Pop quiz: who is most likely to shill for banks?

I'm frustrated by the apparent failure of bankruptcy reform efforts in congress. The New York Times just published an interesting article on where this ship ran aground. A couple of excerpts, briefly:

[...] the banks defeated the bankruptcy change — the industry picturesquely calls it the “cramdown” provision — by claiming that it would push up interest rates and slow the housing market’s recovery, even though academic studies have countered such claims.

The industry also steadfastly refused offers to negotiate over a weaker version. And it poured millions of dollars into lobbying: four of the industry’s top trade groups spent nearly as much on lobbying in the first three months of this year as they did in all of 2001.

[...] an industry strategy of dividing the Democrats had the most success. One target was Senator Mary Landrieu, the moderate Democrat from Louisiana.

I'm really disappointed in that one, because I gave up a month of my own time to go to Louisiana to volunteer in Sen. Landrieu's Dec. '02 runoff. (My supervisor was Mitch Stewart, who was the Iowa caucus director of Obama, and now sends most of you weekly emails as the national head of Organizing for America). Back to article:

Throughout it all, the banks took advantage of the Obama administration’s seeming ambivalence. Despite its occasional populist rhetoric, the White House was conspicuously absent from weeks of pivotal negotiations this spring. “This would have been a much different deal if Obama had pressed it,” said Camden R. Fine, head of the Independent Community Bankers of America and one of the chief lobbyists opposing the bankruptcy change. “The fact that Obama effectively sat it out helped us a great deal.”

That one I'm more OK with - it's not like the White House was off twiddling it's thumbs. The article goes on:

The industry’s worst fears began to come true in early January when Senator Charles E. Schumer announced that he had persuaded Citigroup to endorse the idea. Mr. Schumer had held discussions with Vikram S. Pandit, Citigroup’s chief executive, and Lewis B. Kaden, a vice chairman. Mr. Schumer then spoke to other top executives, including Jamie Dimon, chief executive of JPMorgan Chase, hoping to peel more big banks away from the opposition.

The article goes on to explain that the reform bill's strongest proponents were Dick Durbin of Illinois and Chuck Schumer of New York, while Tom Carper of Delaware and Tim Johnson of South Dakota opposed the bill.

I can go on at length some other time about the economic and legal reasons why the consumer bankruptcy laws need changing, but let me just ask you a question from the political perspective: what does it mean when the senators from New York and Illinois want to get rid of special interest bank legislation, but the senators from those financial hubs of South Dakota, Delaware, and Louisiana work to keep it?

Mis-reporting on the Chrysler Bankruptcy?

Quite out of the ordinary that the administration has gotten so involved in the Chrysler bankruptcy, and that deserves to be a story line in the news reports, but I think articles such as this one, U.S. Played Rough with Chrylser Creditors, WSJ 5/11/09, kind of confuse the issues in the minds of most readers. Based on reading the excerpts below, what do you think the Creditors with whom rough was played by the U.S. ended up getting?

The results of these hardball tactics were on display Friday, as the last resisters of a deal to slash the value of Chrysler debt abandoned their effort to fight it in bankruptcy court. That raised the chances for a relatively swift transit through Chapter 11, producing a new Chrysler 55%-owned by a trust for union retirees, 35% by Fiat SpA -- which hasn't even been a Chrysler creditor -- and not at all by the senior secured lenders.

That conclusion would upend a longstanding tradition concerning rights in a bankruptcy: Senior secured lenders get paid in full before lower-priority creditors get anything. Not this time.

[...]

When the issue of the $6.9 billion in debt came up, Mr. Rattner looked at the lending group and said, "We have in mind for you a much lower number." He silenced the room by proposing they get just $1 billion.

While that wasn't the administration's bottom line, the task force had determined what was: the amount lenders would get in a liquidation of Chrysler assets. A Chrysler analysis in January estimated that at $2 billion. The UAW and Fiat knew about this figure, and also knew that the task force was first going to offer lenders just $1 billion. But the lenders, having waited so long to engage with the Treasury, were in the dark.

[...]

After receiving one more bank counteroffer, the Treasury on April 28 offered what it had planned all along, to buy out the lenders for $2 billion. The only sweetener was that it would be in cash, meaning the lenders didn't have to wait for a reorganized Chrysler-Fiat to pay it.

Mr. Rattner called Mr. Lee: "It's $2 billion, take it or leave it."

The big banks quickly agreed to the deal -- equal to 29 cents on the dollar. Though that offered a profit to a few firms that bought debt as low as 15 cents on the dollar, most of the lenders had paid 50 cents to 70 cents, and the banks 100 cents. News that the big banks were accepting the offer leaked before they had told the smaller lenders. "To say the least, we were floored," says one.

So what's the significance of 29 cents on the dollar, and how did that play in to the negotiations? That's the amount that the government estimated the secured lenders could get if the lenders liquidated the Chrysler assets. Maybe that number is a little low, but work with me here: if you lent 100 million dollars to build a Chrylser factory last year, Chrysler owes you 100 Mil, but what's the value of that factory now if you had to foreclose on it and sell it? There might not be a Chrysler company who plans to keep using it, all the competitors have their own plants, no one else is going to needs a plant in order to like... start a car company right now, and even if they did, what are the odds they want one in Michigan? 29 cents on the dollar sounds pretty reasonable, huh?

The rule in Chapter 11 cases is that to reorganize a company, you can force a creditor to take something other than full payment for his claim as long as he gets at least what he would in a liquidation. OK, now we've met that part of the test.

The fight then, was that some, but not all, of the lenders thought they could get more. What else did they want? The venture funds were looking for stock in a reorganized Chrysler. That new Chrysler stock has a lot of really cool built in features. First of all, the owners of the new stock wipe out the owners of the old stock, so they're already ahead of lots of people. Second, the new company benefits from cabining off a lot of the previously open-ended liability of the old company, which could be a really big deal with liabilities for things like retiree health care. Third, a lot of the other liabilities of the company get paid off out of a really good type of loan available in bankruptcy (debtor in possession financing) that really isn't available to businesses outside of bankruptcy. Fourth, the new company can emerge lean and mean by shedding a lot of unprofitable business units or product lines that would have been tough to drop outside of bankruptcy. All in all, this means that the new stock is a product of the bankruptcy process, it can be really valuable, and a lot of the lenders were planning on getting some.

So what did the lenders lose? Their entire investments? Not even close. They got paid that same 29 cents on the dollar they would see in liquidation, but they got none of the upside of participating in a reorganization. This is pretty unusual, because in all but very large cases, the lenders are the only ones with the money or legal position to keep fighting. It's unusual, but it's not illegal, it's not the result of bullying and intimidation, it's not the result of Putin/Chavez-style crony-capitalism, it's just unusual.

My point here isn't that the Obama effort on Chrysler was divinely conceived and should be beyond scrutiny; my point is that just focusing on the Obama administration role and ignoring the underlying legal and business dynamics only gives you a slightly misleading part of the picture. It's not that the lenders were denied something they had a right to, it's more like they were denied instead something they had a chance at. Some would be-Madame DeFarge figure is certainly weaving the Chrysler episode in to the long memory of the right wing, and I don't expect this explanation to influence any of those, but here's hoping that maybe the other 88% of the country can get a better handle on these issues by seeing the shape of the whole Chrysler bankruptcy forest and not just silhouette of the Obama tree.

McCardle Misses Mass of Mortgage Mod Meaning

Megan McCardle is almost always insightful and interesting, but I have to strongly disagree with her about the efficacy of changing the bankruptcy laws to allow the modification ("cram-down") of mortgages on residences.

A Chapter 13 debtor confirms a plan of reorganization under which she makes payments for up to five years, but not everyone ends up making all the payments for the whole term of the plan. (She believes that proportion of failed plans is 2/3, I think after we change the law, it will get better as a different class of debtor starts filing Chapter 13s). McCardle thinks these debtors will be worse off because their bankruptcies will be dismissed, tossing out of the frying pan of bankruptcy protection, and back in to the fire of foreclosure and state law remedies.

But McCardle's prediction makes two mistakes: one about bankruptcy law, and the other about how people respond to bankruptcy law. Legally, once a debtor fails to make payments under a Chapter 13 plan, the case is not automatically dismissed. Instead, the debtor has the chance to convert her case from a 13 to a 7. This has been made more difficult by the 2005 bankruptcy changes (Sec. 707(b)(3), 'presumption of abuse', and the special cicrumstances test - for those of you playing along in the home game). But not only is it a real possibility to overcome these tests, I'm finding significant 'word on the street' that the U.S. Trustee (the Gov't officials charged with overseeing these sorts of things) aren't challenging the conversions as often as vigorously as they might for fear of having the statute overturned or limited on appeal.

I also think McCardle fails to appreciate the impact outside of bankruptcy that the 13 Cram-down change would engender. Right now, or whole system for making and administering home loans assumes that the mortgage is an all-or-nothing proposition. Until recently, this kept mortgage service costs low and made them easy to securitize. What we see now is that there is some real number of people who ought to be able to refinance mortgages (especially if they were steered in to bad products before), but who won't be allowed to by 'the system.' This is a real economic deadweight loss to not only the borrower, but also the lender, not to mention the neighborhood. Let me rephrase. We are making things worse for no good reason in a lot of these cases.

I've advocated for 13 cram downs before, but under a slightly different rubric than the one Congress proposes. But the current proposal before Congress seems fine. Unfortunately, we've already missed the chance to help a lot of people and avoid some excess harm. But on the positive side, making these changes now will help even-out the rough spots ahead of the next economic decline.