Bankruptcy phobia

Temple Law Review

Volumn 82, Issue 2, 2009, Pages 333-351

  Skeel, David A ^a  

^a UNIVERSITY OF PENNSYLVANIA LAW SCHOOL   (United States)

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EID: 79251538363     PISSN: 08998086     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (116)

1. See, e.g., TERESA A. SULLIVAN ET AL., THE FRAGILE MIDDLE CLASS: AMERICANS IN DEBT 32-33 (2000) (surveying debtors and finding nearly fifty who reported that bankruptcy filing was last resort only after alternatives failed).
2. See Cathy Moran, Bankruptcy Survives, On the Bankruptcy Soapbox, http://www.moranlaw.net/blog/bankruptcy-survives (last visited Nov. 7, 2009) (noting that "some large portion of the public" thinks that bankruptcy relief is no longer available). See infra notes 47-50 and accompanying text for a discussion of the 2005 amendments to the bankruptcy laws.
3. Am. Bankr. Inst., Annual Business and Non-business Filings by Year (1980-2008), http://www.abiworld.org/AM/AMTemplate.cfm?Section= Home&TEMPLATE=/CM/ContentDisplay.cfm&C ONTENTID=56822 (last visited Nov. 7, 2009).
4. The exact numbers are 617,660 in 2006, 850,912 in 2007, and 1,117,771 in 2008. Id. Bankruptcy filings exceeded 1,000,000 for the first time in 1996, continued climbing, and then leveled off at roughly 1,500,000 a year before the 2005 amendments. Id.
5. The subprime crisis does not have an agreed-upon starting date, but one candidate is the failure of two Bear Stearns hedge funds in the summer of 2007.
6. See, e.g., David A. Skeel, Jr., Governance in the Ruins, 122 HARV. L. REV. 696, 734 (2008) (book review) (suggesting that failure of two hedge funds will be identified as beginning of recent subprime crisis).
7. U.S.C. § 1322(b)(2) currently precludes debtors who propose a payment plan under Chapter 13 from altering the terms of a mortgage on their principal residence. 11 U.S.C. § 1322(b)(2) (2006).
8. See Helping Families Save Their Homes in Bankruptcy Act of 2009, H.R. 200, 111th Cong. (2009) (delineating bill sponsored by Representative Conyers that Congress is currently considering); Press Release, Sen. Dick Durbin, Durbin Introduces Bill to Stem Record Foreclosures (Jan. 6, 2009), http://durbin.senate.gov/showRelease.cfm?releaseId=306368 (providing brief overview of Durbin's efforts).
9. By "price discovery," I mean determination of the value of mortgaged properties and of the complex financial instruments based upon them. Many commentators believe that uncertainty about the value of mortgage-backed securities was one of the major contributing factors in the credit crunch.
10. See, e.g., Michael Steinberg, Mortgage "Cram Downs" Quickest Route to CDO, MBS Price Discovery, SEEKING ALPHA, Feb. 1, 2009, http://seekingalpha.com/article/117805-mortgage-cram-downs-quickest-route-to- cdo-mbs-price-discovery (emphasizing need for price discovery in order to unclog movement of toxic assets).
11. The Bush and Obama administrations' mortgage relief efforts as of March 2009 are summarized in CONG. OVERSIGHT PANEL, 111TH CONG., FORECLOSURE CRISIS: WORKING TOWARD A SOLUTION 30-37 (2009), available at http://cop.senate.gov/ documents/cop-030609-report.pdf. The early results of the programs were disappointing. See Ruth Simon, Mortgage Servicers Are Under Pressure to Modify More Loans, WALL ST. J., July 29, 2009, at A6 (stating that administration officials are "[f]rustrated with the slow progress"). As of this writing, more loans are being modified, but the efficacy of the modifications is still in doubt.
12. See, e.g., CONG. OVERSIGHT PANEL, 111TH CONG., OCTOBER OVERSIGHT REPORT: AN ASSESSMENT OF FORECLOSURE MITIGATION EFFORTS AFTER SIX MONTHS 3-5 (2009), available at http://cop.senate.gov/documents/cop-100909-report.pdf (discussing Panel's concerns with current modification programs and offering suggestions for improvement).
13. This argument is made in detail in Kenneth Ayotte & David A. Skeel, Jr., Bankruptcy or Bailouts?, 35 J. CORP. L. (forthcoming 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=1362639.
14. See e.g. Chris Isidore Bush Announces Auto Rescue CNNMONEY.COM Dec. 19 2008 http://money.cnn.com/2008/12/19/news/companies/auto-crisis/index.htm (outlining details and purpose of auto rescue plan).
15. Michael McKee GM Chrysler Failure Would Push Economy into Abyss BLOOMBERG.COM Dec. 15 2008 http://www.bloomberg.com/apps/news?pid= 20601087&sid=aW2D17IBa2Kk&refer=home (quoting Dennis Virag president of Automotive Consulting Group in Ann Arbor Michigan).
16. David Cho & Lyndsey Layton Housing Woes Put Bush Hill at Odds: White House Opposes Use of Tax Dollars WASH. POST Feb. 27 2008 at A1 (internal quotation marks omitted).
17. See generally Paul Krugman Op-Ed. The B Word N.Y. TIMES Mar. 17 2008 at A19 (defending Bear Stearns bailout despite Bear's unsavory reputation as necessary to prevent potentially catastrophic market effects). The Obama administration's proposed resolution authority for systemically important institutions is based on a similar distrust of bankruptcy. See infra notes 92-96 and accompanying text for a discussion of the administration's reform plan.
18. Todd J. Zywicki Don't Let Judges Tear Up Mortgage Contracts WALL ST. J. Feb. 13 2009 at A13.
19. See e.g. Alan Schwartz Op-Ed. Don't Let Judges Fix Loans N.Y. TIMES Feb. 27 2009 at A27 (detailing problems that could arise in bankruptcy courts if Congress passed mortgage modification proposal); Zywicki supra note 15 (predicting likely increase in bankruptcy filings as result of mortgage modification proposal).
20. See e.g. U.S. Senate Rejects Mortgage Modification in Chapter 13 Cases AM. BANKR. INST. J. June 2009 at 10 10 [hereinafter U.S. Senate Rejects] (excerpting statements of Senators Durbin and Kyl including Durbin's emphasis that modification while broad enough to help debtors also contains limitations that protect mortgage servicers).
21. See e.g. id. (emphasizing plan for amendment to assist troubled homeowners whose last resort is bankruptcy); Robert M. Zinman & Novica Petrovski The Home Mortgage and Chapter 13: An Essay on Unintended Consequences 17 AM. BANKR. INST. L. REV. 133 142-43 (2009) (noting that House bill introduced by Congressman Conyers includes each of these restrictions)
22. John Conyers Jr. Loan Modification Can Stop the Foreclosure Crisis WALL ST. J. Jan. 30 2009 at A11 (explaining narrow application of proposal only to existing mortgages).
23. See e.g. U.S. Senate Rejects supra note 17 at 69 (presenting Senator Kyl's statement that cramdown will prolong malaise of housing market by increasing interest rates).
24. See Gretchen Morgenson Fair Game: A Window in a Smoky Market N.Y. TIMES July 6 2008 at BU1 (suggesting that concerns about credit default swaps were key factor in bailout).
25. See William K. Sjostrom Jr. The AIG Bailout 66 WASH. & LEE L. REV. 943 977-83 (2009).
26. A mutual fund"breaks the buck" when a customer who withdraws her money will receive less than a dollar for each dollar she invested.
27. Ayotte & Skeel supra note 10 (manuscript at 24- 25) (detailing Lehman bankruptcy and subsequent effects)
28. See id. (manuscript at 21-25) (arguing that information that major bank was tottering not bankruptcy filing best explains market reaction).
29. The complex capital structures of the nineteenth-century railroads and their role in the advent of corporate reorganization are discussed in DAVID A. SKEEL JR. DEBT'S DOMINION: A HISTORY OF BANKRUPTCY LAW IN AMERICA 60-63 2001).
30. See Justin Fox Don't Call It Bankruptcy TIME Dec. 1 2008 at 32 32 describing Wagoner's objections to bankruptcy).
31. See e.g. Michael E. Levine Why Bankruptcy Is the Best Option for GM WALL ST. J. Nov. 17 2008 at A19 noting that "consumers buy tickets from bankrupt airlines" and rejecting argument that carmakers are different in this regard).
32. See Christopher Mayer Edward Morrison & Tomasz Piskorski A New Proposal for Loan Modifications 26 YALE J. ON REG. 417 419-20 2009) proposing three-part plan of servicer incentives second-lien lender incentives and litigation protection). The Obama administration adopted somewhat analogous strategies in the Homeowner Affordability and Stability Plan. Announced on February 18 2009 the plan provides financial incentives for mortgage servicers to modify troubled mortgages. CONG. OVERSIGHT PANEL supra note 9 at 3-4 providing overview of plan).
33. Compare Adam J. Levitin & Joshua Goodman The Effect of Bankruptcy Strip-Down on Mortgage Markets 41 Geo. L. & Econ. Research Paper No. 1087816 2008) available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=1087816 concluding that mortgage modification would have only modest effects on lending) and Adam J. Levitin Resolving the Foreclosure Crisis: Modification of Mortgages in Bankruptcy 2009 WIS. L. REV. 565 647 same) with Mayer et al. supra note 27 at 427 surveying existing studies including study by Levitin and Goodman and concluding that effect is substantial).
34. See supra notes 20-21 and accompanying text for a discussion of the fears that prompted the Bear Stearns and AIG bailouts.
35. See e.g. Levitin & Goodman supra note 28 at 41 concluding that markets are generally indifferent to mortgage modification risk).
36. See supra note 8 and accompanying text for a discussion of the uncertainty surrounding price discovery.
37. Bankruptcy filings exceeded two million in 2005 due to debtors' rush to file before the 2005 changes went into effect. In 2006 the first full year under the amendments there were only 617660 bankruptcy filings. See Am. Bankr. Inst. supra note 3 compiling data for annual business and nonbusiness bankruptcy filings by year from 1980 to 2008).
38. See e.g. Peter J. Wallison On Regulating and Resolving Institutions Considered "Too Big to Fail" Testimony Before the Senate Banking Committee May 6 2009) transcript) available at http://www.aei.org/speech/100044 criticizing claim that AIG bankruptcy would have crippled derivatives markets).
39. See Jeff Plungis Chrysler Bankruptcy Won't Interrupt Warranties Treasury Says BLOOMBERG.COM May 2 2009 http://www.bloomberg.com/apps/news?pid= 20601103&sid=ai1YZ10u7BcE explaining application of government warranty program to GM and Chrysler).
40. See Liz Rappaport Lewis Testifies U.S. Urged Silence on Deal: Bank of America Chief Says Bernanke Paulson Barred Disclosure of Merrill Woes Because of Fears for Financial System WALL ST. J. Apr. 23 2009 at A1 describing pressure to complete deal because "otherwise it would 'impose a big risk to the financial system'").
41. See Neil King Jr. & Jeffrey McCracken Chrysler Pushed into Fiat's Arms WALL ST. J. May 1 2009 at A1 "The most compliant of Chrysler's big creditors criticizing claim that AIG bankruptcy would have crippled derivatives markets⋯ have received hundreds of billions of dollars in TARP aid.").
42. See Theo Francis Does Citigroup Stand Alone? Industry Balks at Bankruptcy Bill BUSINESSWEEK.COM Jan. 8 2009 http://www.businessweek.com/election/2008/ blog/archives/2009/01/does-citigroup.html?chan=top+news-top+news+index+-+temp- news+%2B+analysis detailing industry's opposition to mortgage modification legislation).
43. See U.S. Senate Rejects supra note 17 at 10 "The mortgage industry has twice succeeded in helping to kill the bankruptcy proposal ⋯ .").
44. See Andrew Ross Sorkin The Case for Saving A.I.G. by A.I.G. N.Y. TIMES Mar. 3 2009 at B1 outlining confidential memo's concern that failure of AIG could spur catastrophic failure of insurance industry).
45. See e.g. Wallison supra note 33 noting this support and expressing surprise that smaller institutions did not initially oppose proposed legislation which would likely benefit the largest institutions by identifying them as too big to fail).
46. See e.g. Andrew Clark Congress Grills Geithner and Bernanke over AIG Bonus Scandal GUARDIAN.CO.UK Mar. 24 2009 http://www.guardian.co.uk/business/ 2009/mar/24/bernanke-geithneraig- bonuses-testimony discussing backlash resulting from distribution of bonuses).
47. Philip Nussel Wagoner's Words Underscore Industry Crisis AUTOMOTIVE NEWS Mar. 30 2009 internal quotation marks omitted) http://www.autonews.com/article/ 20090330/ANA02/903299981/1178/ANA03.
48. See supra note 39 and accompanying text for additional information on the AIG executives' memo.
49. Lehman of course did not succeed and the government ultimately steered the carmakers into bankruptcy as well. Cf. Jeffrey McCracken Lehman's Chaotic Bankruptcy Filing Destroyed Billions in Value WALL ST. J. Dec. 29 2008 at A10 discussing some costs of Lehman's failure to plan for possible bankruptcy filing).
50. See e.g. SKEEL supra note 24 at 1-2 emphasizing uniqueness of American bankruptcy law).
51. Elizabeth Warren & Jay Lawrence Westbrook The Success of Chapter 11: A Challenge to the Critics 107 MICH. L. REV. 603 618 2009).
52. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Pub. L. No. 109-8 119 Stat. 23 codified as amended in scattered sections of 11 U.S.C.).
53. E.g. SKEEL supra note 24 at 203.
54. See e.g. Jean Braucher The Challenge to the Bench and Bar Presented by the 2005 Bankruptcy Act: Resistance Need Not Be Futile 2007 U. ILL. L. REV. 93 94 describing hostility to bankruptcy lawyers and judges reflected in 2005 reforms).
55. See Moran supra note 2 discussing public fears after 2005 amendments).
56. Paulson came from Goldman Sachs where he had risen to the chairmanship from Goldman's investment banking group; Geithner cut his teeth in the international affairs division of the Treasury during the Clinton administration;
57. and Bernanke a scholar with expertise in monetary policy was best known for studies concluding that monetary policy exacerbated the Great Depression.
58. See e.g. DAVID WESSEL IN FED WE TRUST: BEN BERNANKE'S WAR ON THE GREAT PANIC 10-12 40-41 73-75 111-13 2009) detailing backgrounds of leaders confronting crisis).
59. This comment is based on conversations with current and former Federal Reserve economists.
60. The carmaker bankruptcies were a notable exception to this pattern. The auto task force made extensive use of top bankruptcy professionals. See Emily Chasan U.S. Autos Task Force Hires Bankruptcy Lawyer REUTERS Mar. 13 2009 http://www.reuters.com/article/newsOne/idUSTRE52C5V520090314 discussing U.S. government's consultation with bankruptcy lawyers at several large law firms in conjunction with GM and Chrysler restructuring).
61. See David Skeel Give Bankruptcy a Chance WKLY. STANDARD June 29 2009 at 25-27 discussing these points in greater detail).
62. The relationship between corporate scandals and regulatory reform is a major theme of DAVID SKEEL ICARUS IN THE BOARDROOM: THE FUNDAMENTAL FLAWS IN CORPORATE AMERICA AND WHERE THEY CAME FROM 2005) and David A. Skeel Jr. Icarus and American Corporate Regulation 61 BUS. LAW. 155 2005).
63. See e.g. SKEEL supra note 55 at 80-89 analyzing Insull failure).
64. See id. at 94-103 detailing government's regulatory response).
65. Id. at 175-77.
66. CHARLES WARREN BANKRUPTCY IN UNITED STATES HISTORY 150 1935).
67. See SKEEL supra note 24 at 24-28 discussing pattern of enactment and prompt repeal of various pieces of legislation).
68. The Supreme Court struck down the stay laws in 1933 and then finally upheld them a year later. The Supreme Court voted against them before it voted for them one might say). See Home Bldg. & Loan Ass'n v. Blaisdell 290 U.S. 398 447-48 1934) upholding Minnesota stay law that extended temporary relief to homeowners in certain mortgage foreclosures).
69. See e.g. Anna Gelpern & Adam J. Levitin Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage-Backed Securities 82 S. CAL. L. REV. 1075 1141-48 2009) describing Frazier-Lemke Act and enactment of section 75 of Bankruptcy Act).
70. Id.
71. See SKEEL supra note 24 at 101-09 discussing these reforms which added section 77 to Bankruptcy Act for railroad reorganization in 1933 and section 77B for other corporations the following year).
72. Id at 106-07.
73. Id.
74. The gold clause is described in Randall S Kroszner Is It Better to Forgive than to Receive? Repudiation of the Gold Indexation Clause in Long-Term Debt During the Great Depression 4 Oct 1998) unpublished manuscript) available at http://facultychicagoboothedu/finance/papers/repudiation11pdf.
75. This is because the value of gold climbed from $2047 at the time of the abrogation during Roosevelt's first one hundred days to $35 the following year Id at 1.
76. See infra notes 88-91 and accompanying text for a discussion of the passage of the Chandler Act.
77. Cf David A Skeel Jr Creditors' Ball: The "New" New Corporate Governance in Chapter.U PA L REV 917 917-18 2003) noting absence of pressure for bankruptcy reform after Enron and WorldCom scandals of early 2000s).
78. In this second respect bankruptcy reform is much more similar to corporate reform.
79. See eg SKEEL supra note 24 at 33.
80. For a brief description see WARREN supra note 59 at 128.
81. Id.
82. See eg SKEEL supra note 24 at 36-37.
83. For a discussion of the Lowell and Torrey Bills see for example SKEEL supra note 24 at 40-43 and Charles Jordan Tabb A Century of Regress or Progress? A Political History of Bankruptcy Legislation in 1898 and 1998 15 BANKR DEV J 343 354-61 1999)
84. SKEEL supra note 24 at 37.
85. 25 CONG REC 2815 1894) statement of William Jennings Bryan)
86. See generally David A Skeel Jr The Genius of the 1898 Bankruptcy Act 15 BANKR DEV J 321 1999) describing compromises such as incorporation of state exemption laws minimal administrative structure and limits on creditors' ability to file involuntary petitions)
87. Compromise across party lines was much less essential in the late 1930s because the Democrats had a huge numerical majority In 1938 they held seventy-six Senate seats as opposed to sixteen Republicans as well as one Progressive two Farmer-Labor and one Independent) US Senate Party Division in the Senate 1789-Present http://wwwsenategov/pagelayout/history/one-item-and- teasers/partydivhtm last visited Nov 7 2009).
88. See SKEEL supra note 24 at 101-04 109-27 discussing Douglas's background and his role in New Deal bankruptcy reforms).
89. Id at 110-13.
90. The report was published in multiple volumes as SEC & EXCH COMM'N REPORT ON THE STUDY AND INVESTIGATION OF THE WORK ACTIVITIES PERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES 1937-1940)
91. Douglas recounted his relationship with Roosevelt in his autobiography See generally WILLIAM O DOUGLAS GO EAST YOUNG MAN passim 1st ed 1974);
92. cf Jeffrey Rosen The Justice Who Came to Dinner NY TIMES Feb 1 2004 § 4 at 1 3 describing social relationship between Douglas and Roosevelt)
93. See SKEEL supra note 24 at 118 describing resistance and Douglas's refusal to soften mandatory trustee provision).
94. In addition to the Chandler Bill the principal proposals were the Sabath Bill and the Lea Bill See eg John Gerdes Section 77B The Chandler Bill and Other Proposed Revisions 35 MICH L REV 361 368-409 1937) describing Sabath and Chandler Bills and noting that other bills were expected).
95. Cloyd Laporte Note Changes in Corporate Reorganization Procedure Proposed by the Chandler and Lea Bills 51 HARV L REV 672 673-89 1938) describing proposals of Chandler and Lea Bills).
96. Memorandum from Abe Fortas to William O Douglas 3 Oct 7 1935) from William O Douglas Papers Library of Congress copy on file with author)
97. The story is recounted in JOEL SELIGMAN THE TRANSFORMATION OF WALL STREET: A HISTORY OF THE SECURITIES AND EXCHANGE COMMISSION AND MODERN CORPORATE FINANCE 205-11 rev ed 1995)
98. Cf Benjamin Wham Chapter X of the Chandler Act: A Study in Reconciliation of Conflicting Views 25 VA L REV 389 392 1939) recognizing SEC's ability to persuade Drafting Committee of National Bankruptcy Conference to add certain SEC recommendations to Chandler Bill)
99. See SKEEL supra note 24 at 119 describing enactment of Chandler Act).
100. Id at 125-27.
101. See eg Alan J Heavens What a Relief for 1400 Phila Foreclosures PHILA INQUIRER July 1 2009 at C1 describing success of Philadelphia plan).
102. The original proposal is summarized in Davis Polk & Wardwell Client Memo Treasury's Proposed Resolution Authority for Systemically Significant Financial Companies Mar 30 2009) available at http://wwwdavispolkcom/1485409/ clientmemos/2009/033009resolutionauthoritypdf The administration subsequently introduced a revised and expanded set of reforms in June 2009 The subsequent proposals are described in DEP'T OF THE TREASURY FINANCIAL REGULATORY REFORM: A NEW FOUNDATION 2009) available at http://wwwfinancialstabilitygov/docs/regs/ FinalReport-webpdf.
103. See DEP'T OF THE TREASURY supra note 93 at 76-77 proposing new resolution authority).
104. But see Ayotte & Skeel supra note 10 manuscript at 27-29) critiquing proposals that would shift significant regulatory authority from bankruptcy courts to bankruptcy regulators)
105. Two exceptions are a provision that requires the US trustee to request the appointment of a trustee if there are reasonable grounds for believing the debtor's management has committed fraud 11 USC §. 1104e) 2006) and a provision that attempts to limit " .pay to stay" . bonuses for executives id §. 503c) These provisions are discussed in David A Skeel Jr Déjà Vu All Over Again in Corporate Bankruptcy 2005) unpublished manuscript on file with author)
106. Cf Henry J Sommer Trying to Make Sense Out of Nonsense: Representing Consumers Under the " .Bankruptcy Abuse Prevention and Consumer Protection Act of 2005" . 79 AM BANKR LJ 191 221 2005) asserting that " .[t]he real goal of the creditor lobby was to make bankruptcy of all types more difficult for debtors who need it" .)
107. See supra notes 93-94 and accompanying text for a description of the legislative proposal to shift regulatory authority from bankruptcy courts to bankruptcy regulators
108. I have developed and promoted these bankruptcy-oriented proposals elsewhere David A Skeel Jr Bankruptcy Boundary Games 4 BROOK J CORP FIN & COM L forthcoming 2010) manuscript at 22-26 on file with author) advocating special provisions including stay on derivatives for large nonbank financial institutions).
109. Lee C Buchheit & David A Skeel Jr Op-Ed Some Bankruptcies Are Worth It NY TIMES May 19 2009 at A25 proposing interim period for financial institutions in distress).
110. See eg US Senate Rejects supra note 17 at 10 noting after April 30 2009 vote that " .mortgage industry has twice succeeded in helping to kill the bankruptcy proposal" .).
111. See supra notes 9 27 and accompanying text for a discussion of the Columbia and Obama mortgage modification proposals.
112. The latter argument is developed in detail in Ayotte & Skeel supra note 10.
113. See Jonathan C Lipson The Shadow Bankruptcy System 89 BU L REV 1609 1632-38 2009) suggesting that Douglas's study provides template for how to approach study of shadow bankruptcy system).
114. The carmaker bankruptcies are described in detail in Mark J Roe & David A Skeel Jr Assessing the Chrysler Bankruptcy 5-8 Univ of Pa Law Sch Pub Law Research Paper No 09-17. Univ of Pa Inst for Law & Econ Research Paper No 09-22. Harvard Law & Econ Discussion Paper No 645. Harvard Pub Law Working Paper No 09-42 2009) available at http://wwwssrncom/abstract=1426530.
115. See id at 12-20 critiquing terms of Chrysler transaction)
116. Id at 27-29.