Secret liens and the financial crisis of 2008

American Bankruptcy Law Journal

Volumn 83, Issue 2, 2009, Pages 253-296

  Simkovic, Michael ^a  

^a HARVARD LAW SCHOOL   (United States)

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EID: 68149169205     PISSN: 00279048     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (265)

1. The opaque financial environment may also prove to be to the detriment of all taxpayers if government rescue efforts lead the government to absorb losses by overpaying for distressed securitized assets and for equity stakes in insolvent financial institutions.
2. According to the Wall Street Journal, as of November 28, 2008, the U.S. government had committed over $3.5 trillion to rescue programs. The programs include: 1) up to $350 billion in FDIC guarantees of bank issued debt; 2) $700 billion for the Troubled Asset Relief Program (used to inject capital into financial institutions including AIG, Citigroup, Bank of America, Wells Fargo, Morgan Stanley and Goldman Sachs; 3) an estimated $1.3 trillion for the Federal Reserve to buy commercial paper, effectively loaning money to companies such as GE, GMAC, and Ford Motor Credit; 4) $540 billion for the Federal Reserve to buy short term debt from money market funds; 5) $200 billion in loans so that private investors can buy securitized loans, initially limited to auto loans, credit card loans, student loans and small business loans; and 6) $600 billion in government purchases of mortgage backed securities backed by GSEs such as Fred. die Mac and Fannie Mae, as well as purchases of GSE debt. See Jon Hilsenrath and Deborah Solomon, Mortgage Rates Fall as U S. Expands Rescue , WALL ST. J., Nov. 26, 2008, at Al. Of course, there is a difference between contingent guarantees or investments and outright expenditures-the full cost of these efforts is not yet known. A more recent estimate by Special Inspector General Neil Barofsky puts the U.S.'s total commitment at just under $3 trillion, excluding aid to auto companies.
3. See Meena Thiruven. gadam, U.S. Bailouts So Far Total $2.98 Trillion, Official Says , WSJ.coM, Mar. 31, 2009, http://online. wsj.com/article/SB123851 l08664173877.html.
4. According to the Government Printing Office, total federal government receipts for 2007 were $2.4 trillion. BUDGET OF THE UNITED STATES GOVERNMENT, Fiscal Year 2007, Historical Tables, Table 1.1: Summary of Receipts, Outlays, and Surpluses or deficits: 1789-2011, available at www.gpoaccess.gov/ usbudget/fyO7/pdf/hist.pdf.
5. House Financial Services Chairman Rep. Barney Frank (D., Mass.) predicted that 2009 will be the 'best year' for public policy since the New Deal. Speaking before the Consumer Federation of America Thursday, Mr. Frank said Congress would pass a regulatory overhaul comparable to the antitrust laws of the late 19th century and the creation of the Securities and Exchange Commission in 1934." Jessica Holzer, Frank Foresees Sweeping Regulatory Overhaul , WSJ.coM, Dec. 4, 2008, http://online.wsj.com/ article/5B122842202149980375.html.
6. Leverage can refer to the ratio of debt (and off'balance sheet obligations) to equity, or to value at risk relative to capital.
7. See Franco Modigliani & Merton Miller, The Cost of Capital, Corporation Finance, and the Theory of Investment , 48 AM. ECON. REV. 261, 273 (1958) ("Economic theory and market experience both suggest that the yields demanded by lenders tend to increase with the debt-equity ratio of the borrowing firm (or individual).").
8. Peter F. Coogan, Public Notice Under the Uniform Commercial Code and Other Recent Chattel Security Laws , Including 'Notice Filing", 47 IOWA. L. REV. 289, 289 (1962).
9. Jonathan C. Lipson, Secret Liens: The End of Nonce in Cosnsnercsal Finance Law , 21 EMORY BANKR. DEV. J. 421, 429-32 (2005).
10. CIow v. Woods, 5 Serg. & Rawle 275, 1819 WL 1895 (Pa. 1819).
11. *1.
12. *1-3.
13. Id.
14. *5.
15. *4-5.
16. The emphasis in Clow on physical possession may seem strange to modern readers. At the time, physical possession and recordation were the two primary means of providing notice of ownership of tangible property. As the economy became more complex and intangible property rights proliferated, the importance of physical possession declined. See Lipson, supra note 8 at 434-35.
17. *5-6.
18. *3.
19. Id. at 10. The dire consequences Judge Duncan warned would result from secret liens sound remark' ably like recent descriptions of the financial crisis. Nobel Prize-winning economist Paul Krugman de-scribed the financial crisis as "a crisis of faith." He wrote: "[T]he ever-widening financial crisis has shaken investors' faith in the whole system. People no longer trust assurances that fancy financial instruments will function the way they're supposed to ⋯ [W]ould-be borrowers can't get credit. ⋯[Although the Federal Reserve has sharply cut the interest rate it controls over the past few weeks, the borrowing costs facing many companies and households have actually gone up." Paul Krugman, A Crisis of Faith , N.Y. TIMES, Feb. 15, 2008, at A23.
20. See 11 U.S.C. § 544(a)(l).
21. See Act of June 25, 1910, ch. 412, § 8, 36 Stat. 838, 840 (amending an act to establish uniform bankruptcy laws throughout the United States).
22. Congress stated that the strong-arm power was needed "to prevent the evil of secret liens." 45 CONG. REC. 2275 (1910).
23. The 1973 Report of the Commission on Bankruptcy Laws of the United States noted that "[o]ne of the essential features of any bankruptcy law is the inclusion of provisions designed to invalidate secret transfers made prior to the date of the filing of petition." REPORT OF THE COMMISSION ON THE BANKRUPTCY LAWS OF THE UNITED STATES, H.R. DOC. NO. 93-137, pt. I, at 18 (1973).
24. A fraudulent conveyance (or fraudulent transfer) includes a transfer for less than reasonably equivalent value while the debtor is insolvent. See 11 U.S.C. § 548(aXl)(B). Fraudulent transfers are similar to secret liens in that both involve an agreement between the debtor and a third party to the detriment of the debtor's unsecured creditors.
25. See Lipson, supra note 8 at 439.
26. Coogan, supra note 7 at 290-91.
27. See Lipson, supra note 8 at 441.
28. Id.
29. UNIF. TRUST RECEIPTS ACT, 3A U.LA.. App. I, 102-10 (2002).
30. Coogan, supra note 7 at 314-15.
31. U.C.C. § 9-502 cmt. 2.
32. See Lipson, supra note 8 at 485 n.302 (citing U.C.C. § 9-401 (2000)).
33. See Lipson, supra note 8 at 462-67.
34. See Lipson, supra note 8 at 462 n.173 (citing U.C.C. §§ 9-106, 9-104,9-105,9-107, 9-314(a) (2003)). Control security interests can be created in certain types of collateral, including deposit accounts, investment property, electronic chattel paper, and letter of credit rights.
35. Although there may be general knowledge among banks and broker dealers that other banks and broker dealers will have control security interests in debtors' accounts, creditors who are not financial institutions may be less knowledgeable. For example, vendors may mistakenly assume that they have a security interest in "proceeds" from the sale goods they supplied. See Lipson, supra note 8 at 464-65.
36. Id. at 465 (quoting U.C.C. § 9-327 cmt. 3).
37. U.C.C. § 9-342 (2000).
38. See Lipson, supra note 8 at 466 n.189.
39. Id. at 449-50 ("Case law under the strong-arm power is replete with instances of secured parties losing their security interests for reasons that appear, in retrospect, to have been nit-picky, at best, and capricious at worst. ⋯ Even under the [simplified notice requirements of the U.C.C] ⋯ [mistakes in the debtor's name, descriptions of collateral, or the place of filing have all been used against the secured party.").
40. Id. at 452-53.
41. Kenneth Kettering, Securitization and its Discontents , 29 CARDOZO L. REV. 1553 (2008)
42. Id. at 1561.
43. Id. at 1556-57.
44. Id. at 1568;
45. see also Edward J. Janger, The Death of Secured Lending , 25 CARDOZO L. REV. 1759, 1759 n.5 (2004), (discussing Grant Gilmore's "late lamented equity cushion").
46. See Kettering, supra note 40 at 1568.
47. Id.
48. See 11 U.S.C. § 362(a).
49. See 11 U.S.C. § 362(dXl).
50. See Kettering, supra note 40 at 1567 & n.33 (citing 11 U.S.C. § 506{b)).
51. The positive correlation between yield and maturity is known as the "upward sloping yield curve." Although the yield curve is occasionally flat or downward sloping, an upward sloping yield curve is more common.
52. See Kettering, supra note 40 at 1567 & n.33.
53. See 11 U.S.C. §§ 363(cX2), 363(e).
54. Id.
55. See 11 U.S.C. §364(d) (allowing the bankruptcy estate to use collateral to secure post-petition financing, with priority over a prepetition security interest, if the prepetition secured creditor's interest is adequately protected).
56. Id.
57. See Kettering, supra note 40 at 1569-70 & n.41.
58. See Janger, supra note 43 at 1769 (citing Lowell Bryan, The Risks, Potential and Promise of Securitization , A PRIMER ON SECURITIZATION 171-73 (Leon T. Kendall & Michael J. Fishman eds., 1996)).
59. See Kettering, supra note 40 at 1568-70.
60. Kettering asserts that "[substantially all of the benefits claimed for securitization are nothing more than consequences of the structure's purported avoidance of the Bankruptcy Tax, and the resulting willingness of the rating agencies to rate securitized debt on the assumption that payments thereon from collections of the securitized assets will not be interrupted by the bankruptcy of the Originator." See Kettering, supra note 40 at 1569. Kettering is skeptical of claims that securitization creates benefits through "disintermediation." He notes that banks and other traditional financial intermediaries often extend credit through securitization when the deal is large enough to bear the transactions costs (bankruptcy tax avoidance without disintermediation), and that disintermediation is possible without avoiding the bankruptcy tax. Id. at 1570. By contrast, Janger suggests that in addition to bankruptcy remoteness, securitization provides benefits through disintermediation by "making [asset-backed debt] available in smaller denominations to non-specialized investors" and by "allowing] smaller investors to enjoy the benefits of risk pooling." See Janger, supra note 43 at 1769 & n.53 (citing Steven L. Schwarcz, The Alchemy of Asset Securitization , 1 STAN. J.L. BUS. & FIN. 133, 134 (1994)). Of course, selling small quantities of credit risk to investors who have neither the expertise nor the incentive to monitor their investment might benefit debtors more than investors. See Frank Partnoy & David Skeel, Jr., The Promise and Perils of Credit Derivatives , 75 U. CIN. L. REV. 1019, 1040-41 (2007);
61. see also AMERICAN SECURITIZATION FORUM, Restoring Confidence in the Securitization Markets , Dec. 3, 2008, http://www.sifma.org/capitaL markets/docs/survey-restoring-confidence- securitization-markets.pdf at 4-5 ("The market relied too extensively on ratings that in some instances proved overly optimistic⋯ The level of complexity of products developed during the height of the market boom ⋯ exceeded the analytical and risk management capabilities of even some of the most sophisticated market participants").
62. See Kettering, supra note 40 at 1563.
63. '"See AMERICAN SECURITIZATION FORUM, supra note 58 at 24, ex. 8.
64. See id. at 38, ex. 18.
65. See Steven L. Schwarcz, The Alchemy of Asset Securitization, 1 STAN. J.L. BUS. & FIN. 133, 148 (1994).
66. There is a third possible explanation-the "non-adjusting" creditor exploitation hypothesis-that should be mentioned because of the widespread attention it has received in commercial law scholarship. According to this hypothesis, a debtor and its "adjusting" creditors (financial investors) may benefit at the expense of "non-adjusting" creditors such as tort-claimants, who cannot charge higher interest rates, through a bilateral agreement between the debtor and its adjusting creditors that adjusting creditors will receive higher priority in bankruptcy than non-adjusting creditors.
67. See Lucian A. Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy , 105 YALE L.J. 857, 891-95 (1996);
68. see also Lynn M. LoPucki, The Death of Liability, 106 YALE L.J. 1, 14 (1996) (describing debtor's use of secured debt as "the most complex and the most common of judgment-proofing strategies."). The non-adjusting creditor exploitation hypothesis was originally advanced as a possible explanation for secured credit, but works equally well as an explanation for securitised credit because both give investors higher priority than tort claimants. However, empirical studies suggest that non-adjusting creditor exploitation does not explain the pattern of secured credit, and that other factors such as reducing risk of non-payment play a larger role.
69. See Ronald J. Mann, Explaining the Pattern of Secured Credit , 110 HARV. L. REV. 625, 683 (1997) (finding that "secured credit provides borrowers with benefits that are wholly distinguishable from the cost-shifting benefits condemned in the existing scholarship. Specifically, secured credit lowers the costs of lending transactions not only by increasing the strength of the lender's legal right to force the borrower to pay, but also by enhancing the borrower's ability to give a credible commitment to refrain from excessive future borrowing and by limiting the borrower's ability to engage in conduct that lessens the likelihood of repayment.");
70. see also Yair Listokin, Is Secured Debt Used to Redistribute Value from Tort Claimants in Bankruptcy? An Empirical Analysis, 57 DUKE L.J. 1037, 1078 (2008) (finding that firms feeing high tort claims do not use secured credit more than firms facing low tort claims). The "non-adjusting" creditor exploitation hypothesis is tangential to this article as long as one accepts that the hypothesis does not fully explain the pattern of secured credit and securitization.
71. See Kettering, supra note 40 at 1564-66;
72. see also Lipson, supra note 8 at 468.
73. See Lipson, supra note 8 at 468.
74. See Kettering, supra note 40 at 1570-71;
75. see also Lipson, supra note 8 at 469-70.
76. See Kettering, supra note 40 at 1570-71;
77. see also Lipson, supra note 8 at 469-70.
78. David Enrich, Citi's Slide Deepens as Investors Bail Out, WALL ST. J., NOV. 20, 2008, at Cl.
79. Id.
80. David Enrich, Damian Paletta, Matthias Rieker & Carnck Mollenkamp, U S Agrees to Rescue Struggling Citigroup, WALL ST. J., NOV. 24, 2008, at Al.
81. Kettering describes the legal foundations of asset securitization as "shaky." See Kettering, supra note 40 at 1558.
82. See Kettering, supra note 40 at 1558 n.17, 1582 n.79 (citing In re LTV Steel Co, 274 B.R. 278, 285-86 (Bankr. N.D. Ohio 2001));
83. see also Lipson, supra note 8 at 471 & n.213.
84. Janger, supra note 43 at 1775-77.
85. See Lipson, supra note 8 at 471-72 (discussing section 912 of the Bankruptcy Reform Act of 2001, which would have excluded assets subject to qualifying transactions from the debtor's estate).
86. Id at 472.
87. See Kettering, supra note 40 at 1558;
88. see also Lipson, supra note 8 at 467 n.192 (citing DEL. CODE ANN. tit. 6 § 2701A-2703A (2004);
89. ALA. CODE § 35-10A-2(a)(l) (2004);
90. LA. REV. STAT. ANN. § 10:9-109(e) (West 2002);
91. N.C. GEN. STAT. § 25-9A-102 (2002);
92. OHIO REV. CODE ANN. § 1109.75 (Anderson 2002);
93. Tx. BUS. & COM. § 9.109(e) (Vernon 2002)).
94. See Lipson, supra note 8 at 472-73. Delaware's Asset-Backed Securitization Facilitation Statute provides that "[n]ot withstanding any other provision of law ⋯; a bankruptcy trustee ⋯ shall have no rights, legal or equitable, whatsoever to reacquire, reclaim ⋯ or recharacterize as property of the transferor any property" transferred in a securitization.
95. See DEL. CODE ANN. tit. 6 § 27O3A(a) (2004). Ketter-mg argues that state laws such as Delaware's may not be effective because federal law may govern what constitutes property of the estate. See Kettering, supra note 40 at 1581 (citing Butner v. United States, 440 U.S. 48, 55).
96. See Kettering, supra note 40 at 1573.
97. See Janger, supra note 43 at 1771-72. There are exceptions. Notice is required for sales of accounts and chattel paper, and real estate sales must be recorded in land records.
98. Id.
99. Since 1996, qualifying for off-balance sheet treatment has required that the assets in the securitization be beyond the reach of the debtor in bankruptcy. See Kettering, supra note 40 at 1573 n.50 (citing FIN. ACCOUNTING STANDARDS BD., Statement of Financial Account Standards No. 125: Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (1996)) ("SFAS 125 introduced the concept of requiring bankruptcy isolation of the securitized assets as a condition of off-balance sheet treatment.")). Bankruptcy isolation continues to be a requirement for off-balance sheet treatment. See FIN. ACCOUNTING STANDARDS BD., Statement of Financial Account Standards No. 140: Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities 3 (2008) (as amended), available at http://72.3.243.42/pdf/aop-FASl40.pdf (hereinafter "SFAS 140"). Securitizations are not completely secret so much as opaque-SFAS 140 requires disclosure in footnotes, but these disclosures may be more difficult for creditors to interpret and may allow more discretion by management than a straightforward presentation on the balance sheet.
100. See OFFICE OF THE CHIEF ACCOUNTANT ET AL., U.S. SEC. & EXCH. COMM'N, Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 on Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filing by Issuers 102 (2005), available at http://www.sec.gov/news/studies/soxoffbalancerpt.pdf (noting with disapproval that "with respect to securitizations, current standards allow issuers to structure transactions to achieve desired accounting results-that is, either sale or borrowing treatment for the items being securitized-for what are economically similar transactions").
101. See Kettering, supra note 40 at 1573.
102. See Kettering, supra note 40 at 1572 (noting that credit rating agencies such as Moody's and S&P adjust their analysis to treat securitizations as if they were on-balance sheet debt).
103. See Kettering, supra note 40 at 1572.
104. Id. at 1571.
105. Id. at 1571 n.44.
106. See Kara Scannell & Aaron Lucchetti, SEC Tightens Rules for Ratings Firms, WALL ST. J., Dec. 4, 2008, at C3. ("The SEC also didn't implement an earlier proposal that would have required the rating firms to disclose to the public all underlying information about any debt they are rating⋯New York Sen. Charles Schumer, a senior Democrat on the Senate Banking Committee, said, 'None of the rules adopted today are a substitute for the larger regulatory reform that is coming next year'⋯The three major rating firms ⋯ released statements voicing support for the new SEC rules. Others were more critical. The SEC's rules are 'baby steps' that fail to address 'the underlying problem,' said Janet Tavakoli, a structured-finance consultant in Chicago.").
107. Fees from structuring and managing asset securitizations also contributed to banks' profitability.
108. See Jason Bram, James Orr, & Rae Rosen, FEDERAL RESERVE BANK OF NEW YORK, EMPLOYMENT IN THE NEW YORK-NEW JERSEY REGION: 2008 REVIEW AND OUTLOOK 5 (2008), available at http:// www.newyorkfed.org/research/current-issues/ cil4-7.pdf (reporting that average annual salaries in the securities industry in New York was slightly less than $400,000);
109. see also Joseph A. Giannone, Goldman success brings unwanted attention, REUTERS, Dec. 17, 2007, http://www.reuters.com/article/ reuters Edge/idUSNl433734O2OO7l217 (reporting that Goldman Sachs paid bonuses averaging $600,000 per employee, double the average paid at other firms).
110. See U.S. CENSUS BUREAU, INCOME POVERTY AND HEALTH INSURANCE COVERAGE IN THE UNITED STATES: 2007 at 5 (Sept. 16, 2008) available at http://www.census.gov/prod/2008pubs/p60-235.pdf (reporting that median household income in 2007 was $50,233).
111. See Partnoy & Skeel, supra note 58 at 1041 ("The purchasers of CDO tranches typically are sophisticated").
112. The percentage of home mortgages that were securitized increased from approximately 10% in 1980 to over 55% in 2008. The percent of commercial mortgage and consumer credit loans that were securitized increased from almost nothing to over 20%. See AMERICAN SECURITIZATION FORUM, supra note 58 at 37, ex. 17.
113. Securitization grew from 32% of available US new credit issuances in 1998 to 49% in 2007. See AMERICAN SECURITIZATION FORUM, supra note 58 at 38.
114. See Kate Kelly, How Goldman Won Big on Mortgage Meltdown, WALL ST. J., Dec. 14, 2007, at Al ("[Goldman's traders'] big bet that securities backed by risky home loans would fall in value generated nearly $4 billion of profits during the year ended Nov. 30 ⋯ Those gains erased $1.5 billion to $2 billion of mortgage-related losses elsewhere in the firm.⋯ During a discussion with [mortgage department head Dan] Sparks and others, [CFO David] Viniar noted that Goldman had big exposure to the subprime mortgage market because of CDOs and other complex securities it was holding .⋯ Emerging signs of weakness in the market meant that Goldman needed to hedge its bets ⋯ Mr. Swenson and his traders began shorting certain slices of the ABX, or betting against them, by buying credit'default swaps. ⋯").
115. Id. ;
116. see also Partnoy & Skeel, supra note 58 at 1050 & n.79; Stephen J. Lubben, Credit Derivatives and the Future of Chapter 11, 81 AM. BANKR. L.J. 405, 411-12 (2007). Unlike an insurance contract, a credit default swap does not require that the protection buyer have an "insurable interest" or provide proof of actual loss, i.e., own the third party's debt at the time of default. Credit default swaps can be used to speculate (or place a "naked" bet), as well as to hedge (or place a "covered" bet).
117. Id. at 412 & n.49 (citing N.Y. INS. LAW § 3401 (McKinney 2007) ("No contract or policy of insurance on property made or issued in this state, or made or issued upon any property in this state, shall be enforceable except for the benefit of some person having an insurable interest in the property insured. In this article, 'insurable interest' shall include any lawful and substantial economic interest in the safety or preservation of property from loss, destruction or pecuniary damage.")).
118. See Lubben, supra note 96 at 411.
119. Id. at 411-412. It is not necessary that the protection buyer actually own the bonds and experience any loss.
120. Id.
121. See id. at 413 ("In a credit default swap transaction, the protection buyer ⋯ takes on the risk of concurrent default by both the protection seller and the underlying debtor.").
122. See Partnoy & Skeel, supra note 58 at 1021 n.l, 1024 n.7 (citing Alan Greenspan, Chairman Fed. Reserve, Remarks by Chairman Alan Greenspan before the Council on Foreign Relations (Nov. 19, 2002), available at http://www.federalreserve.gov/BoardDocs/Speeches/2002/ 20021119/default.htm (concluding that credit derivatives "appear to have effectively spread losses from defaults by Enron, Global Crossing, Railtrack, WorldCom [and] Swissair ⋯ over the past year ⋯ from banks, which have largely short-term leverage, to insurance firms, pension funds, or others.")). Banks used credit derivatives to hedge approximately $8 billion of risk associated with Enron debt and $10 billion of risk associated with WorldCom debt. See Partnoy & Skeel, supra note 58 at 1021 n.2.
123. Mark Pittman, Goldman, Memll Collect Billions After Fed's AIG Bailout Loans, BLOOMBERG.COM, Sept. 29, 2008, http://www. bloomberg.com/apps/news?pid=20601087&sid=aTzTYtlNHSG8&refer= home (last visited Apr, 1, 2009) (reporting that AIG paid Goldman Sachs, Merrill Lynch & Co., Morgan Stanley, and Deutsche Bank AG as much as $37 billion of federal bailout money).
124. Id.
125. See Lubben, supra note 96 at 408.
126. Id. at 408, 413.
127. Frank Partnoy and David Skeel describe the analysis used by Standard & Poor's and its investment banking clients to rate different CDO tranches as follows: The rating agency and client evaluate the tranches of a CDO using a mathematical algorithm. First, they calculate the expected cash flows of the underlying assets over time. Then they determine how those cash flows would be paid out to each tranche over time. The equity, or most junior, tranche absorbs losses up to the first "attachment point." Then the most junior mezzanine tranche absorbs losses up to the next attachment point, and so on. The rating agencies then give a credit rating to each of the tranches (but usually not to the junior tranche) based on assumptions about certain key variables, including expected default rates, recovery rates, and correlation rates among assets. This process employs sophisticated mathematical techniques. For example, a rating agency might run 100,000 computer simulations to determine the number of times a breach would occur, that is, how often a particular tranche would lose value beyond a specified level. The variable in this assessment is the number of breaches out of the 100,000 runs, not the magnitude of the breach or any qualitative analysis of the breach. For example, for a typical five-year synthetic CDO, S&P might establish a confidence interval for the AAA level of 0.284%, meaning that the particular tranche would be "breached" in 284 runs out of 100,000.
128. See Partnoy & Skeel, supra note 58 at 1030;
129. see also Hedge Funds, Systemic Risk, and the Financial Crisis of 2007-2008: Hearing Before the H. Comm. on Oversight and Government Reform Hedge Funds , llOth Cong. 26 (2008) (statement of Andrew W. Lo, Harris & Harris Group Professor, MIT Sloan School of Management), available at http://oversight.house.gov/documents/20081113101922.pdf ("Pricing [CDOs] is even more complex, involving a blend of mathematical, statistical, and financial models and computations, all of which are typically done under simplistic assumptions that rarely hold in practice, such as constant means, variances, and correlations that are measured without error.⋯ Models such as these are central to the current financial crisis, and their mis-calibration is one possible explanation for how so many firms under-estimated the risks of subprime-related securities so significantly. Unless senior management has the technical expertise to evaluate and challenge the calibrations of these models, they cannot manage their risks effectively.") (hereinafter "Lo Statement").
130. The complexity inherent in CDOs creates opportunities for sophisticated parties to profit at the expense of less sophisticated investors: "[H]edge funds and other sophisticated investors have incentives to manipulate the pricing and structuring of CDOs, and some studies suggest that CDO managers manipulate collateral in order to shift risks among the various tranches." Partnoy & Skeel, supra note 58 at 1040 (citing Kedran Rae Garrison, Manager Incentives in Collateralized Debt Obligations 6 (Aug. 15, 2005), available at http://ssrn.com/abstract=720481)).
131. The rating agency Standard and Poor's allegedly sought to accommodate its investment banking clients by rating CDO tranches without access to information about the underlying loans: In 2001, [S&P analyst Frank] Raiter was asked to rate an early collaterahzed debt obligation called "Pinstripe." He asked for the "collateral tapes" so he could assess the creditworthiness of the home loans backing the CDO. This is the response he got from Richard Gugliada, the managing director: "Any request for loan level tapes is TOTALLY UNREASONABLE!!! Most investors don't have it and can't provide it. Nevertheless we MUST produce a credit estimate.⋯ It is your responsibihty to provide those credit estimates and your responsibility to devise some method for doing so." Mr. Raiter was stunned. He was being directed to rate Pinstripe without access to essential credit data. He e-mailed back: "This is the most amazing memo I have ever received in my business career." Credit Rating Agencies and the Financial Crisis Hearing before the H Comm. on Oversight and Government Reform, 110th Cong. (2008) (statement of Rep. Henry A. Waxman), available at http://oversight. house.gov/story .asp?ID=2255.
132. See Partnoy & Skeel, supra note 58 at 1039 ("In the context of credit derivatives, counterparties also might use ambiguous terms to their advantage. For example, what is the meaning of the term 'restructuring'? If payment on a credit derivatives contract is to be made upon an event of 'restructuring,' a sophisticated counterparty might argue that the event had been triggered with respect to payments counterparties owed to it, but not with respect to payments it owed to counterparties").
133. See Peter Breuer, Measuring Off-Balance Sheet Leverage, 26 J. BANK. & FIN. 223, 236 (2002) ("It is impossible to precisely measure leverage for institutions active in derivative markets without full knowledge of their positions, including hedges.⋯ [D]ata filed by commercial banks and trust companies in the United States with the Office of the Comptroller of the Currency (OCC) allow a rough approximation. ⋯ In the absence of better data, the best approximation ⋯ is an approximation to gross leverage, rather than net leverage because it does not take into account netting across positions⋯[G]ross leverage ratios ⋯ have to be interpreted as the upper limit to the [net leverage] ratio. ⋯").
134. In the case of Lehman Brothers (which as an investment bank was regulated by the SEC, not the OCC), the lack of transparency may have led the market to overestimate the extent of Lehman's downside exposure: "A lack of disclosure on CDS exposures has frequently led the market to overestimate risks: had it been realized that settlement payments on Lehman swaps would be only $6 billion, rather than the hundreds of billions feared, much of the turmoil in debt markets could have been avoided." See THE ECONOMIST, The Great Untangling, Nov. 6, 2008, at 85-86. The difficulty of evaluating counterparty risk may be even greater when counterparties include unregulated entities with minimal disclosure requirements. See Lo Statement, supra note 106 at 3 ("Without more comprehensive data on hedge-fund characteristics such as assets under management, leverage, counterparty relationships, and portfolio holdings, it is virtually impossible to draw conclusive inferences about systemic risk posed by hedge funds.").
135. See Lo Statement, supra note 106 at 27 ("Senior management typically has little time to review the research, much less guide it, and in recent years, many quants have been hired from technically sophisticated disciplines ⋯ but without any formal training in finance or economics⋯[T]he broad-based failure of the financial industry to fully appreciate the magnitude of the risk exposures in the CDO and CDS markets suggests that the problem was ⋯ too little knowledge").
136. The derivatives market also faces significant challenges from a large backlog of unconfirmed trades. See Partnoy & Skeel, supra note 58 at 1026 (reporting an agreement among key derivatives firms to work to resolve the issue);
137. see also Stacy-Marie Ishmael, Banking Staff Face Derivatives Backlog, FIN. TIMES, Oct. 25, 2007, at 27 (reporting ongoing difficulties due to increased volumes).
138. In its 2007 Form 10-K, AIG revealed that it did not understand the value of its credit default swap portfolio. See Causes and Effects of the AIC Bathut. Hearing before the H. Comm. on Oversight and Government Reform, 110th Cong. (2008) (statement of Lynn E. Turner, former chief accountant, U.S. Sec. & Exch. Comm'n), available at http://oversight.house.gov/ documents/20081007l01007.pdf ("[C]ontrols over the AIGFP super senior credit default swap portfolio valuation process and oversight thereof were not effective. AIG had dedicated insufficient resources to design and carry out effective controls to prevent or detect errors and to determine appropriate disclosures on a timely basis.") (hereinafter "Turner Statement").
139. See Lubben, supra note 96 at 416 ("[M]any credit default swaps were assigned to new protection buyers without the prior consent of the seller. Under the terms of the ISDA Master Agreement, the prior written consent of the other party is required when its counterparty in a trade wishes to assign its position in a trade to a third party. However, this non-conforming practice has apparently been tolerated in the community. Thus ⋯ it may not be clear which creditors are protected.");
140. see also Liz Rappaport & Serena Ng, Spotlight Shines on Swap Brokers, WALL ST. J., NOV. 13, 2008, at Cl ("'Everything is supposed to be anonymous before the deal is done,' said Howard Lutnick, chief executive of Cantor Fitzgerald, which owns an interest in interdealer broker BGC. Mr. Lutnick said his brokerage customers want anonymity. If they didn't want that secrecy, they wouldn't trade through brokers.").
141. See Partnoy & Skeel, supra note 58 at 1036 ("Because swaps are structured as over-the-counter (OTC) derivatives, they are largely unregulated. Among other things, this means that the details of particular swaps often go undisclosed.");
142. see also Lo Statement, supra note 106 at 24 ("[A] simple fixed/ floating interest-rate swap contract⋯ has zero value at the start, hence is considered neither an asset nor a liability, but is an 'off-balance-sheet' item. We have learned from experience that off-balance-sheet items can have enormous impact on a firm's bottom line, hence it is remarkable
143. In response to criticism that accounting standards provided inadequate disclosures regarding derivatives, the Financial Accounting Standards Board promulgated FIN. ACCOUNTING STANDARDS BD., Statement of Financial Account Standards No. 161: Disclosures about Derivative instruments and Hedging Activities (2008), available at http://www.fasb.org/pdf/fasl61.pdf. However, there remain significant gaps in disclosure standards that limit the forward-looking, predictive value of the disclosures unless there are already clear signs of distress. "[Disclosure of] contingent features ⋯ capture[s] information about only the reporting entity's credit-nsk-related contingent features for derivatives that are in a liability position at the end of the reporting period (for example, a credit downgrade of the reporting entity). ⋯ The Board may consider in the future a separate project to enhance disclosures about credit-indexed derivatives such as credit default swaps")
144. See id. at 35.
145. See Partnoy & Skeel, supra note 58 at 1036 ("ISDA has actively resisted disclosure of credit default swap documentation, insisting that this information is proprietary"). Some industry participants have recently suggested moving credit default swaps to an exchange, which might somewhat improve transparency with respect to credit default swaps, but not any other OTC derivative contracts. See THE ECONOMIST, supra note 109 at 85-86 ("Federal regulators ⋯ are circling [the credit default swaps market]. Dealers are hoping to head them off with a series of initiatives, which have been stepped up recently at the prompting of the Federal Reserve. Chief among them is the creation of a central clearing house for credit derivatives. Several groups, including a dealer-backed venture led by Intercontinental Exchange and a tie-up between CME Group, another exchange operator, and Citadel, a hedge fund, are vying for licenses. One or more is likely to be awarded in the next few weeks").
146. [D]erivative positions (such as futures and options) allow the investor to earn the return on the notional amount underlying the contract by committing a small portion of equity in the form of initial margin or option premium payments."
147. See Breuer, supra note 109 at 225.
148. Derivatives enhance "the ability of highly leveraged institutions to accumulate leverage off the balance sheet and thus their ability to elude the scrutiny of supervisors and ⋯ counterparty due diligence . ⋯"
149. Id. at 224.
150. "The most striking feature ⋯ is that total gross off-balance-sheet leverage of the top 25 U.S. commercial banks exceeds total on-balance-sheet leverage by a wide margin ⋯ a factor as large as 16, with total gross leverage reaching a level as high as 97"
151. Id. at 237-38.
152. Id. at 224 & n.l ("[Failed hedge fund] LTCM's on-balance sheet leverage may have conveyed a misleading picture: News reports indicate that its on-balance sheet leverage ratio moved from a factor of 25 to 167 at the height of the collapse while its (undefined) off-balance sheet leverage ratio moved from a factor of 270 to 2100").
153. Id. at 225-26.
154. "See John M. Halstead, Shantaram Hegde & Linda Schmid Klein, Orange County Bankruptcy. Financial Contagion in the Municipal Bond and Ban\ Equity Markets, 39 FIN. REV. 293, 294 (2004) ("On December 6, 1994, Orange County, California became the largest municipality in U.S. history to declare bankruptcy. This bankruptcy is prominent not only because of its unprecedented loss of $1.7 billion, but also because it was caused by a highly leveraged derivatives strategy rather than by fundamental cash flow problems of tax revenue shortages and excess spending.").
155. See Shmuel Vasser, Derivatives in Bankruptcy, 60 BUS. LAW. 1507, 1508 (2005) (citing Philip Mc-Bride Johnson, DERIVATIVES: A MANAGER'S GUIDE TO THE WORLD'S MOST POWERFUL FINANCIAL INSTRUMENTS ix (1999));
156. see also Howard Chua-Eoan, Crimes of the Century: The Collapse of Banngs Bank, 1995, TIME.COM, http://www.time.com/time/2OO7/ crimes/18.html (last visited Mar. 30, 2009).
157. See Franklin R. Edwards & Edward R. Morrison, Derivatives and the Bankruptcy Code. Why the Speaal Treatment?, 22 YALE J. ON REG. 91, 99-100 (2005).
158. Id.
159. James B. Kelleher, Buffett's "time bomb" goes off on Wall Street, REUTERS, Sept. 18, 2008, http://www.rcuters.com/article/ newsOne/idUSN 1837154O2OO8O918?pageNumber= l&virtualBrandChan-nel=0 (last visited Mar. 30, 2009).
160. AIG, FORM 10-K at 179 (2007), http://media.corporate-ir.net/ media-files/irol/76/76115/pdf/10K-pdf.pdf ("AIG has issued unconditional guarantees with respect to the prompt payment, when due of all present and future payment obligations and liabilities of AIGFP arising from transactions entered into by AIGFP.").
161. See Kelleher, supra note 121.
162. See Dean Foster & H. Peyton Young, The Not-So-Real McCoy, INSTITUTIONAL INVESTOR, Dec. 15, 2008, available at http://www.iimagazine.com/alpha/Alpha/Articles/2073776/FEATURES/ The-Not-So-Real-McCoy.html ("Let's say you want to deliver a performance record ⋯ [that will] attract large amounts of money [to your fund]. In fact, it is surprisingly easy to duplicate this performance using the piggybacking strategy as long as investors can't see your positions, and as long as you are willing to accept a small annual probability that your fund could go bust.").
163. Id. ("Here's how to do it: At the start of the year, invest all your funds in the S&P 500. Once a year take a short position in a bundle of asset-or-nothing puts on the S&P 500 that have a nearby expiration date. (An asset-or-nothing put pays out one share of the index if and only if the closing price is less than the strike price on the expiration date. You can create such a derivative by combining a plain-vanilla European put with a cash-or-nothmg put, both of which are routinely traded on exchanges.) Let a be the target amount by which you plan to inflate your total return over the next 12 months-the amount of fake alpha. For example ⋯ you would take α = 0.07, which will generate an annual return that is 7 percent higher than the return on the S&P 500. Once you have established the target value of a, choose the strike price so that the options are exercised with probability α(l + α). In our present example, the strike price would be chosen so that the probability of exercise is approximately 0.07/1.07 = 0.065, or 6.5 percent. Now go short the maximum number of puts you can cover. The idea is to go for broke: If the puts are exercised, the fund will be cleaned out; but if they are not exercised, you will increase the number of shares in the fund by the factor (1 + α). In the latter case you just sit back and wait until the end of the year (or any 12-month period), at which time you report that the fund grew by a factor of (1 + α) times the total return on the S&P 500 in that year. (During the entire time you have been fully invested in the S&P 500, which you used as collateral on your options position.) To the investors it looks as if you generated excess returns, and you collect a substantial performance fee. In reality you took a gamble and got lucky.").
164. Id. ("[S]teady growth might look a bit suspicious, but you could dress it up by targeting a value of alpha that varies from one year to the next . ⋯").
165. Id. ("A mimic can set up shop and pad the returns on the S&P 500 by an extra 7 percentage points a year. After five years he will collect his performance fee with a probability of more than 70 percent. If the fee is postponed for ten years, he will collect it with a probability of more than 50 percent.⋯ In five years such a fund will more than double; in ten years it will more than quadruple.").
166. See Jonathan Keath Hance, Derivatives at Bankruptcy: Lifesavmg Knowledge for the Small Firm , 65 WASH. & LEE L. REV. 711, 721-22 (2008) ("Dealers primarily include large commercial investment banks whose goal is to make money by collecting premiums and other up-front fees while end-users typically include entities seeking 'to shift certain market risk associated with the company's assets or liabilities to the dealer.'") (internal quotations omitted).
167. See also id at 722 n.62 ("As a result of acquiring additional risk from an end-user in the derivative transaction, the dealer will, in turn, hedge that market risk by entering into additional agreements with third parties") (citing Mark A. Guinn & William L. Harvey, Taking OTC Derivative Contracts as Collateral, 57 Bus. LAW. 1127, 1129, n.7 (2000)).
168. The comparison between derivatives dealers and casinos is not completely accurate because regulations generally prohibit the use of gambling as a hedge, whereas derivatives can be used to hedge (or offload) existing risks.
169. See Thomas Lee Hazen, Disparate Regulatory Schemes for Parallel Activities- Securities Regulation, Derivatives Regulation, Gambling, and Insurance, 24 ANN. REV. BANKING & FIN. L. 375, 408 (2005) ("[FJutures, options, and other derivatives contracts are treated as bona fide investment vehicles rather than being regulated as differences contracts or other types of gambling. This is in part because derivatives, unlike gambling, are viewed as providing a useful hedging device for at least some market participants").
170. Regulators permit speculation in derivatives markets because speculation facilitates hedging. Id. at 436. ("[O]ne answer to the charge that derivatives are nothing more than legalized gambling is that they provide legitimate hedging opportunities for investors and, more importantly, for commercial participants in the underlying commodities markets. It also is often pointed out that speculators help make markets more efficient by providing additional liquidity, which in turn performs a price discovery function. Commercial participants in the public commodities and derivatives markets (designated contract markets) may thus be relying on speculators to provide them with efficient markets for their hedging activities.").
171. However, under a more consistent regulatory regime, gambling could also serve as a hedge for at least some market participants. Id. at 434-36 ("Consider, for example, merchants in a city hosting major league baseball who have recently enjoyed great success in the fall as a result of the home team making it through divisional playoffs and into the World Series. The merchants clearly have a legitimate interest in hedging against lost sales due to the absence of a post season event. ⋯ [T]o the extent that attendance will increase even during the regular season according to the team's success, there could be an interest in hedging against losses on a daily basis.⋯ Presumably, these hedging contracts against a loss in revenues occasioned by losing a game would constitute illegal gambling.").
172. Entrepreneurs have recently closed the gap between permissible derivatives and illegal gambling, creating a "futures market" for tickets to championship sporting events. Because the contracts are tradable, they permit risk exposures essentially identical to wagers on the outcomes of individual games. See Alan B. Krueger, Wait Till Jiext rear, but Lock In the Ticket Price Now, N.Y. TIMES, Feb. 2, 2006, at C3, available at http://www.nytimes.com/2006/02/02/business/02scene.html?ex= 1296536400&en=ldadc O87aal4ece8&ei=5O88&partner=rssnyt&emc=rss (last visited Apr. 2, 2009) C[T]he weekly gambling odds from SportingbetUSA explained 96 percent of the variability in [sports] futures prices").
173. See Hance, supra note 128 at 722 ("OTC derivatives place the risk of default not on the exchange but on the individual actions of the OTC counterparty. Performance risk, therefore, remains a paramount concern to parties entering into OTC derivatives.").
174. See Rhett G. Campbell, Financial Markets Contracts and BAPCPA, 79 AM. BANKR. L.J. 697, 712 (2005) ("A cynic might argue that the financial safe harbors are indeed a "bankruptcy opt-out clause" for a certain class of capitalists because their money is more important than everyone else's. Does that mean that Chapter 11 reorganization rules apply to the average company but not to those who deal in sophisticated financial instruments? At what point does a class of financial instruments or market group become so important that the threat of being mired in bankruptcy sufficiently threatens world financial markets and, as a result, traditional Chapter 11 rules ought not applyr);
175. see also Edwards & Morrison, supra note 119 at 122 ("Our analysis, however, should worry members of Congress and legislators in other countries. They have been lobbied heavily by special interest groups (such as ISDA) to expand the special treatment of derivatives on grounds that such legislation is necessary to prevent a systemic meltdown in OTC derivatives markets should a derivatives counterparty suffer financial distress. Our analysis casts serious doubt on this proposition. Systemic risk may be a real threat, but bankruptcy law has no role to play in minimizing it.").
176. See H.R. REP. NO. 97-420, at 2 (1982) as reprinted in 1982 U.S.C.C.A.N. 583, 584 ("[T]he Bankruptcy Code (92 Stat. 2549; Public Law 95-598), as enacted in 1978, expressly provides certain protections to the commodities market to insure the stability of the market. These protections are intended to prevent the insolvency of one commodity firm from spreading to other brokers or clearing agencies and possibly threatening the collapse of the market"). Subsequent amendments contained similar language about mitigating systemic risk by protecting the solvency of derivatives dealers.
177. See Edward R. Morrison & Joerg Riegel, Financial Contracts and the J^ew Bankruptcy Code. Insulating Markets from Bankrupt Debtors and Bankruptcy Judges, 13 AM. BANKR. INST. L. REV. 641,642 n.14 (2005) (citing H.R. REP. NO. 109-31 at 3 (2005) (justifying amendments to Code as "provisions designed to reduce systemic risk.")).
178. See supra notes 43-54 and accompanying text.
179. See Edwards & Morrison, supra note 119 at 91 C[T]he Bankruptcy Code ⋯ contains numerous provisions affording special treatment to financial derivatives contracts, the most important of which exempts these contracts from the 'automatic stay' and permits counterparties to terminate derivatives contracts with a debtor in bankruptcy and seize underlying collateral. No other counterparty or creditor of the debtor has such freedom; to the contrary, the automatic stay prohibits them from undertaking any act that threatens the debtor's assets.").
180. See Vasser, supra note 118 at 1525 & nn. 110-16 (citing 11 U.S.C. §§ 365(e)(l), 541(c)(l) (prohibiting ipso facto clauses). Derivatives are exempt under the following provisions: 11 U.S.C. § 555 (exception for securities contracts);
181. 11 U.S.C. § 556 (exceptions for forward and commodities contracts);
182. 11 U.S.C. § 559 (exceptions for repos);
183. 11 U.S.C. § 560 (exceptions for swaps);
184. and 11 U.S.C. § 561 (exception for master netting agreements). Contracts for extension of credit enjoy a similar exception. See Edwards & Morrison, supra note 119 at 111 n.83 (citing 11 U.S.C. § 365(c)(2)).
185. See Campbell, supra note 131 at 697 n.3 (citing 11 U.S.C. §§ 362(b)(6)-(7), 546(e)-(g), 555, 556), 705-709. There are also exceptions for derivatives. See 11 U.S.C. §§ 362(b)(17), (27).
186. See Edwards & Morrison, supra note 119 at 95-96 ("Generally, when a debtor firm enters bankruptcy, it is party to many ongoing ('executory') contracts, in which the debtor and its counterparties have continuing obligations to each other. Some of these contracts will be profitable to the debtor (they are 'in the money'); others will not be (they are 'out of the money'). The automatic stay prevents counterparties from taking any step to terminate these ongoing contracts. Instead the debtor has an exclusive right to 'assume' profitable contracts and 'reject' (i.e., breach) unprofitable ones, the consequence being that the counterparty to the 'rejected' contract will receive an unsecured claim for damages, which will usually be paid a few cents on the dollar. In other words, the Bankruptcy Code generally allows debtors to 'cherry pick' profitable from unprofitable contracts.").
187. The extensive rights of derivatives dealers to setoff through cross-product netting and to terminate contracts upon the debtor's bankruptcy prevent this sort of "cherrypicking."
188. See id. at 96 ("This cher-rypicking power comes to an end, however, when the underlying contracts are derivatives contracts. Thanks to an exemption from the automatic stay, derivatives counterparties typically may terminate ongoing contracts when a debtor enters bankruptcy. Moreover, if a counterparty has entered multiple derivatives contracts with the debtor, the counterparty can set-off in-the-money contracts against out-of-the-money contracts. (The process of terminating and setting-off contracts is often termed 'close-out netting.') Finally, if a debtor posted margin or other collateral to support its obligations under these contracts, the counterparty is free to seize it to the extent that the debtor is a net obligor to the counterparty. In other words, thanks to an exemption from the automatic stay, derivatives counterparties can minimize their exposure to losses arising from the insolvency of a debtor. If the debtor has posted collateral sufficient to cover its obligations, the exemptions from the automatic stay effectively eliminate a counterparty's exposure to loss").
189. However, critics contend that extensive rights to netting and termination for derivatives have created a reverse situation in which non-debtor counterparties can cherrypick contracts to net, terminate other contracts, and drain cash from the bankrupt debtor. See Campbell, supra note 131 at 706 & n.56 (citing Bankruptcy Reform Act of 1999 (Part HI) Hearing on HR. 833 Before the Subcomm. on Commeraal and Admin. Law of the H. Comm. on the Judiciary, 106th Cong. 369 (1999) (statement of Prof. Randal Picker, University of Chicago Law School, on behalf of the National Bankruptcy Conference), available at http:// commdocs.house.gov/committees/ judiciary/hju63847-OOO/hju63847-Of.htm).
190. See Morrison & Riegel, supra note 132 at 646 & n.32. (citing 11 U.S.C. § 546(e) (declaring that, unless payment is fraudulent transfer under § 548(aXlXA), trustee cannot use his powers under §§ 544, 545, 547, 548(a)(l)(B), and 548(b) to avoid margin or settlement payments by or to protected parties to commodity, forward, and securities contracts prior to case commencement);
191. 11 U.S.C. § 546(f)) (offering same safe harbor for margin or settlement payments in connection with repurchase agreements);
192. 11 U.S.C. § 546(g)) (offering same safe harbor for transfers under or in connection with swap agreements));
193. see also Vasser, supra note 118 at 1534 & n.184 ("Protection is supplemented by Bankruptcy Code sections 548(dX2)(B), (C), (D) and (E) providing that protected parties that receive margin or settlement payments are deemed to have provided value.").
194. See supra notes 46-54 and accompanying text. Although lenders with executory contracts to extend credit may terminate those agreements upon bankruptcy, ordinary lenders who have already extended credit enjoy relatively limited rights of setoff. Prepetition payments to secured creditors on the eve of bankruptcy are voidable as preferences to the extent that these payments place creditors in a better position than they would have been in bankruptcy. The automatic stay prevents secured creditors from seizing and liquidating collateral.
195. See Edwards & Morrison, supra note 119 at 96 ("If the debtor has posted collateral sufficient to cover its obligations, the exemptions from the automatic stay effectively eliminate a counterparty's exposure to loss.").
196. See supra notes 71-77 and accompanying text.
197. PUB. L. No. 109-8, 119 STAT. 23.
198. See Morrison & Riegel, supra note 132 at 641 ("The reforms of 2005 direct judges to apply a formalistic inquiry based on industry custom: a financial transaction is a 'swap,' 'repurchase transaction,' or other protected transaction if it is treated as such in the relevant financial market. The transaction's loan-like features or its effect on outstanding obligations of the debtor are irrelevant, unless they affect the transaction's characterization in financial markets. Absent fraud, form trumps substance"), 656-57 ("Absent badges of fraud ⋯ [a] combination of financial contracts, even one that mimics a loan, merits protection if the underlying contracts fall within formal categories explicitly protected by the Code. This follows directly from the text of the new Code. It protects not only any transaction that a market participant would call a 'swap,' 'repo,' 'forward,' 'commodity contract,' or 'securities contract,' but also any combination of such transactions. No exception is made for combinations that, in effect, resemble a loan. Additional support for this conclusion can be found in the new definition of'securities contract,' in section 741(7). It extends protection to 'any other agreement or transaction that is similar to' those mentioned elsewhere in the definition, including 'repurchase or reverse repurchase transactions.' Thus, a combination of agreements that resembles a repo would seem to merit protection, even if it exhibits loan-like features. The new Code, in other words, places form over substance in characterizing protected transactions. A combination of contracts merits protection-regardless of its underlying economics-if the contracts are commonly recognized in the marketplace as swaps, forwards, or another type of contract protected by the Code. Indeed, margin loans -loans secured by the debtor's securities portfolio-are now explicitly protected even though they are, in form and in substance, simply loans.") (emphases in original).
199. See Calyon New York Branch v. American Home Mortgage Corp. (In re American Home Mortgage, Inc.), 379 B.R. 503, 516-17 (Bankr. D. Del. 2008) (The reference to 'repurchase and reverse repurchase transactions' is intended to eliminate any inquiry under section 555 and related provisions as to whether a repurchase or reverse repurchase transaction is a purchase and sale transaction or a secured financing. ⋯ Succinctly stated, if the definition of 'repurchase agreement' is met, the section 559 safe harbor provisions apply, period.").
200. See Jeanne L. Schroeder, A Repo Opera- How Crumi Mae Got Repos Backwards, 76 AM. BANKR. L.J. 565, 567 (2002) (discussing In re Criimi Mae, Inc., 251 B.R. 796 (Bankr. D. Md. 2000)). Although repos are sometimes referred to as "financial market contracts" rather than "derivatives," repos are referred to as "derivatives" throughout this article because they receive essentially the same treatment in bankruptcy as derivative contracts such as forwards, futures, and swaps.
201. See Morrison & Riegel, supra note 132 at 641. Repos are equivalent to a forward contract combined with a cash transaction.
202. See THE ECONOMIST, supra note 109 C[Fr the] big dealers, such as Goldman Sachs and JPMor-gan ⋯ estimates of⋯ total revenue related to CDSs run as high as $30 billion a year.");
203. see also Carrick Mollenkamp & Charles Fleming, Why Students Of Prof. El Karoui Are In Demand, WALL ST. J., Mar. 9, 2006, at Al ("On average, revenue from derivatives based on stocks now accounts for about 30% of an investment bank's total revenue from stock-related businesses, according to a Citigroup Inc. report issued in January.").
204. For a brief history of the growing exceptions for derivatives, see Hance, supra note 128 at 737-759.
205. Id. at 737-38.
206. Id. at 753-55;
207. see also Kettering, supra note 40 at 1710 ("Congress has provided broad exceptions from most of the ordinary consequences of bankruptcy for various classes of financial markets contracts, and has seen fit to add to those favored classes from time to time. The Bankruptcy Code of 1978 gave that privileged treatment to 'commodity contracts' and 'forward contracts'; to these favored classes were added 'security contracts' in 1982, 'repurchase agreements' in 1984, and finally 'swap agreements' in 1990").
208. See Morrison & Riegel, supra note 132 at 651 ("[BAPCPA included] massive changes to the defini-tion of'swap agreement.' Old section 101(53B) defined it as a swap involving currencies, interest rates, commodities, or 'any other similar agreement,' including 'any combination of or 'master agreement for' such agreements. The newly amended definition covers these transactions as well as options, forwards, and futures involving the same subject matter. Additionally, a 'swap agreement' now includes swaps, options, forwards, and futures on debt or equity and various other derivative products, such as credit swaps, total return swaps, and weather options. And there is the familiar opening clause, making clear that nearly all 'similar' agreements are covered as well. These amendments do much more than simply expand the list of protected swaps. They expand it to include virtually every contract traded in derivatives markets.⋯ It is difficult to imagine a derivative that would not be encompassed by section 101(53B).");
209. see also Hance, supra note 128 at 754-55 ("Congress determined that the term 'swap agreement' was too limited to address the evolving nature of derivatives agreements. ⋯ Protected 'swap agreements' now include 'any agreement or transaction that is similar to any other agreement or transaction referred to in [§ 1O1(53B) of the Bankruptcy Code] and that is of a type that has been, is presently, or in the future becomes the subject of recurrent dealings in the swap markets.'" (citing 11 U.S.C. §§ 101(53B)).
210. See Hance, supra note 128 at 715 & nn. 17-18 (citing INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, Summaries of Mar\et Survey Results, 2006, available at http://www.isda.org/statistics/ recent.html;
211. Emil E. Henry Jr., Assistant Sec. of the Treasury, Remarks Before the Fixed Income Forum: Hedge Funds and Derivatives Markets: History, Issues, and Current Initiatives (Mar. 9, 2006)).
212. See Morrison & Riegel, supra note 132 at 650-52 ("With respect to forward, commodity, and securities contracts, the original Code singled out particular parties for protection-a 'commodity broker, forward contract merchant, stockbroker, financial institution, or securities clearing agency.'⋯ [However amendments under BAPCPA] expand the list of protected swaps ⋯ to include virtually every contract traded in derivatives markets ⋯ [T]hese amendments also extend the Code's protections to every counterparty to a derivatives contract because the definition of 'swap participant'⋯ encompass[es] any entity that 'at any time before the filing of the petition, has an outstanding swap agreement with the debtor.' As a result, the amendments to 'swap agreement,' move the Code from protecting particular parties (to forwards and commodity contracts) to protecting entire derivatives markets.");
213. but see Ketter-ing, supra note 40 at 1711 C[T]he Bankruptcy Code limits the availability of these benefits to particular kinds of counterparties. In the case of securities contracts, commodity contracts, and forward contracts that limitation has some bite, as the Bankruptcy Code generally limits the full range of benefits to nar-rowly-circumscnbed classes of financial professionals (though the 2005 amendments expanded the class of protected counterparties to include any sufficiently large and active participant in financial market contracts of the protected types).").
214. See INTERNATIONAL MONETARY FUND (IMF), Global Financial Stability Report. Containing Systemic Risks and Restoring Financial Soundness, Apr. 2008, at 79 Table 2.3, available at http://www.imf.org/external/pubs/ft/gfsr/2008/01/pdf/text.pdf (showing a sharp increase in participation by hedge funds in the credit default swap market relative to banks between 2004 and 2006. Hedge funds increased from 16% of protection buyers to 28%, while banks declined from 67% to 59%. Similarly, Hedge Funds increased from 15% of protection sellers to 31%, while banks declined from 54% to 43%.).
215. Virtually all derivatives combine extensions of credit with directional bets. For example, if an investor wants to place a leveraged bet that stock X will increase in value, he can either borrow money and buy stock X or he can sell put options and buy call options on stock X. Either series of transactions combines a directional bet with leverage to produce a range of potential gains or losses that is much greater than the size of the initial investment. However, it is possible to structure a series of derivatives contracts in which the directional bets cancel each other out, leaving only an extension of credit. The simplest example is a cash sale combined with a futures contract (i.e., a repo). For additional examples of such derivatives-as-loans structures, see Morrison & Riegel, supra note 132 at 658 n.109, 660 n.119. To the extent that an investment bank acts as a pure market-maker in the derivatives market rather than a directional player-in other words, the bank enters back-to-back transactions that cancel each other out- the investment bank can reduce its own financing costs by requiring counterparties to both transactions to post collateral. From the perspective of the investment bank, the collateral is an interest-free short-term callable loan, similar to a checking account (or demand deposit) for a retail bank. The investment bank bears no market risk. Unfortunately for the bank, however, it aggregates counterparty risk.
216. See supra notes 128-130 and accompanying text.
217. See supra note 102 and accompanying text.
218. A protection seller receives small upfront payments, and possibly periodic fees, in return for taking on the risk that at some future time, the protection seller may have to make a relatively large payment to protection buyers. The difference between a credit default swap and a loan is that the repayment amount and date are contingent on a credit event. Put differently, AIG mixed borrowing with a directional bet.
219. See Morrison & Riegel, supra note 132 at 653 ("Many financial contracts have a credit component; one party temporarily extends credit to the other."), 641 (u[F]orm trumps substance-a desirable outcome, we argue, in light of the impossibility of drawing coherent lines between combinations of ordinary financial contracts and loans, dividends, or debt repurchases.").
220. AIG did not disclose the identities of its credit default swap counterparties until March 15, 2009, roughly six months after the government's initial $85 billion aid package (later expanded to over $170 billion). The disclosures came amid intense criticism of a lack of transparency regarding the use of bailout funds and of executive pay at AIG. See Liam Pleven, Serena Ng & Sudeep Reddy, AIG Faces Growing Wrath Over Payouts , WALL St. J., Mar. 16, 2009, at Al. Even so, AIG emphasized that "disclosure of the counterparties does not change AIG's commitment to maintaining the confidentiality of its business transactions. Our decision to disclose these transactions was made following conversations with the counterparties and the recognition of the extraordinary nature of these transactions."
221. See AIG NEWS RELEASE, AIG Discloses Counterparties To CDS, GIA and Securities Lending Transactions , Mar. 15, 2008, at 2 (internal quotations omitted) available at http://www.aig.com/aigweb/ mternet/en/files/ Counterpartiesl50309RELonly-tcm385-155648.pdf. The disclosures revealed that roughly $50 billion in federal aid was paid to credit default swap counterparties from September to December 2008. Roughly $22.4 billion was paid from AIGFP and $27.1 billion was paid from Maiden Lane III, an entity created by AIG and the Federal Reserve in November 2008 to assist in winding down AIGFP's CDS contracts.
222. See AIG, Form 10-K (2007) supra note 122 at 33 ("Approximately $379 billion of the $527 billion in notional exposure on AIGFP's super senior credit default swap portfolio as of December 31, 2007⋯").
223. See Robert Pickel, Net exposure is the best guide to derivatives' market impact, FIN. TIMES, Jan. 29, 2008, at 22, available at http://www.ft.eom/cms/s/0/80fOe842-ceOc-lldc-9e4e- 000077b07658.html? nchck-check=l (last visited Apr. 2, 2009) ("[Conventional market use of economically offsetting positions [in credit default swap contracts] ⋯ reduces the amounts at stake sharply. ⋯ [T]he $50,000bn 'notional' or nominal amount [of CDS outstanding] is just that; a nominal figure that references the "underlying' bonds and loans being protected by use of credit derivatives. Focus on the net exposure of these transactions, many of which hedge or offset one another. A recent Fitch Ratings survey estimates net exposure at less than $l,000bn"). Robert Pickel is the CEO of ISDA.
224. See id. at 22 ("[N]ot all defaults occur suddenly. A market participant that has written net protection will probably have an opportunity to manage its position in response to what is usually a gradual decline in creditworthiness by the reference entity. While this does not alter the net amount of protection written, it clearly reduces the financial impact on that individual participant of the entity's default.").
225. See Turner Statement, supra note 110 at 3-6 ("[T]ime and time again AIG has failed to provide the requisite transparency to its investors. ⋯ If one follows the disclosures made by the company, they ⋯ raise questions. For example, in AIG's June 30, 2007 quarterly filing, the company disclosed:'⋯ a downgrade of AIG's long-term senior debt ratings to 'Aa3' by Moody's or 'AA-' by S&P would permit counterparties to call for approximately $847 million of collateral.' ⋯ But just six months later in its annual report, the company [made disclosures that seriously called into question the earlier disclosures] as the company disclose[d] (1) that counter parties have questioned the company's valuations and (2) required $5.3 billion in collateral, as opposed to the $847 million amount disclosed earlier. ⋯ Six months later, AIG disclosed in its June 30, 2008 quarterly report that AIGFP had posted collateral ⋯ in an aggregate net amount of $16.5 billion [and faced] unrealized market valuation losses of $26.1 billion In one year, the disclosures from the company had gone from not losing a dollar to over $26 billion in valuation losses and counter parties that to this day have not been disclosed demanding over $16 billion in collateral. And on October 3, 2008 the Company disclosed that at the end of September it had borrowed $61 billion from the federal government due to the liquidity crisis such calls on collateral had placed on AIG. Clearly it would seem that in light of this, the company had failed to provide investors with a clear view of the magnitude of the potential demands for collateral").
226. Id.
227. See Mollenkamp & Siconolfi, supra note 157 ("The Fed first stepped in to rescue AIG in mid-September with an $85 billion loan when the collateral demands from banks and losses from other investments threatened to send the firm into bankruptcy court. A bankruptcy filing would have created losses and problems for financial institutions ⋯ that were relying AIG to insure them. ⋯ By November, AIG had used up a large chunk of the government money it had borrowed to meet counterparties' collateral calls and began to look like it would have difficulty repaying the loan. On Nov. 10 the government stepped in again with a revised bailout package. This time, the Treasury said it would pump $40 billion of capital into AIG in exchange for interest payments and proceeds of any asset sales, while the Fed agreed to lend as much as $30 billion to finance the purchases of AIG-insured CDOs at market prices."). Total government aid to AIG has since increased to over $170 billion.
228. See Liam Pleven, Serena Ng & Sudeep Reddy, AIG Faces Growing Wrath Over Payouts, WALL ST. J., Mar. 16, 2009, at Al.
229. See Lynn M. LoPucki & Joseph W. Doherty, Bankruptcy Fire Sales, 106 MICH. L. REV. 1, 3-4 (2007) ("We compared the prices for which thirty large public companies were sold with the values of thirty similar companies that were reorganized in the period 2000 through 2004. We found that companies sold for an average of 35% of book value but reorganized for an average fresh-start value of 80% of book value and an average market capitalization value-based on post-reorganization stock trading-of 91% of book value. Even controlling for the differences in the prefiling earnings of the two sets of companies, sale yielded less than half as much value as reorganization. These results suggest that creditors and shareholders can more than double their recoveries by reorganizing large public companies instead of selling them").
230. See Ben S. Bernanke, Stabilizing the Financial Markets and the Economy, Speech at the Economic Club of New York (Oct. 15, 2008), http://www. federalreserve.gov/newsevents/speech/bernanke 2O081015a.htm (last visited Apr. 13, 2009) ("In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure would have severely threatened global financial stability and the performance of the U.S. economy. We also judged that emergency Federal Reserve credit to AIG would be adequately secured by AIG's assets. To protect U.S. taxpayers and to mitigate the possibility that lending to AIG would encourage inappropriate risk-taking by financial firms in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm's owners, managers, and creditors.").
231. Several critics, including former AIG Chairman and CEO Maurice "Hank" Greenberg, have suggested that AIG shareholders and taxpayers would have been better off if AIG had declared bankruptcy, and that the primary beneficiaries of the bailout are AIG's credit default swap counterparties.
232. See Causes and Effects of the AIG Bailout: Hearing before the H. Comm. on Oversight and Government Reform, 110th Cong. 8 (2008) (statement of Maurice R. Greenberg), available at http://oversight.house.gov/documents/ 20O81OO71O1332.pdf ("It was not necessary to wipe out virtually all of the shareholder value held by AIG's millions of shareholders, including tens of thousands of employees and many more pensioners and other Americans on fixed incomes. Those millions of Americans could have fared better if AIG had filed for bankruptcy protection, since they would at least have had the chance of recouping value on their investments in AIG over the longer term. Bankruptcy would not have had to affect AIG's sound operat-ing companies because the bankruptcy could have been limited to the parent company and impaired subsidiaries. Although AIG stockholders could have fared better if the company had filed for bankruptcy protection, other stakeholders-like AIG's Wall Street counterparties in swaps and other transactions-would have fared worse. Those transactions would have been frozen in a bankruptcy rather than gradually unwound. Although that result could have posed systemic risk absent a broader federal bailout, it's not clear that dismantling AIG was a better solution. Nor is it clear why, in designing a federal response to AIG's short-term liquidity problem, some AIG stakeholders were prioritized over others.");
233. see also Carol D. Leonnig, Effectiveness of AIG's $143 Billion Rescue Questioned, WASH. POST, NOV. 3, 2008, at A18, available at http://www.washingtonpost.com/wp-dyn/content/ article/2008/ll/02/AR2008110 202150.html.
234. See supra notes 164-165.
235. Although derivatives have many advantages over secured loans, obligations under derivatives contracts remain vulnerable to losses in bankruptcy to the extent that the debtor has not posted collateral and the non-bankrupt counterparty does not have an obligation to the debtor that it can setoff.
236. See 11 USC § 544 (bXl) C[T]he trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title");
237. 11 USC § 502(GX2) ("A claim for damages calculated in accordance with section 562 shall be allowed under subsection (a), (b), or (c), or disallowed under subsection (d) or (e), as if such claim had arisen before the date of the filing of the petition.");
238. 11 USC § 502(H) ("A claim arising from the recovery of property under section 522, 550, or 553 of this title shall be determined, and shall be allowed under subsection (a), (b), or (c) of this section, or disallowed under subsection (d) or (e) of this section, the same as if such claim had arisen before the date of the filing of the petition.");
239. 11 USC § 553(BX1) ("Except with respect to a setoff of a kind described in sections 362(b)(6), 362(b)(7), 362(b)(17), 362(b)(27), 555, 556, 559, 560, 561, 365(h), 546(h), or 365(i)(2) of this title, if a creditor offsets a mutual debt owing to the debtor against a claim against the debtor on or within 90 days before the date of the filing of the petition, then the trustee may recover from such creditor the amount so offset to [a certain specified] extent").
240. See Leonnig, supra note 165 ("Another concern is that in this depressed market, AIG, and the taxpayers that now own 80 percent of the company, will lose coming and going. The company may be forced to borrow additional federal funds for rising payouts to counterparties⋯ The company also may be forced to sell many more assets at low, fire-sale prices. As part of its loan deal, AIG was to sell some assets-valued at $1 trillion before the crisis-to raise cash to pay off the loan.");
241. but see Bernanke, supra note 165 ("I would like to stress once again that the taxpayers' interests were very much in our minds and those of the Congress when these programs were designed. ... In the case of the TARP program, the funds allocated are not simple expenditures, but rather acquisitions of assets or equity positions, which the Treasury will be able to sell or redeem down the road. Indeed, it is possible that taxpayers could turn a profit from the program, although, given the great uncertainties, no assurances can be provided. . . . The larger point, though, is that the economic benefit of these programs to taxpayers will not be determined primarily by the financial return to TARP funds, but rather by the impact of the program on the financial markets and the economy. If the TARP, together with the other measures that have been taken, is successful in promoting financial stability and, consequently, in supporting stronger economic growth and job creation, it will have proved itself a very good investment indeed, to everyone's benefit.").
242. See supra footnote 132 and accompanying text.
243. See supra notes 109-115 and accompanying text.
244. See supra note 138.
245. The prisoner's dilemma is a game theory framework in which two players make independent decisions without the ability to communicate with one another. The framework's name derives from a situation in which two suspects are held and interrogated separately by the police.
246. See ANATOL RAPOPORT ET AL., PRISONER'S DILEMMA 24 (1965). The outcome for each player depends on his own actions and those of the other player, specifically whether each player chooses to defect (to confess) or to cooperate (to remain silent). If both players cooperate, they will both receive short sentences. If one defects and the other cooperates, the one who defects will go free and the other will receive a very long sentence. If both defect, both will receive sentences of intermediate length. If each is purely self-interested and there are no reputational effects, then both will defect and both will receive intermediate sentences, even though each would have been better off if both cooperated. One "solution" to the dilemma is to enable the players to communicate with one another and coordinate their activities through credible commitments. In the context of secret hens, this means enabling creditors to coordinate with one another by forcing disclosure through a recordation or notice system.
247. A positive feedback loop is a system that responds to a stimulus by producing additional stimuli in the same direction. In contrast, a system that responds to a stimulus in the opposite direction is called a negative feedback system. Positive feedback loops lead to exponential growth and dramatic movement away from the point of origin, often with explosive and destabilizing results. Negative feedback loops are self-correcting and self-stabilizing. A common example of a positive feedback system is an ecosystem without predators, in which a species will grow exponentially until it exhausts its food source and the population crashes.
248. See DAVID GEOFFREY GREEN ET AL., COMPLEXITY IN LANDSCAPE ECOLOGY 69-71,111-13 (2006). In the context of secret liens, the ability to borrow cheaply by hiding leverage creates an artificial appearance of superior performance (higher profits with lower risk), which enhances the ability to borrow additional funds cheaply and further inflate financial performance, until losses lead to a dramatic crash. In contrast, a system in which leverage is disclosed is a negative feedback loop system because higher leverage increases the cost of borrowing and limits the extent to which additional leverage may be obtained.
249. The tragedy of the commons is similar to the prisoner's dilemma but with multiple players. The tragedy of the commons is a dilemma in which multiple individuals acting independently in their own self-interest will eventually destroy a shared limited resource through over-exploitation, even when it is clear that it is not in their long term interest to do so. The solution to the tragedy of the commons is either to divide the commons into enclosures by assigning property rights, or to regulate and limit the use of the shared resource.
250. See id. at 185. In the context of secret liens, the commons or shared resources are the cash flows and assets of the debtor that back up its obligations to creditors. Assigning property rights is analogous to introducing payment priority through a notice or recordation system for hens, while regulating use of the shared resource is analogous to establishing minimal capital requirements.
251. Financial Derivatives Supervisory Improvement Act of 1998: Hearing before the H. Comm. on Baling and Financial Services, 105th Cong. (1998) (statement of Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System), available at http://www.federalreserve.gov/BOARDDOCS/ TESTIMONY/1998/19980724.htm (last visited Apr. 4, 2009) ("Professional counterparties to privately negotiated contracts ⋯ have demonstrated their ability to protect themselves from losses from fraud and counterparty insolvencies ⋯The huge increase in the volume of OTC transactions reflects the judgments of counterparties that these instruments ⋯ add significant value to our financial structure, both here in the United States and internationally. ⋯ Inappropriate regulation distorts the efficiency of our market system and as a consequence impedes growth and improvement in standards of living."). After the financial crisis of 2008, Greenspan admitted that he may have been "partially" wrong in opposing derivatives regulation. See Edmund L. Andrews, Greenspan Concedes Error on Regulation, N.Y. TIMES, Oct. 23, 2008, at Bl.
252. See Charles Schumer & Michael Bloomberg, Sustaining New York's and the US' Global Financial Services Leadership (Jan. 22, 2007), available at http://www.abanet.org/buslaw/committees/ CLll6000pub/materials/library/ NY-Schumer-Bloomberg-REPORT-FINAL.pdf (last visited Apr. 14, 2009). The report was commissioned by Mayor Bloomberg and Senator Schumer, who jointly signed the preface and endorsed the findings, and was prepared by the consulting firm McKinsey & Company. The report's recommendations include the following: "[N]ew guidance should enable auditors and management to exercise more judgment rather than rely on specific rules. It should also emphasize materiality-i.e., what really important to investors and management-rather than comprehensiveness ⋯"
253. Id. at 98. "[B]usiness professionals believe that the pendulum has swung toward excessive litigiousness, imposing unreasonable costs on market participants. ⋯ [T]he legal environment is detrimental to America's spirit of entrepreneunahsm and innovation. ⋯ [UJnless significant changes are made to America's litigation system, financial services businesses will likely continue to shift an increasing share of their activities to less litigious jurisdictions." Id. at 101. The report praised the UK's less burdensome regulatory regime. Id. at 17 ("Business leaders increasingly perceive the UK's single, principles-based financial sector regulator-the Financial Services Authority (FSA)-as superior to what they see as a less responsive, complex US system of multiple holding company and Industry segment regulators at the federal and state levels. Regulatory enforcement style also matters, with the UK's measured approach to enforcement seen as more results-oriented and effective than a US approach sometimes descried as punitive and overly public"). Ironically, a report commissioned by the Mayor of London on the UK's financial competitiveness suggested that, in the wake of the financial crisis, more stringent regulation would make the UK more competitive.
254. See Review of Competitiveness of London's Financial Centre, London: Winning m A Changing World 7 (June 2008), available at http://www.london.gov.uk/mayor/economy/docs/london-winning-changing- world.pdf (last visited Mar. 29, 2009) ("In the wake of the financial crisis, the industry and regulatory authorities must act together to rebuild the UK's reputation. The industry must support the Financial Services Authority's planned move from risk-based supervision to a more intense supervisory model and do all it can to support the creation of a new global regulatory framework. The Government must urgently review the UK's administration laws to restore trust in London-based financial services subsidiaries of overseas firms. Statutory immunity must be granted to whistleblowers as one step to establishing 'credible deterrence' to insider dealing.").
255. See David Enrich, At Citigroup, Bonuses Are Cut as Part of Bailout Agreement, WALL ST. J., Jan. 2, 2009, at C3;
256. see also Erich Dash & Louise Story, Citigroup's Top Executives to Forgo '08 Bonuses, N.Y. TIMES, Dec. 31, 2008, at B1.
257. Industry-led drives toward greater transparency include the American Securitization Forum's Project RESTART for mortgage backed securities. See American Securitization Forum, Overview of ASF Project RESTART, http://www.americansecuritization.com/story.aspx?id=2655.
258. See John Glover & Hamish Risk, Exchange-Traded Credit Derivatives Poised to Curb Ban\ Monopoly, BLOOMBERG.COM, Dec. 11, 2008, http://www.bloomberg.com/apps/news?pid=20601100&sid= AUKjpHV5t9FA&refer= Germany (last visited Apr. 1, 2009).
259. If public disclosures are content-rich but wanting in terms of presentation or ease of use, private fee-based services will likely reorganize the data into a more user-friendly format. For example, Dun & Brad-street gathers information for its credit reports in part from state-based filing systems.
260. FINANCIAL INDUSTRY REG. AUTH. MANUAL 7730 Trade Reporting and Compliance Engine (a), (b), http://finra.comphnet.com/en/display/display-main.html?rbid=2403&element-id= 4480 (last visited Apr. 1, 2009).
261. Id. at 7730 Trade Reporting and Compliance Engine (c).
262. President Obama has called his stimulus plan "the largest new investment in national infrastructure since the creation of the federal highway system in the 1950s." See Beth Fouhy, Cas- Poor States Eager for a Piece of Obama Plan, ABCNEWS.COM, Jan. 2, 2009, http://abcnews.go.com/Politics/wireStory?id=6566448 (last visited Apr. 14, 2009). Although the Obama plan emphasizes physical infrastructure projects such as roads, bridges, and broadband internet access, given the origins of the economic downturn in financial services, the administration may wish to extend the stimulus to financial infrastructure as well.
263. U.S. SEC. & EXCH. COMM'N, FY 2009 Congressional Justification 23, Feb. 2008, available at http://www.sec.gov/about/secfy09congbudgjust.pdf.
264. $124 million / $3.6 trillion = 0.003%
265. 1/0.003% = 29,032. This treats the full $3.6 trillion government outlay as an expense. If one assumes instead that only 1/3 of the bailout commitment is an expense, disclosure still pays for itself almost 10,000 times over in any year that it prevents a bailout.