Add a New Chapter to the Bankruptcy Code, Redux

Given the news of the morning, I thought I would dust off my four-month old proposal Add a New Chapter to the Bankruptcy Code.  Until we limit our dear government’s power to encourage the private sector to borrow money until it chokes, we need something that enables timely reduction of debt in TBTF (too big to fail) institutions, delevering them  with minimal impact to taxpayer and the rest of the economy.

This morning we have the following articles:

In my proposal, the Treasury Secretary would initiate the process, but then would get handed off to a special bankruptcy court for adjudication of claims.  The Treasury becomes the DIP lender, but otherwise is a minor player in the process.

Why not let the Treasury do it all?  Wouldn’t it be faster?  Yes, it would be faster, but at a price.  The current Bush/Obama administration policies have relied heavily on intelligent discretion from regulators.  We haven’t gotten that yet.  Even really intelligent regulators are men with limited time.  Even big organizations staffed with Ph.D. economists and other bright people like the Federal Reserve are less than the sum of the parts, as the bureaucracy enforces groupthink (and the Treasury is even worse).

When the Treasury Secretary or the Fed Chairman acts with discretion, there is always the charge of unfairness that can be laid at their doors.  Why is the credit of the US going to support special interests?  You say that it is for the good of the nation, but then why aren’t equity and preferred shareholders wiped out, management thrown out, and bondholders forced to compromise, and accept back equity in the new firm in exchange for their debt claims?

Our bankruptcy processes are transparent, fair, and even speedy (for what is being done) in the US; we just need to augment them for firms that pose risk to a large portion of the financial and economic systems.  But regulatory discretion in bailing out firms in this crisis has been a disaster.  Speed kills; a handoff to the bankruptcy court with the US Treasury backstopping the firm in the short run would be the best minimalist solution, stopping contagion, and allowing for an orderly resolution of competing claims under conditions transparent to the US taxpayer.