Not Again!

So I was sitting in my office listening to Siouxsie and the Banshees preparing for class, when the mail arrived. My new ABI Journal was hidden among the enticing offers to buy various pieces of foreclosed New Jersey real estate, so I began reading the article by Sheila Blair.

Then my head exploded. Again.

 Again, because the ABI Journal piece actually is just a reprint of her remarks from last month before the FCIC. She gives three reasons why chapter 11 does not work for financial firms. None of them are too convincing.

First, she argues that chapter 11 does not facilitate the kind of pre-planning and coordination among the debtor, regulators, and potential that is routinely seen in FDIC bank takeovers. This simply shows the continued disconnect between the banking and bankruptcy community. For most bankers Lehman told them all they need to know about bankruptcy. But the readers of this blog know that the vast majority of big chapter 11 filings are not "free falls," but rather highly orchestrated events.

She also argues that debtors in chapter 11 might not be able to continue operations, with disruptive effects on counterparties. Oddly, she notes the effects of the Lehman UK proceedings to support this point. Of course, chapter 11 has not been enacted in the UK. Indeed, one of the big shocks to many hedge funds was the lack of a SIPA like process in the UK. And SIPA itself expressly draws in parts of the Bankruptcy Code.

The real point is that debtors that require liquidity need to be able to demonstrate that on the first day of the case. Typically this is done by having a DIP facility in place before the filing, which goes back to the first point about pre-planning a chapter 11 filing. For a financial firm, the size of the facility would be vital, and thus the quality of the firm's assets would be an issue in a case like Lehman. Also, in times of widespread financial panic, the government might have to backstop the facility to "make it happen." But these problems are not impossible to fix.

 And finally she argues that the FDIC approach is better because chapter 11 costs so much, just look at Lehman as compared with WaMu. Of course, we don't really know what the FDIC approach costs, because its run by government employees. But I'll grant that the costs of administration are probably lower.

But if the FDIC destroyed a few hundred million dollars of value in WaMu, as some argue, then the cost point becomes a bit hazy. Bondholders probably are indifferent as to whether their low recovery is caused by big attorneys' fees or selling assets too cheaply. They'd rather neither.