Sunday, August 17, 2014

Lehman Creditors Recover Another $ 4.6 Billion

Thus far, unsecured creditors of failed Lehman Brothers have recovered $ 57.1 billion according to today's Wall Street Journal.  This doesn't include more than $ 105 billion that was returned to customers in the immediate aftermath of the Lehman Bankruptcy.

What this suggests is that, had Lehman had a path to Chapter 11 bankruptcy, it may well have managed its way through and returned as a new Lehman Brothers, rather than go through liquidation.  In the 1930's, nearly a third of the banks that failed turned out to have positive net worth after liquidation, suggesting that the bank runs that put them under were purely psychological.

Similarly, it is looking more and more like what put Lehman under was psychology not economics.  The collapse of Lehman's access to the repo market in October of 2008 was the precipitate cause of Lehman's bankruptcy.  That is the modern form of a "run on the bank."

Normally, when companies can't pay their bills, there are two alternatives available to them (or, more accurately, to their creditors): 1) Chapter 7 bankruptcy (liquidation); or 2) Chapter 11 bankruptcy (recapitalization of the balance sheet reducing overall debt and ultimately emerging as a new company with a clean(er) balance sheet).  This latter process is not available to financial service companies, mainly because no one will do business with a bankrupt financial service company.

Strangely, travelers have no hesitation flying on bankrupt airlines or shopping at bankrupt stores or gaining health care at a bankrupt hospital.  But, partly by law, partly by custom, financial services entities cannot, in practice, utilize Chapter 11.

That should be changed.

There is no reason to liquidate an ongoing concern if a reorganization of the balance sheet can keep the business alive.

The current government strategy is to strangle financial service companies with regulations so that they cannot fail.  That is a sure fire way to guarantee that they will fail.

Better is to provide through legislation a Chapter 11 path, so that the Lehman Brothers of the world can operate like United Airlines -- go bankrupt but emerge healthier and wiser after bankruptcy.  Chapter 11 puts the onus on equity holders (who normally lose everything) and bond holders (who lose a lot but become partly bond holders and partly equity holders in the new company).  The taxpayers and customers are normally spared in Chapter 11.  That's the way it should be.

1 comment:

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