Sunday, October 16, 2011
National Conference of Bankruptcy Judges--10/15/11--Mythbusters--Westbrook and Porter Share the Latest Empirical Research
Prof. Jay Westbrook and Prof. Katie Porter presented a delightful tour de force of empirical research titled Mythbusters. They compared ten statements of conventional wisdom to the results of empirical research. As Jay said, “There are all kinds of things that everyone thinks are true but we don’t know whether they are really true.” (For this post, I will refer to the speakers as Jay and Katie since these two professors go out of their way to be accessible so that it just seems appropriate).
1. BAPCPA permanently crippled consumer bankruptcy.
The answer is not necessarily. Filings today are very similar to what was seen before BAPCPA. Today’s filing levels of 1.5 million cases per year are about equal to filings during 2001-2004. The income profiles today are similar with chapter 7 debtors averaging $24,000 per year and chapter 13 debtors averaging $34-35,000. The only thing that can’t be measured is what filings would have been like if BAPCPA had not been passed. Given the weak economy, filings might have been much higher without the legislation.
2. For big business, reorganization in Chapter 11 really just means a 363 sale.
While 363 sales are more common in large cases, they are not the norm. Cases with above $50 million in assets resulted in 363 sales in less than 33% of the cases while in chapter 11 cases of all sizes only 10-15% resulted in 363 sales.
3.Young people are more likely to file bankruptcy because of a decline in stigma.
Research shows two things: survey respondents report mortifyingly high rates of stigma and bankruptcy is increasing among the elderly and declining among the young. A study in 2001 showed that 84.3% of persons filing bankruptcy said they would be embarrassed or very embarrassed if their families or friends found out. Another survey showed that bankruptcy was more traumatic than the death of a friend or separation from a spouse.
Another study showed that people are waiting longer before they file bankruptcy. In 1981, people filed bankruptcy when their debt to income ratio was 1.41 while in 2001 that number had more than doubled to 3,04. Of persons surveyed, most had been struggling with debt for more than two years before filing.
Bankruptcy filings for those aged 75-84 increased by 433.3% from 1999-2007 and rates for those aged 65-74 increased 125%. Meanwhile the overall rate of filing decreased 29.2% and the filing rate for those aged 18-24 fell by 64.1%. The unfortunate fact is that bankruptcy is becoming a reality for the Greatest Generation.
4. There is nothing important in business bankruptcy between Mom & Pop and WorldCom.
Among some academics, there are two categories of chapter 11 cases, important (more than $100mm) and not important (everyone else). In the real world, 60% of chapter 11 cases fall into the range of $100,000 - $5 million in assets, while only 6% had $100 million in assets or more. Additionally, 20% of all chapter 11 cases were filed by individuals. The professors opined that this shows the difficulty of trying to construct a one size fits all chapter 11 model.
5. Small businesses linger endlessly in chapter 11.
A study done prior to BAPCPA showed that 50% of small business cases that ultimately failed were dismissed or converted within six months while 50% of successful cases took 15 months to confirm. The professors noted that small business cases take just as long to confirm as big business cases, although small business cases were dismissed or converted much faster than their larger counterparts (107 days faster in 2002).
According to Jay, if the 2005 time limits had been in effect in 2002, 80% of the successful small business cases might have failed. He added that the effect of the 2005 small business amendments may have been to “maim cases that could have succeeded.”
6. The bankruptcy experience is race neutral.
While the Bankruptcy Code is race neutral on its face, the “Ideal Debtor” for chapter 7 is one who holds retirement accounts, has high but reasonable expenses, financially supports only legal dependents and has little or no child support of student loan obligations. This is more likely to describe a white debtor than a minority debtor.
The most accurate predictor of whether someone will file chapter 13 is whether they are African American. African Americans file for chapter 13 at twice the rate of other debtors.
In 2007, Hispanics were likely to pay 25% more in attorney’s fees than white or African American debtors.
The professors were quick to say that they can’t say why this is happening, only that this is what the numbers show.
7. Forum shopping is all about getting to Delaware or New York.
It turns out that forum shopping happens in other parts of the country as well. Of 409 large cases filed outside of Delaware and New York since 1980, 27% were forum shopped
According to Katie, large cases should file in Jay and Kate’s districts because they would have easy access to academics and cheap beer. Jay noted that Austin had live music as well.
8. Bankruptcy works for pro se filers.
Chapter 7 works reasonably well for pro se filers, while chapter 13 is a complete disaster. Among pro se chapter 7 debtors, 17.6% of debtors had their cases dismissed for technical reasons compared to 1.9% of those with counsel.
Among pro se chapter 13 debtors filing since 2006, only 4% had their cases pending or discharged at the four year mark compared to 45% of those represented by counsel. 90% of pro se chapter 13 cases are dismissed prior to confirmation compared to just 15% of those represented by counsel.
According to Katie, pro se debtors are playing Las Vegas odds in chapter 13 and might do better taking their filing fee to Las Vegas. She said we have “constructed a complex machine that most of the time may require a lawyer.”
9. Many of the chapter 13 cases that do not complete plans are actually successes.
When Warren, Westbrook and Sullivan released their study that only 33% of chapter 13 cases result in discharge, they were treated as heretics. Now this success rate is conventional wisdom, but a new narrative has arisen that failed chapter 13 cases may actually be successes. The data says no.
While the debtor remained in bankruptcy, chapter 13 avoided foreclosure for 81% of debtors while 70% faced loss of their home within 2-3 months after dismissal.
Once their cases were dismissed, 57.5% of debtors reported that their situation was the same or worse than when they filed. 60% of debtors very much disagreed with the statement that they exited bankruptcy because they had accomplished their goals or found another solution compared to 20% who agreed or agreed very much with the statement.
In a chilling statistic, 33% of debtors whose chapter 13 cases were dismissed reported that they struggle to pay for food.
10. Lenders maximize recoveries in each case.
Sarah Pei Woo conducted a study of chapter 11 bankruptcies of residential real estate developers during the recession. Tragically, she passed away after a brief illness after her study was completed.
She found that banks acted not to maximize recovery but to increase short-term liquidity and accede to regulatory pressure. The question was not how much they would recover but when.
Among residential real estate developers, 81.7% were liquidated, 11.1% were sold in 363 sales and just 4.6% reorganized. Secured lenders filed a motion for relief from stay in 72.5% of the cases. Banks who were in financial distress were 24.9% to 28.6% more likely to seek relief from the automatic stay.
Dr. Thomas Hoenig was the Friday luncheon speaker. He served for twenty-five years as President and CEO of the Federal Reserve Bank of Kansas City. He said that he “wanted to get you on board that Too Big to Fail is bad policy.” He warned that the crisis brought about by Too Big to Fail in 2008 was likely to recur. He said that “unless you acknowledge the problems that brought about the crisis, it would happen again. He identified some of the factors as distorted incentives, not allowing the market to function and subsidizing favored groups.
Dr. Hoenig identified three pieces of legislation as creating the climate for Too Big to Fail. The Glass-Steagall Act extended protections to commercial banks in the form of deposit insurance in return for separating out their risk-based activities. He described Glass-Steagall as “a covenant between government and the private sector” to “extend protection around you because of your role in society.” He said that “in return for special protection, we will limit (the activities of commercial banks) to payment systems and financial intermediation systems because these are the purposes we want to protect.” He said that if commercial banks wanted to engage in risk-based activities, they would have to do so with their own capital in a separately chartered entity. He said that Glass-Steagall was the system in place until the 1980s and “worked reasonably well.”
According to Hoenig, “with stability comes its own sources of weaknesses.” The demand to take down the wall between commercial banking and other activities led to the Gramm-Leach-Bliley Act of 1979. The effect of GLB was to allow banks to invest in risk with a federal backstop. The risk of this was predicted by Adam Smith who noted that merchants would seek to widen the market and narrow their competition. While widening the market is desirable, narrowing competition is not. GLB narrowed competition by allowing some players an artificial subsidy. By eliminating Glass-Steagall, the market share of the largest banks was increased from 14% in 1979 to 60% in 2007. “Thus was born too big to fail.”
The Dodd-Frank legislation was supposed to fix Too Big to Fail. He said, “I am concerned that it won’t” because “the incentives haven’t changed.” The largest institutions are now 20-30% bigger and the cost of capital is being kept artificially low. Under Dodd-Frank, if a TBTF institution finds itself on the ropes, the regulators must make a decision about whether the institution is solvent but illiquid or insolvent. This decision must be made on a Friday afternoon and must be approved by the Secretary of the Treasury and the Chairman of the Federal Reserve with possible involvement by the courts. He asked, “Who can take an institution of $2.2 trillion into receivership over the weekend?” As a result, he predicted that regulators would be inclined to find that the entity was solvent but illiquid and inject federal dollars to keep it afloat. As a result, he said, “the market doesn’t function” and “there is no cleansing of the market.”
Dr. Hoenig said that anything this large cannot be allowed to fail. As a result, the incentives must be changed. He noted that in the current system, profits are privatized and losses are socialized. He recommended that investment banking, trading and other risk-based activities be moved into separate entities with private capital. He also called for making the competitive market more fair. He said that regional banks cannot compete with the twenty largest entities because they are not subsidized.
Dr. Hoenig said that he disagreed with those who said that current capital requirements for commercial banks are too stiff. He disagreed, noting that before there was a federal safety net, financial institutions maintained capital of 15-20% compared to the current 7%. He said that (15-20% capital) is “what the market called for.”
He also disagreed with those who said that such measures would place U.S. financial institutions at a competitive disadvantage compared to institutions in other parts of the world. Dr. Hoenig said that foreign banks were not a good model to follow. He said “look at their banks.” He said, we are “not in a competitive process to excellence, but a competitive process to the bottom.”
He also warned that the country was too leveraged. He said that consumer debt as a percentage of GDP had grown from 80-90% to a high of 125% before dropping to the current level of 114%. At the same time the savings rate fell from 8% to 0% although it has risen back to 5%.
Dr. Hoenig described the federal government as being in crisis. He said that government debt had increased from 40% of GDP in 1990 to 100%. Currently interest rates average 2.5%. He asked what if market interest rates began to apply? He said that monetary policy has been captured by Too Big to Fail.
(I apologize in advance if I incorrectly transcribed any of Dr. Hoenig’s statistics or their units of measurement. I was taking notes as quickly as I could but possibly not quickly enough. Any statements that do not make sense are the result of my reporting rather than the content of the speaker).
Rajeev Date had the unenviable job of filling a speaking slot originally assigned to Elizabeth Warren to discuss the creation of the Consumer Financial Protection Bureau. He is currently the Special Advisor to the Secretary of the Treasury on the Consumer Protection Bureau. Prior to that, he worked for over a decade in the financial services industry, including stints at Capital One Financial and Deutsche Bank.
Mr. Date described the similarities between his job and that of bankruptcy lawyers pointing out that both deal with people getting wiped out because of something financial and both seek to help consumers.
The Consumer Financial Protection Bureau was a signature part of the Dodd-Frank legislation. He stated that its goal was making consumer financial markets work. Before Dodd-Frank, consumer protection functions were assigned to seven agencies which had other responsibilities as well.
He sketched out some recent history to show the need for the Bureau. He said that consumer debt exploded during the years before the financial crisis. He said that it “covered everything, big ticket, small ticket, secured unsecured. Everything grew and everything grew fast.” From 1999-2007, household debt nearly tripled. He cited college kids with credit cards, home mortgages with teaser rates and people exhausting their savings on high cost debt as emblematic of the period. Mr. Date said that consumers were signing up for “things they didn’t understand.”
Mr. Date noted that the mortgage industry was at the epicenter of the financial crisis. While lenders usually have incentives to ensure borrowers can pay them back, the mortgage industry was different. Because the brokers and banks that originated loans were compensated up front, risk and reward were delinked.
He also said that there was a breakdown in the market. Because originators could shop for the most favorable legal regime, they did so.
Additionally, there were problems with transparency. He defined transparency as both parties understanding the terms of the deal and talking about the same deal. Mr. Date said that transparency was absent during the years leading up to the financial crisis. The fastest growing products were things that were hard to understand. In order to gauge the risk involved in some financial products, it was necessary to have extensive knowledge of how the rate caps worked and interest rate history. He said that “problems of transparency continue today. Borrowers deserve to know what they are signing up for.”
Mr. Date was enthusiastic about the prospect of starting a new agency from the ground up. He quoted Steve Jobs for the proposition that “the only way to great work is to love what you do.” He described his challenge as creating new perspectives, creating a new structure and recruiting new talent.
Although the CFPB is only a few months old and lacks an Executive Director, it has grown to 690 employees, has begun taking consumer complaints, started education programs and has released examination guidelines. Notwithstanding the lack of an Executive Director, the authority to carry out the Bureau’s powers has transferred to the Secretary of the Treasury.
He pointed out that from 2001-2007, the volume of unusual mortgages exploded dramatically. He described one of the worst products offered as a mortgage with a one month teaser rate. He said that while the Bureau is working to clean up new originations, there are already $10 trillion in mortgages out there.
Mr. Date answered several questions related to mortgage servicing. He said that when he was in the financial services business, he would walk the floors of collection operations for automobile lenders and credit card lenders to evaluate whether to purchase the business. He said that they understood that there were some people who wouldn’t pay and planned for it.
On the other hand, income in the mortgage servicing industry is largely fixed regardless of whether the loan performs or does not. When a loan is performing, the cost to service the loan is less than the fees paid. However, when a loan is not performing, the servicer’s costs exceed their revenue. As a result, “the incentives don’t line up” for mortgage servicers to work with borrowers in default.
He also pointed out a disparity in that mortgage servicers can “fire” their borrowers by selling the portfolio to a new servicer, while borrower cannot fire their servicer.
The CFPB has released its manual for mortgage servicer examinations. Mr. Date said that in the past, examinations of mortgage servicers were neglected because these operations did not affect the “safety and soundness” of the financial institution. He said that the servicing manual does two things: it sets standards for consistency and lets servicers know what to expect.
Three different judges asked questions relating to home mortgage modifications. One judge spoke about debtors who submitted everything they were asked to and didn’t hear back for months only to be told their information had been lost. Another judge asked, “What do I do? What do I tell them?”
Mr. Date pointed out that mortgage brokers were good at holding consumers’ hands during the application process. However, no one is holding their hand in the modification process. He pointed out that the CFPB will put consumers in touch with HUD-approved housing counselors. This information is available at consumerfinance.gov.
He also said that enforcement was a tool available to the Bureau. He said that the Bureau would choose the right areas for investigation and bring cases when we need to. He said, “There are bad guys. If you don’t know who they are, you may be one yourself.”
National Conference of Bankruptcy Judges--10/14/11--Does the Bankruptcy World Need Another Talk on Stern v. Marshall?
Prof. Ralph Brubaker and Prof. Ken Klee spoke on “Not Again! Will Bankruptcy Courts Survive the Supreme Court’s Second Look At Stern v. Marshall?” However, their panel could have been titled, “Does the Bankruptcy World Need Yet Another Talk on Stern v. Marshall?” Fortunately the answer was yes.
The History of Summary/Plenary
Prof. Brubaker discussed the history of bankruptcy adjudication going back “before the beginning” to English bankruptcy practice. He said that the summary/plenary distinction began with English bankruptcy commissioners. Commissioners operating under the supervision of the Lord Chancellor could administer bankruptcy estates and make certain determinations of law and fact, such as adjudicating claims. Their power was by the concept of in rem so that they could decide any question regarding property in the possession of the assignee, who was the equivalent of a trustee. If the assignee had to sue someone to recover property, that proceeding had to be brought in the appropriate superior court.
In the Bankruptcy Act of 1800, Congress expressly allowed non-Article III bankruptcy commissioners to adjudicate all summary proceedings in a manner similar to English practice. This principle became even more firmly in place in the Bankruptcy Act of 1898. The jurisdictional statute expressly stated that there was no plenary jurisdiction except for some matters such as preferences and fraudulent conveyances. The 1898 Act introduced non-Article III officers similar to commissioners designated as Bankruptcy Referees. The full extent of the referee’s authority was not defined with perfect clarity resulting in multiple Supreme Court decisions. The Supreme Court invoked the summary/plenary distinction finding that plenary matters had to be brought before an Article III judge, while bankruptcy referees could determine summary matters and their decisions would be given the same effect as one from an Article III judge.
When Congress reformed the bankruptcy laws in 1978, it expanded the scope of bankruptcy jurisdiction. Jurisdiction was now extended to any proceeding related to the Bankruptcy case. All of that very broad jurisdiction was to be exercised by non-Article III bankruptcy judges subject to appellate review. The Marathon decision struck down the 1978 jurisdictional scheme as unconstitutional. However, the Court in Marathon never said where the constitutional line was. Indeed, there was not even a majority opinion in the case. Nevertheless, he said that “the most obvious explanation for why the court found the Code unconstitutional was that the Marathon case would have been a plenary suit which should have been tried in an Article III court.
Congress reacted to Marathon by enacting the core/non-core distinction which Prof. Brubaker equated to a codification of the summary/plenary distinction. He noted that in Granfinanciera, Justice Brennan, who authored the Marathon plurality, equated the Seventh Amendment right to trial by jury with plenary suits under the Bankruptcy Act of 1898 that could only be tried in an Article III court. He said that Congress could not take away the right to jury trial by classifying a matter as a core proceeding. Prof. Brubaker described this as constitutionalizing the summary/plenary distinction. He noted that in Stern v. Marshall, Chief Justice Roberts relied heavily on Seventh Amendment decisions to establish the right to decision by an Article III judge.
Prof. Klee said that Stern v. Marshall was not a politically decided case. Rather, it was about fundamental power, whether non-Article III courts should be limited or whether their authority should be based on pragmatism.
Prof. Klee had two good lines that don’t otherwise fit with this post. He said “Vicki was well endowed in her own right but not financially.” He also said that as a result of Pierce Marshall’s attorneys decision to file a proof of claim “history was made.”
Power vs. Jurisdiction
Prof. Klee was quick to point out that Stern v. Marshall was not about jurisdiction. Jurisdiction was vested in the district court. The Bankruptcy Judge can decide matters if they are delegated by the District Court and that delegation is constitutional. As a result, the case was not about jurisdiction, but who could exercise that jurisdiction. He said this distinction was important to the question of whether parties could consent to decision by a Bankruptcy Judge. “If it’s just lack of power, you can consent. If it is lack of subject matter jurisdiction, you can’t consent.”
Chief Justice Roberts placed a lot of emphasis on the early case of Murray’s Lessee which held that if an action could have been decided by the English courts of law, equity or admiralty, they could not be assigned to non-Article III tribunals in the absence of a public rights exception.
According to Prof. Klee, the public rights exception in bankruptcy is probably limited to cases in which the United States is a party. (Although not pointed out by the speakers, the Chrysler and GM cases would be good examples of the public rights exception). However, he made the interesting comment that Justice Scalia’s concurrence showed that in his heart, he does not want to overturn the bankruptcy system because it is a long-established system. This was similar to his ruling in the BFP case in which he relied on the long-established practice of state foreclosure laws. Thus, for Justice Scalia, historical practice is a way to get to authority. Prof. Klee recommended perusing Blackstone’s Commentaries to look for historical practice.
Claims and Consent
Under Stern, Bankruptcy Courts can still decide proofs of claim. Filing a claim establishes a claim to the bankruptcy res and constitutes consent to adjudication of the claim itself. However, filing of a proof of claim does not constitute consent to anything beyond that. In Stern, Pierce Marshall’s filing of a proof of claim was not consent to determination of Vicki’s counterclaim. As the Supreme Court pointed out, Pierce really had no choice about filing a proof of claim, so he did not consent to anything beyond determination of the claim.
Prof. Brubaker said that filing a claim is only consent to determining the claim because that is a natural consequence of filing a claim.
Prof. Klee argued that “The current court is re-writing history. Under the Act, we had jurisdiction by ambush.” In Gardener v. New Jersey, the court held that the state’s filing of a proof of claim waived sovereign immunity. The Court also held that filing a proof of claim waived the Seventh Amendment right to jury trial. Prof Brubaker rejected the notion of jurisdiction by ambush as consent. “Jurisdiction by ambush means they are not consenting to anything.”
Prof. Brubaker would analyze Stern v. Marshall as a case on supplemental jurisdiction. “The Stern majority never acknowledged supplemental jurisdiction, but signed on to it.” However, he said that the nexus for supplemental jurisdiction is “tightly circumscribed.” He said it is only available to the extent necessary to dispose of independent matters already before the court.
Things That Can Be Done or Not
Prof. Klee said that there are still many things Bankruptcy Judges can do. They can employ counsel, approve compensation (which drew applause from the audience) and administer the estate. However, he noted that according to Blackstone, English commissioners could not enter the discharge. They could certify the discharge to the Chancellor but could not enter it. He added, “If bankruptcy judges cannot enter discharges, we are in a new world.”
The professors had a vigorous discussion on whether bankruptcy judges could enter money judgments in nondischargeability cases. Prof. Klee thought it was permissible so long as the debtor was the defendant. On the other hand, Prof. Brubaker said that “historically courts have considered nondischargeability as a separate claim.” Prof. Klee responded that the debtor was res to which Prof. Bubaker said “nah.”
They also discussed whether Bankruptcy Courts could follow the report and recommendation procedure in core proceedings where the Bankruptcy Court lacked constitutional power to enter a final judgment. Prof. Klee pointed out that there were now three categories of cases: core proceedings where the Bankruptcy Court can constitutionally enter a final judgment, noncore proceedings in which the Bankruptcy Court may submit proposed findings of fact and conclusions of law and core proceedings in which the Bankruptcy Court lacks power to enter a final judgment. Prof. Brubaker said that if Congress had authorized courts to enter a final judgment, it implicitly had authorized them to take the lesser action of submitting proposed findings and conclusions. Prof. Klee, while initially taking the position that submitting proposed findings and conclusions was not authorized noted that the best retort to his own position was Stern v. Marshall in which the Supreme Court “didn’t bat an eye” when the District Court treated the Bankruptcy Court’s ruling as proposed findings and conclusions.
So What Are We Left With?
My question after listening to this discussion is whether the Bankruptcy Court has any broader power now than it did under the Bankruptcy Act of 1898 or than was possessed by English bankruptcy commissioners. I am more sanguine than the professors. I think that will be too difficult to turn back the clock on thirty years of expansive power exercised by Bankruptcy Judges. To the extent that historical practice or specialized expertise are grounds for vesting power in a non-Article III tribunal, there is a case for vesting more power in the Bankruptcy Courts than they enjoyed prior to 1979. Bankruptcy Courts have developed specialized expertise in dealing with the consequences of financial failure. They have developed into our national courts of commerce. While most historians would scoff at thirty years as a mere blip in time, it is significant enough that it will be difficult to roll back the clock.
The Long and Short of It: Financial Engineering Meets Chapter 11 was one of the more esoteric presentations at the conference with an unusual lineup of panelists. The group included New York Bankruptcy Judge James Peck, investment banker David Barse, Professor Edward Janger, Dr. Riz Mokal from the World Bank and Edward Murray, an English solicitor. They discussed the effect of safe harbors granted to certain financial contracts under sections to 555 to 562 of the Code. These sections were extensively re-written by BAPCPA.
Certain financial contracts, such as swaps and repos are granted safe harbors under the Bankruptcy Code. These contracts can be liquidated, terminated or accelerated notwithstanding the Bankruptcy Code. They are also exempt from recovery under preference and fraudulent transfer theories. According to the panelists, this was done to protect the interest of sophisticated parties and avoid the risk of financial contagion. The rationale was that if one party went down, that the transaction could not be unwound and pull down the counter-party. Additionally, the ability to do close-out netting under a contract allows parties to reduce their risk.
One problem with these provisions is that, even with the extensive re-writing of definitions in 2005, the definitions are still imperfectly drawn. Section 555 applies to securities contracts and was intended to protected intermediaries. However, as written, it could apply to a transaction with Bernie Madoff’s Ponzi scheme.
Prof. Janger suggested that these provisions may have “done exactly the opposite of what they were supposed to do” in the 2008 financial crisis. He said that when a Bear Stearns or a Lehmann Brothers files bankruptcy, their hands are tied and they can’t reorganize. The drafters did not anticipate that large entities would be filing bankruptcy.
The panel debated whether the immunities granted to financial contracts increase the risk of transactions. Dr. Mokal noted that the provisions were put in the Code in 2005 and the financial crisis followed three years later.
Ed Murray described the immunities as a “safety net” and said that they did not eliminate incentives to monitor credit risk. He said that parties want to make good transactions and noted that “credit officers are a pain” regardless of the immunities.
David Barse was much more direct. He said, “If we don’t get comfort, we don’t participate. If secondary parties don’t participate, then primary can’t participate.” He described the protections as providing a “comfort zone” and said that “providing great clarity is very important.” He added that “the practical answer is that two parties to a contract should be allowed to play it out and shouldn’t be regulated.”
Dr. Mokal stated that the safe harbors are an important part of a sophisticated insolvency system. He said that in other countries, there are not sophisticated bankruptcy regimes and that there is “no certainty about the court’s ability to understand or apply sophisticated rules or statutes.” He said that this was “unlike in this country where courts understand exactly what Congress intended,” a comment which drew chuckles from the audience.
The panel also discussed how financial contracts could be used to commit mischief in the bankruptcy system. Prof. Janger discussed the problems of empty voting and the empty creditor where there is a separation of the economic interest from the ownership interest and separation of the economic interest from governance rightst in bankruptcy and workout situations. He said that creditors can go short and bet against a company’s reorganization and then cause trouble. He analogized the problem to a secured creditor voting its deficiency claim to sink the reorganization and acquire the asset. He said that the tools available to bankruptcy judges to combat this problem included disclosure under Rule 2019, designating ballots and subordination.
Mr. Barse said that this was a big problem. He said that creditors using ever more sophisticated tools can drive decisions on corporate governance. He said that while his firm doesn’t use these tools to drive corporate governance that they could be used by corporate raiders. He also added that “Derivatives are tools of destruction. We don’t really know what they do.”
Saturday, October 15, 2011
Thursday’s lunchtime speaker was Gregory L. Miller, Chief Economist for SunTrust Banks, Inc. His presentation was not too gloomy but a bit disturbing. He began Saturday Night Live style saying, “I’m the economist and you’re not.”
Miller predicted that “there is not going to be a double dip recession.” He said that his “subjective prospect that the economy will fall into recession is not significant.” He estimated the prospect of recession at 25% which he said was not great because at any given time, there is a 15% prospect of recession.
On the other hand, Mr. Miller said that the rest of the world has a 60% chance of recession, noting that at least three countries in the Euro Zone were already in recession and that others were at risk.” Nevertheless, he said that, “whether or not the rest of the world goes into recession, we will not.” Mr. Miller suggested that a global recession could even help the United States, since it would make foreign goods less expensive. He said this would be good for lovers of French wine. He noted that despite the weak economy elsewhere in the world U.S. exports were still increasing.
Miller noted that the private sector in the United States was “fine under the circumstances” but that the “public sector is not pulling its weight at a time when it should be doing it.” He added that “Pulling the economy deeper when it’s already in the soup is not a government function but that’s what it’s doing.” Miller said that the private sector was growing at a rate of 3.6% while the overall economy was growing at a rate of 2.8% indicating that the public sector was a net drain of 0.8% on the economy.
Mr. Miller said that in the U.S. economy, the housing, government and credit sectors were weak. He said that the housing sector was at the bottom but that condos were “a virtual black hole.” He said that housing and credit are usually leading sectors, but that the rules are different now and the standards are higher. He said that two trillion dollars has been dumped into bank balance sheets where it is stuck in capital accounts of regulated banks who aren’t sure what their capital requirements are. He said that banks were reluctant to put loans on the books when they don’t know whether they will pass audit.
With regard to the labor market, he pointed out that the Obama administration’s current jobs bill consists largely of former Republican proposals. However, “the opposition is obliged to hate the dominant party’s policy even if it is the right thing.”
Mr. Miller noted that the current $450 billion proposal would have more effect than the previous $800 billion stimulus bill because it funneled money to the private sector where the multiplier is higher rather than the prior stimulus which went through state and local governments.
However, he said, “It’s not the jobs. Nine percent unemployment is not what’s wrong with the economy.” He said that the natural unemployment rate is 6% and that when we had 4% unemployment, there was too much employment in the economy. He said that 30% of the newly unemployed came from the construction and mortgage finance sectors. He said there is a mismatch between those who want jobs and those who are looking to employ. He said that two-thirds of the unemployed would likely remain unemployed and “we don’t want them employed.”
Miller said that interest rates will remain painfully low until at least the middle of 2012. Nevertheless, banks are finding it more profitable to park their cash at the Fed where they can earn 0.25% interest. He pointed out that reserves have increased from $500 billion to $3 trillion. He said that to get banks lending, the Fed would need to lower the rate it pays to zero or even charge banks to keep their cash parked at the Fed.
He said that the Euro sovereign debt crisis was a crisis of banking and culture, not an economic crisis. He said that U.S. banks held only 0.10% of their assets in European sovereign debt and that this was concentrated in banks that could afford to absorb the loss.
In summary, the U.S. economy is not going into recession, the prospect for the rest of the world looks bleak, unemployment is not going back to where it once was, banks are not lending and the U.S. government is dysfunctional. That’s about as rosy of a view as you can get from an economist.