Category: Bankruptcy


The Biggest Fraudulent Conveyance Lawsuit Ever

New York Attorney General Andrew Cuomo has been making headlines because he has strong-armed AIG into trying to recover “outrageous” bonuses and other perks while its financial condition was not so great.

Cuomo’s leverage (so to speak) arises from, among other things, laws forbidding fraudulent conveyances and similar transactions. Fraudulent conveyance law is a complex, if vital, corner of debtor-creditor law. It essentially says that a company cannot convey property for less than “reasonably equivalent value” if it is “insolvent,” undercapitalized, or the like. If you’re in financial trouble, the saying goes, “you must be just before you are generous.”

Among other things, this means that if a company like AIG was paying bonuses (or redeeming stock) while it was in fact in distress, those who received AIG’s cash—like Joe Cassano, who was paid millions for running AIG’s brilliant credit default swap shop–should have to pay it back unless they gave AIG “reasonably equivalent value.” Gifts are axiomatically not supported by any (much less reasonably equivalent) value.

But if AIG is Cuomo’s only target, he’s thinking WAY TOO SMALL. Today’s New York Times reports the following “grim milestone: All of the combined profits that major banks earned in recent years have vanished:”

In the case of the nine-largest commercial banks — Citigroup, Merrill Lynch, Bank of America, Morgan Stanley, JPMorgan Chase, Goldman Sachs, Wells Fargo, Washington Mutual and Wachovia — profits from early 2004 until the middle of 2007 were a combined $305 billion. But since July 2007, those banks have marked down their valuations on loans and other assets by just over that amount


Read More


Maverick-Backed Securities

In last night’s debate, John McCain proposed that Treasury purchase defaulted mortgages, thereby providing relief to distressed homeowners.

“As president of the United States,” Mr. McCain said, “I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished value of those homes and let people make those, be able to make those payments and stay in their homes. Is it expensive? Yes.”

How? He didn’t say. But he’d have to overcome a mountain of contractual and legal obstacles in the “toxic” securities (bonds) that these defaulted mortgages were supposed to back (pay for).

Georgetown Law Professor Adam Levitin has done a good job of explaining why simply purchasing the bonds themselves will provide little relief to homeowners: Unless the government purchases a controlling amount and number of bonds–meaning lots of bonds–it will lack the voting power, among other things, to cause any changes to the underlying mortgages.

Read More


The Craziest Claims Yet about the Credit Crisis

The credit crisis has provided ample opportunities for foolishness. Certainly California Republican Darrell Issa’s claim that the House bill would have been a “coffin on top of Reagan’s coffin” was an oddly necrophilic bunkmate to President Bush’s penetrating insight that “this sucker’s going down.”

But the prize for crazy claims about the credit crisis must go to former Dallas Fed President Bob McTeer, whose Monday post on the New York Times’ Economix blog claims that: (i) Wall Street banks were the real victims of the crisis; (ii) the real villains were minorities; and (iii) the only thing needed to fix the crisis is to change accounting rules.

I kid you not.

Let’s consider each in turn.

1. Banks are Victims

“[A]ll the focus on C.E.O. salary caps,” he writes “implied that the holders of illiquid mortgage-backed securities were the villains in this drama rather than the victims. They didn’t package the securities, or sell them; they bought them as an investment.”

Read More


A Defense of Asset Securitization from Bedford Falls

Over the last couple of weeks, the reputation of MBSs and CDOs have taken a drubbing, with folks insisting that they are little more than instruments of irresponsible speculation at best and fraud at worst. To which I say, “Nonsense!” To understand why, consider this clip from “It’s a Wonderful Life!,” which I used in my Article 9 class last week as a starting point for discussing the financial crisis.

Read More


Chapter 11 as Metaphor: The Financial Systems Restructuring Act of 2008?

lipson.JPGLast week, when all that was on the table was the mere collapse of a few investment banks and one large insurance holding company, I posted Jonathan Lipson’s lucid analysis, identifying the “selective socialism” of A.I.G.’s bailout as a consequence of the Bankruptcy Amendments of 2005.

Now that we’re frying bigger fish, I wondered what Lipson would say. His comments follow:

There are many options for a bailout. One that has received surprisingly little (if any) attention in Washington is reorganization under Chapter 11 of the United States Bankruptcy Code.

Strictly speaking, Chapter 11—which governs business reorganizations—would not apply in any meaningful way to many of the entities that are concerned here. Nor should it. But its general approach may, by analogy, be instructive.

Chapter 11 is a response to the collective action problem presented by a company’s general default. It is designed to enable parties to work out—restructure—legal and economic relationships with a mix of market incentives and government oversight. Some features of that system might, by analogy, help to avoid the growing stalemate in Washington while also creating mechanisms that actually resolve the underlying financial problems.

What, then, might a Financial Systems Restructuring Act of 2008 modeled on Chapter 11 do?

Read More


The Loophole that Became a Wormhole: Why the Fed Had to Bail out AIG

lipson.JPGMany explanations have been offered for the “why” of the Fed found it necessary to bail-out AIG, mostly centering around uncertainty and risk. It’s not exactly that AIG was “too big to fail,” but rather that no one could say, with any certainty, that its failure wouldn’t lead to a real market crash of enormous scope. That is, AIG is a good example of the precautionary principle in action. Maybe so. But I still am a little unclear why AIG is so exceptional in that regard.

Back in the Spring, when Bear failed, I asked my colleague Jonathan Lipson to offer a set of observations about Bear’s bailout. (Check out also Ribstein’s response to Lipson here.) Based on a recent correspondence with him about AIG, I thought it would make sense to share with you his unique & very interesting perspective on the problem.

Why did the Fed bail out AIG but not Lehman?

The conventional answer—which is true but incomplete—is that AIG was too big to fail. But that begs two questions: Too big how? And why?

In part, AIG was too big to fail because it could owe an astronomical amount—allegedly about $300 BN—on credit default swaps issued to support mortgage-backed securities.

The problem, however, is not just the amount AIG owes, but the fact that these obligations are not like other obligations. They occupy a series of loopholes that make them unusually dangerous. Perhaps the greatest loophole of all came in the 2005 amendments to the Bankruptcy Code. Although designed ostensibly to “get tough” on profligate debtors, those amendments also made certain that CDS holders would get special treatment in bankruptcy—special treatment that may have made the Fed bailout inevitable.

Read More


On the Uses of Greed and the Current Finacial Mess

1Gordon-gekko.jpgHow useful is it to think about our reactions to the current financial meltdown in terms of greed? It seems to me that there are two questions here. The first is positive. To what extent can I use greed as a concept to explain the current implosion in the markets?. The second is normative, namely to what extent does greed help us understand how to best deal with the crisis?

First to the positive question. Greed as an explanation posits that we are in this mess because the single-minded pursuit of profit by financial speculators, irregardless of its wider consequences has caused our problems. On this view, the problem is that we have been suffering some sort of a unique spiritual crisis that has come to a head at this moment with dire consequences. The question then becomes cultural. Why did we suddenly become greedy now in such a way as to create this problem?.

Frankly, I’m skeptical. Rather, it seems to me that what we are seeing is a classic bubble caused by sharply rising asset prices. Was the rise in prices fed by greed? No doubt in part, but a better candidate is, I think, the Fed’s loose monetary policy. In effect, we had a huge, government-sponsored intervention in the price mechanism that resulted in a massive misallocation of resources. Now that misallocation is getting unwound. Indeed, if the speculators were greedy, they were also stupid and many who were greediest — those who leveraged themselves the most and for the longest periods — are now the one’s most likely to lose their shirts. My point here is not that investors, brokers, and other players in the financial markets are all saints. There is more than enough greed to go around, I’m sure. Rather, my point is that I think that there are other causal factors that are more important.

Read More


It’s a Sad Day when Nationalization is the Silver Lining

socialistrealism.gifDave asks “What do you think, Nate should “Berneke and Paulson [have] looked on in stony indifference” here too?” To be entirely honest, the answer is I don’t know. Frankly, I am not sure that anyone else really knows either. My instincts are for letting it fail. I have no idea how I am supposed to evaluate the too-networked-to-fail argument.

Although it is hard to tell from the details that we have now, I am encouraged by the fact that the government didn’t simply shell out cash to save the company. I think that it is better if feds end up owning AIG, or at least holding the threat of ownership. This at least diminishes some of the moral hazard effect, and I think that if the tax-payers are going to foot the bill for a company’s debt, then going forward the company ought to be managed in the interests of the tax payers. Better nationalization than a world of promiscuous government guarantees of private actors.

On the other hand, I have a hard time thinking that nationalizing the home-mortgage and insurance industries is a path to prosperity. Particularly, when the tax payers are left owning the bits of the industry that no one else wanted. In favor of a bit of creative destruction, I would point out that it is worth remembering that even when we are talking about sub-prime mortgages, most of them ARE NOT in default. At the margins they are in default, and the margin is a lot bigger than everyone expected. On the other hand, there are still — even in the troubled bottom end of the home lending market — a lot of valuable assets out there, and I am not convinced that letting the losses lie where the contracts put them will bring the entire system to its knees. On the other hand, I am a lawyer, which means that almost by definition I don’t know what I am talking about when it comes to finance.

Still, its a sad day when the silver lining for me is nationalization.


And the Winner is…

PilesofCash.jpgOne of my students sent me the pages from Lehman’s filings listing the 30 top unsecured creditors. It’s a simple column of figures that makes sobering reading, even for a let-the-market-punish-them enthusiast such as myself. First past the post is CitiBank with $138 billion in unsecured bonds. Just for fun, I tried to find out what $138 billion will get you in today’s world. It is equal to:

The second quarter 2008 revenues of ExonMobile.

The value of all of the cement produced in China in 2006.

The amount of money, according to the EPA, that will have to be spent over the next 20 years to repair and update all drinking water systems in the United States.

The value of the Florida Retirement System, i.e. public pensions.

The amount of money spent under the Presevation of Public Lands of America Act, a bill originally introduced by my former Senator George Allen as a joke. (Okay, so my source on that one is The Onion.)

Looking just in the ball park and you get:

The total value of all goods purchased at self-checkout kiosks in the United States in 2006. ($137 billion)

The amount of money necessary to run the State of Texas for two years. ($139 billion)

The value of total U.S. investment in the Korean stock market in the last year. ($140 billion)

Interestingly, $138 billion is also exactly the amount of money that JP Morgan advanced to Lehman Brother’s yesterday and today in what Bloomberg calls “Federal Reserve backed advances.”


I am Irving Fisher

417px-Irvingfisher.jpg“You are a perverse soul,” my office-suite mate told me this morning after I expressed my glee at the fall of Lehman Brothers and the imminent death-by-merger of Merril Lynch. Perhaps, I am just Irving Fisher. Of course, my office-suite mate and I have differing time horizons. She is not that far from retirement and is in that stage of life where every twitch, hiccup, and nose-dive of the market ripples through one’s 401(k). I’m decades from cashing out my retirement savings, and I have to confess that the fall of a major financial institution puts me in a down right jaunty mood.

Sure, the markets already have lost 3%, but what makes me happy is the news that Lehman Brothers threw itself at the knees of the Fed and the Treasury Department over the week end, and Berneke and Paulson looked on in stoney indifference. At last, it would seem, capitalism is going to do what capitalism is supposed to do: Punish those who make bad investment choices. Hopefully, we are in for a bit of short term pain while markets find their bottom and the dead and dying are taken out behind the barn to be shot. On the other hand, once the carnage is over those with money to loan, invest, and spend — and there are lots of them — will come out from hiding in their bunkers with the knowledge that we’ve unwound the risk, and a market that has learned something about the valuation of credit derivatives can move forward. To be sure, the landscape will be utterly changed, but that had to happen any way. Better this way than through a long, slow, expensive process of bailing out the super-rich. This is bad for the financial markets and the real economy may take a hit as well. It is good, however, I think for the long-term political health of capitalism.

I am also frankly skeptical about the notion that we are facing a crisis that will call for New Deal-esque responses. Just a quick reality check: When the New Deal was being put together we had near 25 percent unemployment, roughly 50 percent of all home-mortgages in default, and the GNP contracted by over 13 percent in a single year. This simply IS NOT the second coming of the Great Depression. This is an enormous financial crisis, but one that — as Dave notes in the Greenspan quote in his post — has been having less than catastrophic effects on the economy. It is a big nasty problem, to be sure, but I do not think that it is an apocalypse. Gordon is right, however, that the big question is going to be what will be the regulatory response. This is undoubtedly a bigger event economically than Enron, and the regulatory response to that problem does not give me a great deal of confidence going forward. What I fear is less the markets, than what Congress is likely to do in response. It is the sort of thing that we might want to ask our Presidential hopefuls about, although the chances of a productive discussion on this between now and election day are … low.