Systemic Risk, Business Risk and Bankruptcy
Yale economist Robert Shiller argues that we need to add a new structure to the bankruptcy code, one designed to deal with systemic risk. He notes that the failure of a giant hedge fund or of multiple businesses could bring down the whole economy, and that we need to put in place the tools to deal with such a crisis now--before the next crisis is upon us.
I think Dr. Shiller is right about 1) the need for a mechanism to deal with systemic failure, and 2) that bankruptcy is the right place to develop such a scheme. I also fear that most policymakers won't see the need until it is too late.
But things are worse that Professor Shiller suggests.
Over time, bankruptcy law is becoming less able to deal even with ordinary business risks, thus diminishing the effectiveness of a structure that would provide some stabilization in a shaky economy. The problem is that different interest groups have picked away at the general rules of bankruptcy, making a comprehensive reorganization of a business (or a family) less and less likely.
Start with the 1978 Code, a slim volume that laid out a basic structure of how businesses could deal with failure and, if there was a going-concern value to be preserved, get back on their feet. The pain of non-payment would be distributed among their creditors, with the theme of equity-is-equality as the centerpiece and exceptions to that rule carefully cabined. (The exception, of course, has been the treatment of secured debt.) But work through the 1984 amendments, the 1994 amendments, and the 2005 amendments. The code is twice as long, and most of the changes are about special deals for special groups.
Shall we start a list? Airplane engine financiers? Repo swaps? Shopping center landlords? Inventory suppliers? Sure, every group can explain why it needs a special exception, and sometimes those reasons may be compelling. But total up all the changes, and the impact is to make bankruptcy work less and less effectively to hold all the creditors together to share the pain of discharge and to give the debtor a meaningful chance to reorganize a going-concern business.
Other amendments that aren't tied to a specific creditor group are also aimed at reducing the likelihood of reorganization. So, for example, Unrealistic time limits to confirm a plan of reorganization or expansion of the ordinary course of business exception to voidable preferences push more businesses toward liquidation.
The changes to Article 9 of the UCC have compounded the problem. Secured creditors have been given the tools to vacuum up every crumb of value. Now in Chapter 11, as Jay Westbrook keenly observes, secured creditors are often in control.
Trying to save a failing business is tough. Many efforts will fail. Success can be important not only for the business managers, owners and creditors, but also for the employees, retirees, taxing authorities, suppliers, and communities that depend on that business. When the economy is strong, there is a lot of value derived from a well-functioning bankruptcy law, but in a lousy economy, there is more value. In other words, everyone in this economy has a stake in a well-functioning bankruptcy law.
Defenders of a neutral, well-functioning bankruptcy system are in constant opposition to single-interest groups. Over the past three decades, the single-interest groups have dominated the legal process. Perhaps, as Dr. Shiller suggests, it is time to look at the big picture again.