Stiglitz Calls for ‘Super Chapter 11’ to Avoid Systemic Collapse
(Bloomberg Businessweek) -- Bankruptcy laws were written to help individual companies. They don’t work so well when many get into trouble at once. The companies’ balance sheets are interdependent: Reducing what one owes will weaken its creditors, making it impossible for them to pay their creditors, and so on. Businesses that could have bounced back are forced to liquidate as their court cases drag on.
This is called systemic bankruptcy, and it’s the nightmare scenario for the financial impact of the Covid-19 pandemic. Steps can be taken to avoid it, but it’s not clear whether governments and central banks in the U.S. and around the world will take them in time.
The best way to avoid debt gridlock is to use government support to keep the number of bankruptcies below the tipping point at which they become systemic, says Joseph Stiglitz, a Nobel laureate economist at Columbia University. He co-wrote a paper with Tarik Roukny and Stefano Battiston about interconnectedness and systemic risk that was published in 2018 by the Journal of Financial Stability. “Somewhere between the case of an isolated bankruptcy (American Airlines) and mass default (Indonesia, with 70% of businesses in arrears) is the borderline between individual and systemic bankruptcy. There’s no bright line,” Stiglitz wrote in an email on April 6. (His example of an isolated bankruptcy, American Airlines, was under protection from creditors from 2011 to 2013.)
If government aid fails to stem the tide, Stiglitz says, the fallback should be what he calls “super Chapter 11”—building on the chapter of the federal bankruptcy code that’s designed to keep a company in business. It would resolve the problems of many companies at once under the auspices of a government-appointed supervisor. It would also be fast, usually keep management in place, and give more consideration to workers and less to creditors than in conventional bankruptcies, in his vision.
In some cases the federal government would inject money in return for shares, so taxpayers would get a piece of the potential upside. “This is going to be rough justice,” Stiglitz says. Companies that don’t like the government’s offer could try their luck in standard Chapter 11. He says he hasn’t been approached by anyone in Congress or the White House about implementing super Chapter 11, which he and co-author Marcus Miller broached in an unpublished paper in 1999 and again in 2010 in an article in Britain’s Economic Journal.
Systemic bankruptcy is more than a remote threat. The record jump in initial claims for unemployment insurance—10 million in the two weeks through March 27, vs. a recent two-week average of fewer than half a million—shows that companies are in extreme distress and a lot of consumers are having trouble paying bills. A handful of companies have already filed for Chapter 11 citing Covid-19, including British clothing retailer Laura Ashley Holdings Plc and U.S. energy companies Whiting Petroleum Corp. and Hornbeck Offshore Services Inc.
The underlying problem is that, as Harvard economist Lawrence Summers has put it, economic time has stopped because of the pandemic, but the financial clock continues to tick. Interest payments, rents, and other obligations are still coming due, but the money to cover them has dried up. Yet a blanket moratorium on all financial obligations isn’t the right solution. It would benefit some well-off individual and business debtors that don’t require the help and harm some who need the payments, such as an elderly homeowning couple who live off the rent from a tenant or two.
What’s needed, says David Skeel, a University of Pennsylvania Law School professor, is a yellow flag like the one waved at a Nascar race when there’s an accident. The flag doesn’t stop movement, but it locks all the cars—in this case, all the debtors and creditors—in the same order so no one gets an advantage during the pause.
The $2.2 trillion CARES Act that President Trump signed on March 27, and the monetary actions of the Federal Reserve, attempt to wave a yellow flag for the U.S. economy. The stimulus bill includes grants to families and loans to companies that will be forgiven if they don’t reduce staff. Small businesses can reorganize in Chapter 11 more easily under a new subchapter that took effect in February, and the CARES Act temporarily makes businesses with up to $7.5 million in debt eligible for the flexibility. Meanwhile, the Fed is buying Treasury securities and mortgage-backed securities to suppress borrowing costs and finding creative ways to extend a lifeline to various sectors.
It’s almost certainly not enough, though. The U.S. economy needs nothing short of life support for the duration of the lockdown, and some sectors aren’t being helped. For example, Michael Bright, chief executive officer of the Structured Finance Association, says that mortgage servicing companies—which collect payments—are caught in a vise between home and building owners who are skipping payments and the ultimate lenders, or owners of mortgage-backed securities, who continue to expect payment on the loans. “The government is kind of waiting to see how bad it gets. It’s a dangerous game they’re playing,” he says.
Companies that lack investment-grade bond ratings also have less access to help, though some are eligible for the Small Business Administration’s Paycheck Protection Program or the Federal Reserve’s forthcoming Main Street Business Lending Program. Critics say some of those debtors, such as companies that borrowed heavily to juice their investment returns in the expectation of good times, shouldn’t be bailed out. But Lee Shaiman, executive director of the Loan Syndications and Trading Association, says circumstances are so extreme that all companies should be eligible for aid, regardless of their investment rating: “I look at this as a meteor hitting the Earth. It could never have been anticipated.”
The same thing happened in the 2008-09 financial crisis, which pitted those who favored bailouts to rescue the economy against those who opposed helping fat cats. Stiglitz says a few simple rules can separate the deserving from the undeserving. Without such rules, he says, “This could be a drawn-out process. If it’s a drawn-out process, the likelihood of systemic bankruptcy increases.”
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