Part Three Begins

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.

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.

Transparency

I encountered recently a quotation attributed to J.P. Morgan: the elder of the father-son financiers with that illustrious name. One has to give him credit for a neat turn of phrase here:

"The time is coming when all business will have to be conducted with glass pockets."

Morgan apparently said this in a spirit of weariness or frustration. The whole idea of public scrutiny of what he was doing was repugnant to him, but he was practical enough to make some adjustments in that direction, and to prophecy that his heirs would have to go further.

The idea of business transparency has made some headway in the ninety-six years since the elder Morgan died. But then, by the standards of most earthly projects, that's a long time. Morgan barely lived long enough to see the inauguration of Woodrow Wilson.

These thoughts come to my mind this morning because the world is moving closer toward one prerequisite of transparency -- a single global system of accounting standards. The fact that different countries and regions have long had different standards can itself make balance sheets and income statements confusing or (in terms of our guiding metaphor here) opaque.

http://www.financialweek.com/apps/pbcs.dll/article?AID=/20071119/REG/711190318/1016/ECONOMY