I have been of two minds on bailouts.  First, I would prefer we did not do them because bailouts beget more bailouts.  Free money brings out the worst in humanity.  Where is the logical end?  How do we choose what is critical, and what is not?

Second, if we’re going to do bailouts, they should be a last resort to the companies receiving them.  Unlike the relatively sweet terms of the capital offered to the banks, bailout capital should be something that a management says, “Ugh, time to fall on our swords, guys, but at least the business and much of the rank-and-file will survive.”

So, when I look at hopeless cases like the “big” 3 automakers, I think that we need a new chapter in the bankruptcy code for businesses that are “too big to fail.” [TBTF]  The rules would be a little different here:

• Failure of a TBTF institution usually occurs during a major economic crisis.  Other institutions would be stretched too thin, so the US Treasury (together with the Fed) would serve as the Debtor-in-Possession [DIP] lender.
• In addition to being senior to the existing debt, the Treasury would receive some stock in the reorganized entity.
• There would be a special court to deal with the competing claims, with a goal of speedy resolution.  Marginal claims would get thrown out early.  Claims without a lot of variability would get little attention.
• The Court would have the power to throw out contracts, including union and management contracts.
• The idea is to preserve the business while finding who really owns the new equity, and quickly, so that real life can resume with a balance sheet that has little debt.
• The court would choose who puts together the first restructuring plan, aiming for the party that has the most at stake, skipping the current nominal equity, in favor of the parties that practically are the equity.
• A Chapter 11 case could be moved into this chapter if no DIP lender is found, at the option of the Secretary of the Treasury.

A method like this tries to respect the taxpayer, making it unlikely that bailout funds would be tapped, while still allowing for situations where TBTF institutions could be reorganized in an emergency where the banks can’t lend, rather than a quick liquidation.  It’s a tough balancing act, but one that has to be done for the good of the nation as a whole.  Formalizing methods like this could have value for future crises, such that businesses end up saying that they don’t want to go down the TBTF Bankruptcy Chapter, which would be good for the nation.

That’s my reasoning.  I am open to other ideas, and improvements to the concept.

This entry was posted on Thursday, November 20th, 2008 at 3:30 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.