The IMF is Not/Not - NOT- Reviving Its Sovereign Bankruptcy Proposal

For all the hopers, dreamers, and scaredy-cats out there--Relax. The long-awaited IMF overview paper on sovereign debt restructuring is here, the first since 2005. And it does not revive the Sovereign Debt Restructuring Mechanism (SDRM) proposal, which died in 2003 at the hands of the United States and the big emerging markets (or more politely, "failed to command the majority needed ... due to the members' reluctance to surrender ... sovereignty"). The new paper takes great pains to establish that the core political reality has not changed, even though SDRM would have solved many of the problems with sovereign debt restructuring that have arisen in the interim. O well.

Within its crystal-clear political constraints, the Fund goes on a measured march across sovereign debt restructurings from 2005 to 2012, or from Argentina to Greece, through Belize, Jamaica, St. Kitts and Nevis. I came away thinking that the paper was not particularly radical, generally constructive, and refreshingly precise.  But it does point to potential changes.

Equitable Mootness and Forum Shopping

A few weeks ago, the Supreme Court denied cert in a case called Law Debenture Trust Co. v. Charter Communications, Inc. (No. 12-847). The issue was whether the Second Circuit had correctly applied the doctrine of equitable mootness to an appeal in the Charter Communications bankruptcy. Paul Allen -- yes, that Paul Allen -- held an ownership stake in Charter that should have been worth approximately zero because that is usually the value of an ownership stake in a bankrupt company.

Charter, however, needed to retain Allen's voting interest in the company to avoid a default in its senior credit facility with J.P. Morgan and also to preserve net operating losses. By the time negotiations were over, Allen had $375 million, Charter's purchase of his preferred stock in a Charter subsidiary, a liability release, and other consideration. The junior creditors complained the deal violated the absolute priority rule, the requirement in chapter 11 that creditors be paid in full before shareholders receive anything. Allen responded that it was a perfectly cromulent deal because he was being paid to help out Charter and not because he was a shareholder. The legal dispute revolved around the meaning of "on account of" in § 1129(b)( bb76uyhj09-=09g hewa*a[0g zzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzz . . . .

Ice Cube Bonds: New Paper on 363 Sales and Chapter 11

FAC UT ARDEAT, begins The Flamethrowers by Rachel Kushner. It means "made to burn," the narrator learns (from that "gasbag . . . Chesil Jones"). Whether your preferred hurry-up 363 sale metaphor involves flames, ice, or a wagon full of rotting salmon, Ted Janger and I have just posted a draft of an article reframing the problems with pre-plan going-concern sales, and reallocating the risk associated with such sales. The abstract:

Financially-distressed companies can melt like ice cubes. In Chrysler’s Chapter 11 bankruptcy, the finding that the debtor was losing $100,000,000 per day justified the hurry-up sale of the company to Fiat.  This assertion -- that the firm is a rapidly wasting asset -- is frequently offered, and accepted, in support of quick sales under section 363(b) of the Bankruptcy Code. This raises a policy question:  is this speed and streamlined process a “bug” or “feature?” Do these hurry-up going-concern sales create a speed premium and maximize value for the bankruptcy estate, or do they facilitate collusive deals between incumbent managers, senior creditors and potential purchasers? The answer is, “a little bit of both.” It is, therefore, crucial to distinguish between sales where the court and parties have good information about the value of the company and the costs of delay, from those in which melting ice cube leverage is used to exploit information asymmetries and to lock-in a favored deal. To accomplish this sorting and reduce transactional leverage, we seek to allocate the increased risks of foregone process to the beneficiaries of the sale. We propose that a reserve – the Ice Cube Bond – be set aside at the time of sale to preserve any potential disputes about valuation and priority for resolution after the sale has closed. This approach retains expedited section 363 sales as a useful way to quiet title in complex assets and preserve value, while preserving the opportunities for negotiation and adjudication contemplated by the Bankruptcy Code.

Perhaps Ice Cube Bonds is the long weekend reading material you were hoping would come your way? We'd value your feedback.

Match image courtesy of Shutterstock.

Non-exempt Exempt IRAs and Undercompensated Chapter 7 Trustees

Some chapter 7 trustees have found a problem that could affect thousands of IRAs, leading to the first post in a  two-post series on unintended consequences. A better reading of the law is that these IRAs should remain exempt from the bankruptcy process. Cases are wending their way through the court system, and until the courts resolve the issues, many IRAs may remain under threat. And, there is no guarantee the courts will agree with me on how the cases should be resolved.

The situation begins with the 2005 changes to the bankruptcy law. One of the few ways these changes were favorable to consumer debtors was to clarify and expand the exemptions available to retirement assets, including IRAs. Most retirement assets are exempt from the bankruptcy process, meaning debtors can retain these assets even after the bankruptcy case.

MLEA at the University of Illinois

On October 11 & 12, the University of Illinois College of Law will host the 12th annual Midwestern Law & Economics Association conference. The event consists of law professors and economists presenting papers with varying degrees of law-and-economics content, ranging from empirical analyses and formal economic modeling to legal philosophy and doctrinal papers infused with economic thinking. Paper submissions are due by August 1 and should be submitted to me at rlawless-at-illinois-dot-edu. More information can be found here.

On the Valuation of Hedge Funds (or Hedge Fund Managers)

So Felix Salmon has taken a justifiable swipe at some oddish Bloomberg articles on Citibank's spinoff of its internal hedge fund, as required by the Volcker Rule.

But in doing so, it seems as though he may have hit his own wicket.  (OK, I'll admit to wishing I was here, rather than grading Con Law exams).

For example, he argues that "all future income is reliant on both the investors and the managers sticking around, which means that the value of a hedge fund to its managers is always going to be higher than the value of a hedge fund to an outside investor with little ability to keep the managers in place."

First off, I assume he is referring to the manager, rather than the fund itself. And if value is reliant on the managers sticking around – why is a hedge fund that much different than any other company? Even a company with a large amount of fixed assets depends on the quality of its management to give those assets real value (e.g., GM) and companies with slight physical assets don't disappear when a key manager departs (e.g., Apple).

He also says "almost nobody buys and sells stakes in hedge funds as an investment" and thus suggests that hedge fund "valuation should start at zero, rather than with some academic discounted-cash-flow analysis."

Well there is the case of Och-ZIff, a publicly traded hedge fund manager. Its outside shareholders do seem to think that there is some value in the future cashflows there, despite the fact that the managers might up and leave at a moment's notice. Either that or investors are buying the stock regardless of price. That seems likely.

Cries for Relief from the Hungarian Financial Crisis

No, not that Hungarian financial crisis. Now that the country seems to have more or less righted itself, its citizens are still struggling with their own debts. Reuters reports that the Managing Director of the National Bank of Hungary has called for the country to adopt a personal insolvency law, much as Ireland just did in the midst of its own crisis. The Director seems to envision an approach along the lines of an emerging European standard, a clean slate after a 4- to 5-year payment plan. The IMF agrees, noting in its latest annual report on Hungary (see p 15, para  25) that establishing a personal insolvency system would help the banking sector to clear out its portfolio of non-performing loans and get Hungarian productivity back on track.

So what's the holdup? "Resistance from the banks." Where have we NOT heard that before!? Of course the banks resist, because they want to continue to maintain the illusion that their non-performing loans are actually worth more than a few fillér on the forint (if not zero). A Hungarian economics ministry secretary reports in the Reuters story that they're in talks with the banks about a potential personal insolvency law, but it is "unlikely to be launched this year," as "there should be sufficient time to prepare for it." Time!? A full-blown and well-developed proposal for a new personal insolvency law was floated and commented on by, among others, me, beginning in the fall of  ... 2008!  Is five years not "sufficient time" for these banks? And why did the 2008-09 proposal fail?  "Resistance from the banks." Someone over there in Hungary needs to stand up to the banks and stop allowing the time-honored cry of "we need more time" to delay reasonable relief that complies with an international standard that has developed throughout Europe during the past 30 years.

Forint photo courtesy of Shutterstock.

Who is Mel Watt?

On May 1, President Obama nominated Rep. Mel Watt (D-N.C.) to be the director of the Federal Housing Finance Agency, the conservator for the mortgage giants Fannie Mae and Freddie Mac.

These two entities together currently back a large majority of new mortgages and hold or guarantee about half of all U.S. mortgages. Like other entities immersed in the mortgage market, Fannie and Freddie suffered great losses in the mortgage meltdown and were taken over by the federal government at the end of the Bush administration in September 2008.

Watt could be a key figure in the late stages of the mortgage crisis and in redefining the role of Fannie Mae and Freddie Mac going forward.  So who is this eleven-term congressman and what does he care about most?

Probably the most important points to stress are these:  He rose from humble beginnings through the meritocracy and is a Yale-educated lawyer who likes to immerse himself in the facts.  He is broadly respected at home in Charlotte, N.C., and represents a safe district where he has biracial support.  He carefully listens to the financial services industry, a major player in his community, and one that has supported his campaigns.  Most important of all, he has made working for the economic well-being of African Americans his life’s work, whether as a lawyer in private practice representing minority businesses or as a lawmaker seeking to shore up consumer protection, particularly to strengthen the legal basis for challenging predatory lending, often used against racial minorities and other vulnerable populations.

Jon Stewart's Residential Evil

Any time The Daily Show has a piece that mentions both MERS and the OCC, it gets a link on Credit Slips. There is even a short clip featuring former Credit Slips blogger and current U.S. Senator (in that order) Elizabeth Warren. 

Bankruptcy Filings Over the Next 12 Months

Bankruptcy filings have continued to decline, and using data supplied by Epiq Systems, my analysis suggests the same trend will occur over the next twelve months.

First, looking back at March and April, bankruptcy filings declined 12.0% and 11.8% respectively on a year-over-year basis. The daily filing rate in March was just short of 4,900 and in April was 4,575.

If we extrapolate these numbers out over the rest of the year, bankruptcy filings should just barely surpass 1.0 million for calendar year 2013. If filings continue for the rest of 2013 at the same pace they have for the first four months, the number will be closer to 1.1 million, but the filing rate is typically strongest in the spring and then tapers off each year. Thus, a figure closer to 1.0 million is more likely and that rate of filing would represent an annual decline of 14% in the number of U.S. bankruptcies for the second straight year in a row.

Obama to Replace DeMarco at FHFA

with Mel Watt, according to an AP story today. Congressman Watt of North Carolina was a moving force behind Miller-Watt-Frank, the mortgage reform legislation that eventually found its way into Dodd-Frank financial reform. Given that our all-but-nationalized housing finance system is directed by this somewhat obscure agency, the occupant of this post can have a huge influence on the future direction of credit, housing and the economy.

If he is confirmed, Watt can be expected to make major changes to Fannie and Freddie policies, for example on principal write-downs and cracking down on mortgage servicer errors and abuses. Perhaps he could also begin to envision a more rational future assignment of the public and private roles in financing homes, in which public subsidy serves a public purpose and private capital carries the burden of its own credit risk.

The Stakes Of Design

That 99% invisible is a vibrant architecture and design podcast might have been beside the point in Credit Slips land -- but for the fact that its current show (Episode 78) focuses on the design and technology of casino slot machines, and the particular profitability of penny slot machines. The short piece is built on the work of M.I.T. professor and anthropologist Natasha Dow Schüll. Lots on the consumer finance and cognitive behavioral side of things; don't expect any mention of bankrupt casinos.

Slot photo courtesy of Shutterstock.

Harry's Here! -- Everyone Wants a Piece of NML's Pari Passu Pie [Updated]

Just two sunny weekend days after NML et al. filed their rejection of Argentina's offer, a new batch of defaulted bond holders have come to ask the court for their piece of Argentina's pari passu distribution. The Duane Morris Individual Plaintiffs apparently believe that

[T]he only sensible resolution is a lump-sum payment of all interest and principal that has accrued and become due and payable in eleven years to all the current holders of the holdout bonds ... . Such a payment would be directed through an order for specific performance, which this Court has endorsed as the appropriate remedial device. NML Capital Ltd., 699 F.3d at 261-262.4B. [Emphasis in the original.]

NML et al. disagree and urge the court to reject the proposed amicus brief:

[T]his Court’s March 1 Order directed Argentina to state what it is prepared to pay Appellees specifically, not what it is willing to pay adversaries in other cases.

No, they are not talking about adversaries suing Argentina for unpaid paperclips -- but other bondholders under the very same 1994 Fiscal Agency Agreement that laid the golden ratable payment egg for the plaintiffs-appellees. 

Argentina, Fintech, and two groups of restructured bond holders don't want the court to friend Duane Morris either, but there is more than a whiff of we-told-you-so in their filings:

[T]he Motion demonstrates that the present appeal does not concern “only” the $1.47 billion demanded by NML and the other plaintiffs-appellees ..., but potentially the entire amount of outstanding defaulted Republic debt subject to a pari passu clause. ... [A]cceptance of the district court’s “ratable payment” formula could open the floodgates for over $15 billion in similar pari passu claims.

In retrospect, one wonders why it took Harry as long as it did to join Tom and Dick at the pari passu party. And when will Sally, Sue and Fred wake up?

UPDATE: Things happen quickly in the pari passu world. Apparently convinced that no one wanted Duane Morris at the party, the Second Circuit denied their motion to file an amicus brief earlier today. Hat-tip to Joseph Cotterill at FTAlphaville, who posts the order here.

Qualified Residential Mortgages

The New York Times has a major article about the Qualified Residential Mortgage rulemaking under the Dodd-Frank Act. I think there's a lot of confusion about this ruling-making. I'm going to try and clarify a few things in this post.

MF Again

The MF Global trustee filed his lawsuit against Jon S. Corzine and other former MF Global executives.

But the complaint itself, while quite well done, makes for rather strange reading upon further reflection.