March 2007
A Cheer for Bloomberg News
Does information really "want to be free"? Of course not. A piece of information isn't a wanting or doing sort of creature.
Anthropomorphism aside, is there some natural tendency in the world, now that the world has an internet (and wireless access yet!) toward the ever-wider spread of what had been secret?
There is a historical tendency here, but it isn't inherent in technology. The tendency is one that Adam Smith would have understood quite well. If there is a demand for information (a demand in the market sense, a demand that will express itself in the payment of money), then someone will seek to supply it. The greater that demand, supply being constant, the greater the price. If we also assume constant costs, then the increase in price will make for a greater profit.
As you can see, there are a lot of assumptions involved in that reasoning. Still, private and corporate espionage both long predated the internet. What information "wants" is to be bought and sold. Free in the sense of "liberated," not "free" in the sense of "gifted."
But then there are the structures of power. And they haven't changed all that much of late. I doubt I'll get into any conspiracy theorists' hall of fame if I make the general observation that governments like to keep secrets, and they like to enable their private sector cronies to keep secrets as well. These are the would-be prisons whence information has to be liberated in order to be (freely) bought and sold.
These thoughts didn't drop down into my head out of the blue. They've come to me now because of the ongoing Northwest Airlines bankruptcy proceedings. Bloomberg News and its counsels, to their undying credit, are fighting the good fight here, trying to obtain and make public information about who owns what claims against the company in the context of that reorganization.
The issue is whether certain Wall Street speculators can use court orders -- and, thus, governmental power -- to keep certain secrets "under seal" that have a good deal of relevance to Main Street USA -- to the future of an important company within a very high-visibility and troubled industry. A ruling Friday went the way Bloomberg News wanted. It now appears that the speculators will have to disclose.
We should mark this as a small victory for the liberation of data. Information doesn't want anything, but those of us who are wanting beings should want this sort of information to be available.
Anthropomorphism aside, is there some natural tendency in the world, now that the world has an internet (and wireless access yet!) toward the ever-wider spread of what had been secret?
There is a historical tendency here, but it isn't inherent in technology. The tendency is one that Adam Smith would have understood quite well. If there is a demand for information (a demand in the market sense, a demand that will express itself in the payment of money), then someone will seek to supply it. The greater that demand, supply being constant, the greater the price. If we also assume constant costs, then the increase in price will make for a greater profit.
As you can see, there are a lot of assumptions involved in that reasoning. Still, private and corporate espionage both long predated the internet. What information "wants" is to be bought and sold. Free in the sense of "liberated," not "free" in the sense of "gifted."
But then there are the structures of power. And they haven't changed all that much of late. I doubt I'll get into any conspiracy theorists' hall of fame if I make the general observation that governments like to keep secrets, and they like to enable their private sector cronies to keep secrets as well. These are the would-be prisons whence information has to be liberated in order to be (freely) bought and sold.
These thoughts didn't drop down into my head out of the blue. They've come to me now because of the ongoing Northwest Airlines bankruptcy proceedings. Bloomberg News and its counsels, to their undying credit, are fighting the good fight here, trying to obtain and make public information about who owns what claims against the company in the context of that reorganization.
The issue is whether certain Wall Street speculators can use court orders -- and, thus, governmental power -- to keep certain secrets "under seal" that have a good deal of relevance to Main Street USA -- to the future of an important company within a very high-visibility and troubled industry. A ruling Friday went the way Bloomberg News wanted. It now appears that the speculators will have to disclose.
We should mark this as a small victory for the liberation of data. Information doesn't want anything, but those of us who are wanting beings should want this sort of information to be available.
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