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The Bear is Dead

posted by Elizabeth Warren

The Fed's extraordinary step in propping up Bear Stearns, followed by Morgan Stanley's JP Morgan's purchase of the company at a fire-sale price, has everyone reeling.  But for Credit Slipsters there's an odd little irony worth noting:  Why didn't the Bear file for Chapter 11? 

In the be-careful-what-you-wish-for category, the Wall Street Journal noted:  "Bankruptcy experts said filing for bankruptcy protection wouldn't have been an attractive option for Bear Stearns, partly due to recent changes in the federal Bankruptcy Code relating to financial instruments like derivatives and repurchasing trades. Unlike most parties in bankruptcy, lenders in such transactions aren't stayed or prevented from acting to seize or control the assets involved in those deals."

David Levine, HBS/HLS 2010, sent the WSJ quote my way this morning.  Thanks, David.

Of course, it is possible that Bear could not have survived in Chapter 11.  It is also possible that the imposing a broad automatic stay would have created more chaos in the market.  We can have a long debate on whether the Bear might have survived in a pre-amendment Chapter 11 world and whether the Fed would have been required to put in billions of taxpayer guarantees to prop up an investment company. 

But before that debate starts, we need a minute to focus on the implications of amending the bankruptcy code to make some transactions--and hence some companies--essentially bankruptcy-remote.  I would be willing to bet a sizeable sum of money that Bear Sterns was one of those Wall Street giants that pushed for the amendments that ultimately cut off their last hope of survival.

Bankruptcy is one of those pieces of infrastructure that an economy needs in place all the time.  Everyone wants to pick away at the pieces that make it work--right up until they need to use those laws.  Then, of course, it is too late.


Your schadenfreude is definitely not misplaced, and bankruptcy is definitely vital infrastructure.

However, the WSJ's gloss on bankruptcy stay "exemptions" facing Bear Stearns likely refers to the derivatives and brokering and swap obligations exemptions instituted by laws like the SEC Acts, the Commoditiy Futures Modernization Act of 200, and to a lesser extent, in the BAPCPA of 2005.
These exemptions are almost all narrow exemptions necessary for highly regulated financial markets to continue operating when a participant faces bankruptcy. Compelling the actual delivery to a client of securites held in the role of a broker, or allowing remittance of periodic payments on fixed-variable interest rate swaps - these are the type of market activities that needed to be exempt from a stay.

I have no doubt Bear advocated for many of the provisions that now hobble it in contemplating bankruptcy, as well as many onerous and anti-consumer provisions in general, BUT (unlike so many of the rent-seeking exemptions sought these days) some of these particular provisions do offer vital transparency and predictability to certain regulated markets transactions.

Franklin Edwards and Edward Morrison (Columbia Law) have done excellent, non-"shilling" work on this issue.
( http://papers.ssrn.com/sol3/papers.cfm?abstract_id=589261 )

They lay out the details of why some exemptions do everyone good, and some other exemptions (apparently including some of the BAPCPA "netting" ones) are nothing more than the to-be-expected rent-seeking variety that causes so much grief.

You think the creditor lobby will start talking Bankruptcy reform now? Maybe then we will actually get it and then we can piggyback consumer reforms to it. We have to get Big Biz to pull for it otherwise it falls on deaf ears. Big Biz gets their bail out but consumers get none. How much has the government guaranteed now? Bush calls a press conf. and is on the phone working on the weekend because of Bear Sterns. You think individual consumers can get that kind of reaction?

Bush will say “economic stimulus”, when the president does not want debtors to save, he wants them to spend! Who does that help? Poor people do not save! They spend! That’s just the way it is. What they really need to do is save for a rainy day and believe me, it is raining. They won’t though and the government knows that. They are going to go out and buy that big screen, or nice rims for that beat up old truck and are going to be worse off for it but not the economy…. Maybe way down the line it will help consumers, who knows?

P.S. loved your testimony on Capital Hill. I liked the term “sneaky fees”.

JPMorgan Chase purchased Bear Stearns, NOT Morgan Stanley. Please get the facts straight. Even though some might view the identity of the purchaser as trivial to the rest of your post, it bolsters confidence in the reader if he or she knows you have paid careful attention to the content of your writing.

The repo and swap exceptions to the automatic stay won't get a lot of attention until a non-financial company's get cleared out because of them. Why do a secured loan and be subject to the automatic stay and the possibility you messed up the UCC-1 when you can instead just structure the deal as a repo or a swap? My understanding is that some lenders are now doing their secured loans as repos/swaps, so we might see quite a bit of this in the next couple years. This issue has already come up in American Home Mortgage Investment Corp. (Bankr. D. Del.), where the court held that if it is called a repo, then it's a repo (which is exactly what the 2005 BAPCPA amendments made clear should be the case) and not subject to the stay, end of story.

NY Times lead story today said
"In a highly unusual maneuver, Fed officials said they would secure the loan by effectively taking over the huge Bear Stearns portfolio and exercising control over all major decisions in order to minimize the central bank’s own risk."

Since the taxpayer is subsidizing this bailout, the Fed should conduct a thorough and public examination of the books so that we can learn from Bear Stearns' actions. It should also remember that the Fed is also supposed to protect consumers, something that it has woefully neglected. It could start by appointing a consumer advocate/ ombudsperson in each of the units that are still operating. Bear Stearns owned at least one subprime service - EMC Mortgage - and one vulture debt buyer - eCast settlement. If the Fed is in charge of the Bear Stearns portfolio it should not allow "business as usual" when a large part of the business is based on taking unfair advantage of consumers. For one thing, it has not turned out to be safe and sound business practice to do so.

Excellent idea David. The only problem with it is that no one on the INside wants anyone on the OUTside to see how things REALLY work. You obviously have an idea of how EMC has been allowed to conduct business over the years. I've had EMC victims tell me horror stories that make my seven year battle against Fairbanks/SPS look like a cake walk.

Stark v. EMC, for instance (available here: http://www.msfraud.org/law/lounge/lounge.html ). There is obviously much to the story but the basic gist is that the family goes out one evening and comes back to find that "someone" has "forcibly entered" their home (read broken in) and physically changed the locks on the property. Fortunately for them, they had been advised to move out while the legal battle continued so the family was apparently living literally across the street.

EMC demanded that an arbitration clause in the Stark's mortgage be enforced. The arbitrator awarded the Starks $6 million as a result. EMC had the audacity to appeal an arbitration decision that it insisted upon and lost.

EMC/Bear, SPS/CSFB (formerly PMI Group majority), Litton/Goldman Sachs (formerly CBASS), Ocwen, Countrywide, Ameriquest, and a host of others all have "in-house" servicing operations. They all have, or have had, significant litigation filed against them by borrowers. No one on the inside wants the operations cracked open because if that happens they lose their flock of golden egg laying geese.

Never mind that Mortgage Servicing Fraud has significantly contributed to the current foreclosure crisis. Servicers wouldn't be making $100 million/month if they have to do business "by the book". And if John Q and "regulator X" both get a good look at the books the game is over because X will HAVE to take action if for no other reason than John Q saw the same thing and will be demanding that legal action be taken.

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