Making Bankruptcy an Option
For a long time in the United States, we’ve had a way of dealing with failing businesses — the bankruptcy process and bankruptcy courts. It’s a good process, it works well, and it’s served the country well for a long time. It does lead to some firms being liquidated, but many bankrupt firms — just like individuals who need to declare bankruptcy — end up recovering better off than they’d been before. But of course bankruptcy doesn’t work well for all institutions. In particular, conventional bankruptcy has been seen to be inadequate for your standard depositary banks. The fear that a bank will go bankrupt can cause a run on the bank which, in turn, leads it to go bankrupt.
Consequently, we developed a different process for dealing with banks gone bad — FDIC receivership. And even in these times of economic peril and financial crisis, that process seems to be working fine.
At the same time, we’re now suddenly being told that there’s a whole range of other kinds of institutions that don’t fit the FDIC model but for which bankruptcy is also “not an option.” Turns out that all sorts of investment banks and the like can’t be allowed to go bankrupt. And certain kinds of insurance firms like AIG. And also large car companies. And maybe all that is right. But the FDIC model shows us the way we ought to go if there’s some class of entities such that we don’t want to allow the entities to go bankrupt — namely to construct a different process for dealing problems at those firms. You would have some criteria for what kinds of firms count as eligible — not a post hoc “oh, bankruptcy doesn’t work for car companies or investment banks!” proclamation — and a clearly laid-out process for what’s supposed to happen.
Responding on an ad hoc basis to unexpected events is understandable. But a big part of any new regulatory framework needs to be creating a proper framework for cleaning up messes that we don’t think should be cleaned up by the bankruptcy courts. But we’re now months into the current cycle of bailouts, and there’s no sign of public momentum on that front. Meanwhile, doing things in an ad hoc way leaves who gets what more open to the scale of a firm’s political clout (i.e., Citibank > Chrysler > Circuit City) than to any kind of objective assessment of what the economy needs.
31 Responses to “Making Bankruptcy an Option”
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December 4th, 2008 at 12:14 pm
MY has a plan for everything. That is what makes reading him so funny. He cannot seem to appreciate that the world is a product of many thousands of generations’ worth of evolutionary adjustments, compromises, and innovations that he could not possibly hope to know about…nor can he imagine that there is any situation—no matter how remote or complex—that his own little mind cannot improve.
December 4th, 2008 at 12:18 pm
I think Matt gets this exactly right. But I would extend his little inequality further:
Citibank > Chrysler > Circuit City > Taxpayer & Worker
Big companies have the financial clout to make sure that instead of bankruptcy they get taxpayer money. Ordinary people don’t. As a result we have all of this money being thrown at well connected companies while efforts to reform personal bankruptcy, extend unemployment benefits, etc. are an after-thought. Let’s stop bailing out the people who created this mess and start helping the ordinary Americans caught in the middle.
December 4th, 2008 at 12:19 pm
I agree with BA @ 1. Aren’t there any missing white women we could speculate about?
December 4th, 2008 at 12:21 pm
A non-bankruptcy alternative might work best for businesses whose customers depend on the businesses’ long-term viability, such as financial institutions and auto makers.
December 4th, 2008 at 12:24 pm
BA, you don’t really understand this “blog” thing, do you? Is this your first time using the Internet? It’s exciting, isn’t it? But just like in real life, just because you can say something, doesn’t mean you should say it.
December 4th, 2008 at 12:30 pm
This was the topic of a WSJ article by prominent conservative economists. You’re absolutely right on this.
December 4th, 2008 at 12:30 pm
The best policy is to rigorously enforce the current anti-trust laws (and possibly expand them) to reduce or eliminate the number of companies that are “too big to fail”. Denying mergers would reduce job losses and breaking up companies would increase employment.
December 4th, 2008 at 12:46 pm
Meanwhile, doing things in an ad hoc way leaves who gets what more open to the scale of a firm’s political clout (i.e., Citibank > Chrysler > Circuit City) than to any kind of objective assessment of what the economy needs.
Really? Does anyone here want to dispute that the overall economy is more dependent on Citibank than it is on Chrysler (and more dependent on Chrysler than it is on Circuit City)?
The present crisis seems, to me, to be the result of the unregulated $60-trillion market in derivatives. As I see it, there’s not much choice but for the Fed to guarantee enough of those derivatives to keep banks lending—regardless of the size or structure or relative solvency of the organizations holding the actual paper.
December 4th, 2008 at 12:47 pm
My point being: bankruptcy or non-bankruptcy doesn’t really make a difference in the bigger picture.
December 4th, 2008 at 12:52 pm
FWIW, the Italian did something similar after the Parmalat scandal (the biggest food company in Italy, brought down by its founder the Enron-way ),a special bankruptcy law for very big companies. It worked fine for Parmalat, but this year they twisted it for Alitalia, with Berlusconi’s input and his usual (lack of) respect for the Law. Not so much what MY would like any more.
So it can be done, but beware ad-hoc manipulation by the politician class.
December 4th, 2008 at 1:02 pm
But the FDIC model shows us the way we ought to go if there’s some class of entities such that we don’t want to allow the entities to go bankrupt — namely to construct a different process for dealing problems at those firms.
Why? You’ve merely used the verb “ought” here — you haven’t justified why lack of process is superior in this case — in this national emergency — over simply following our instincts with respect to what constitutes “too big to fail.” Circuit City apparently isn’t. GM apparently is. That sounds about right to me. Maybe in a couple of years — when we’re no longer in the midst of a veritable emergency — even firms of GM’s size and scope will be allowed to fail.
I can think of some advantages to having a defined process for situations that fall between the cracks. But I can also think of some drawbacks, including lack of flexibility, and, yes, further extension of moral hazard.
Meanwhile, doing things in an ad hoc way leaves who gets what more open to the scale of a firm’s political clout.
Which in turn corresponds in nearly perfect fashion to an entity’s impact on real people and real lives. It’s frankly almost an, er, elegant solution: if your failure doesn’t threaten the livelihoods of a sufficiently large number of people, and the political pressure to give you government help therefore isn’t sufficiently intense, it’s probably for the best that you aren’t able to strong arm cash from taxpayers.
December 4th, 2008 at 1:13 pm
The present crisis seems, to me, to be the result of the unregulated $60-trillion market in derivatives. As I see it, there’s not much choice but for the Fed to guarantee enough of those derivatives to keep banks lending—regardless of the size or structure or relative solvency of the organizations holding the actual paper.
As Krugman succinctly put it in that Newsweek interview “We basically had a $10 trillion shadow banking system shrivel up and die.”
Regualtions? We don’t need no stinking regulations!
Then the last two investment banks left standing went crying to mama and quickly becamre regular old banks.
Why did all of this happen? Greed. Makes one feel all warm and fuzzy inside.
December 4th, 2008 at 1:30 pm
I agree Matt.
December 4th, 2008 at 1:43 pm
And certain kinds of insurance firms like AIG.
Insurance companies are already exempted from federal bankruptcy laws in favor of state insurance liquidation and rehabilitation (and sometimes conservation) proceedings. Insurance holding companies and non-insurer affiliates of insurance companies are subject to federal bankruptcy laws, but these presumably will have very little to do with the writing of insurance.
December 4th, 2008 at 2:04 pm
The car companies should be allowed to go bankrupt. Simply throwing money at them won’t do anything. They’ll continue to operate the same way and pay the same executive salaries, with no incentive to change.
Bankruptcy will do them good. They need to rethink their business and make cars people actually want to buy.
GM is spending millions of dollars to develop the Volt, which is still very far from ready for production and will require infrastructure changes to support electric cars. Until you can charge it anywhere and aren’t limited by the 40 mile range, it isn’t practical for most people.
Meanwhile, Toyota is selling the Prius as fast as they can build it. Unlike the Volt, it doesn’t need to be plugged in and has the same range & uses regular gas like any other car, so there’s no big barrier to switching.
Why can’t GM or Chrysler make something like that? It may not be the ultimate technology of the future, but it’s still better than anything else you can buy right now.
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