Dollars and Jens
Thursday, September 25, 2008
bankruptcies and fraudulent transfers
One of my thoughts for Bear Stearns was that they should have sold their operations to JPM, along with a long-term contract for JPM (viz. Bear Stearns operations) to continue to service and wind down BSC, which at that point would hold a bunch of assets and have a bunch of liabilities. (Perhaps it would be best to require that JPM own some stake in BSC as well to mitigate agency issues.) It seems to me the biggest impediment to this plan would have been the expectation by JPM of lawsuits; assuming BSC was insolvent in the sense of the Uniform Fradulent Transfers Act, JPM would be on the happy side of the law provided they paid "fair consideration" for what they received, but you can bet that people who still hold stock in a company that's going under are those who place the highest estimate on the value of the company's assets, and their notion of "fair consideration" would be different from those of the boards of directors; a judge might well be of the mindset that JPM would find themselves involuntarily having given away an option, being left with the operations (and BSC securities) if they deteriorated as a court date approached and being forced to pay out for any gains they realize in that time.

The common law legal tradition is averse to "advisory opinions", but it seems to me that this especially might be a good place for a bankruptcy court — that's where I'd expect the relevant expertise to be — to be able to put its imprimatur on a deal and say "this isn't constructively fraudulent", thereby shielding the buying company in a good-faith purchase from various successor liabilities that would otherwise make the valuable parts of the company impossible to preserve. That kind of indemnification could allow a lot of non-bankruptcy bankruptcies to take place where bankruptcy bankruptcies might do a poorer job of preserving the values of assets than they're supposed to.

A good current candidate for this process might be Washington Mutual. I have read recently that the retail banking business generates $8 billion a year, but that the thrift is facing unrecognized losses that could be tens of billions of dollars. If the operations continue to produce $8 billion a year, that's a positive net value for the firm, even if its current balance sheet, fairly reckoned, were $40 billion in the hole; that is not, however, how the financial system works, especially not today, and it's certainly not how thrift regulation works. A single large buyer of new preferred equity, in the amount of $50 billion or so, could probably extract a reasonable return while ensuring the company's solvency, but there's a coordination problem there. Recapitalizing a separate new entity that would purchase Washington Mutual's operations — probably, in part, for equity in this separate entity — would enable this source of new capital to be senior to existing Washington Mutual debtholders, and would allow the recapitalization of a valuable financial operation under terms that would also be worthwhile to the new investors. This would require less new capital to get it to a viable point.

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