Bankruptcy or Bailouts
2009; Volume: 35; Issue: 3 Linguagem: Inglês
ISSN
0360-795X
AutoresKenneth Ayotte, David A. Skeel,
Tópico(s)Corporate Governance and Law
ResumoI. INTRODUCTION II. THEORIES OF FINANCIAL DISTRESS: FIRM-SPECIFIC COSTS A. Debt Overhang B. Creditor Runs III. BANKRUPTCY LAW AND FIRM-SPECIFIC SOLUTIONS TO FINANCIAL DISTRESS IV. FINANCIAL INSTITUTION BANKRUPTCY: DREXEL AND LEHMAN A. The Drexel Burnham Bankruptcy B. Lehman Brothers V. FIRM-SPECIFIC COSTS OF GOVERNMENT AD-HOC RESCUE A. The Case for Rescue Loans: Illiquidity vs. Insolvency B. Direct Costs to Taxpayers C. Moral Hazard (of Equity and Debt) D. Corporate Governance Distortions E. A Comparison to Bankruptcy Resolution VI. SYSTEMIC RISK CONSIDERATIONS: IS BANKRUPTCY APPROPRIATE? VII. SYSTEMIC CONCERNS WITHIN BANKRUPTCY VIII. NEW RULES FOR SYSTEMICALLY IMPORTANT FIRMS? IX. CONCLUSION I. INTRODUCTION The onset of the current financial crisis brought with it an unprecedented intervention in financial markets by the Federal Reserve and the United States Treasury. Starting with the bailout of Bear Stearns in early 2008, these governmental bodies and their leaders were prominently involved in the negotiations and the ultimate resolution of each major non-bank financial institution that encountered financial distress. The government arranged outcomes on an ad-hoc basis, with varying degrees of taxpayer support. In the Bear Stearns case, taxpayer funds facilitated a merger. In the AIG case, the Federal Reserve made a substantial direct loan to the company. With Lehman Brothers, the government declined to offer any money, and the company ultimately filed for Chapter 11 bankruptcy. Although it was hard to distill a consistent policy rule from the government's rescue efforts, one guiding principle was its preference to avoid all possible bankruptcy filings because of the supposedly severe consequences that would follow. Federal Reserve Chairman Ben Bernanke acknowledged this policy in a rare public interview on 60 Minutes: There were many people who said, Let 'em fail. You know, It's not a problem. The markets will take care of it. And I think I knew better than that. And Lehman proved that you cannot let a large internationally active firm fail in the middle of a financial crisis. (1) Treasury Secretary Timothy Geithner echoed these sentiments in defending the rescue loan to AIG: We were caught between these terrible choices of letting Lehman fail--and you saw the catastrophic damage that caused to the financial system--or coming in and putting huge amounts of taxpayer dollars at risk, like we did at AIG, to keep the thing going, unwind it slowly at less damage to the ultimate economy and taxpayer. (2) This point of view has become the conventional wisdom, which now points to the Lehman bankruptcy as the singular, defining moment of the financial crisis. The government's decision to allow Lehman to file for bankruptcy, instead of providing a government rescue, was, in the standard account, the primary cause of the severe economic and financial contraction that followed. (3) Critics emphasize two different shortcomings of bankruptcy, often without distinguishing between them. The first focuses on the effect of bankruptcy on the value of the distressed firm itself. Bankruptcy, the reasoning goes, would severely dissipate the value of the firm's assets. We will refer to this first set of concerns as the firm-specific risks of a bankruptcy filing. The other rationale highlights the negative repercussions of a bankruptcy filing outside the firm. A bankruptcy filing directly affects the firm's contractual counterparties, some of whom (such as lenders and derivatives counterparties) have direct claims on the firm, while others hold contracts whose value is tied to the distressed firm. (4) A bankruptcy filing also may have broader spillover effects, such as a general effect on confidence. We will call these direct and indirect spillover effects systemic risks. (5) This Article will seek to explore the widespread perception that firm-specific and systemic risks make bankruptcy untenable for financial institutions. …
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