Thursday, October 9, 2008

It's Only Bankruptcy

The other day, Alison quoted from economist Jeffrey Miron who suggested that the current financial crisis might best be managed by letting troubled financial institutions seek refuge in bankruptcy. In today's Washington Post, columnist David Ignatius made a better point. Instead of firm by firm failure and either bankruptcy or bailout, wouldn't it be fantastic if the whole world economy could seek relief under Title 11 of the US Code?

Although the word bankruptcy is scary, the analogy to bankruptcy process is quite comforting. Ignatius writes: "Bankruptcy doesn't mean a company has run out of good people or ideas, or that it's going to stop making products. It means that it's out of money and must seek the protection of the government to continue operating. Bankruptcy, if properly managed, is a workout process that provides a pathway back to solvency. A company seeks protection from its creditors through bankruptcy court, which appoints a trustee to supervise an orderly unraveling of its debts and other obligations. Sifting through the claims can take years and creditors often receive less than full value, but there's a reliable process. Companies often reemerge from bankruptcy healthier than before; often, some assets are sold to other companies that can make better use of them."

That doesn't sound like a global financial crisis of historic proportions. That sounds like bankruptcy litigation, and entirely within the province of lawyers -- bankruptcy lawyers to be specific.

Sadly, there is no bankruptcy court that can take jurisdiction over the global economy. For the U.S. financial system, the equivalent of the bankruptcy court is the rescue operation cobbled together and headed by the Federal Reserve and the Treasury. Ignatius notes that these bodies traditonally supply liquidity where it is needed to lubricate a balky system. This problem, however, is bigger than just a little unexpected friction in the machine. Ignatius recommends a bankruptcy trusteeship as a new metaphor for the solution: "the task of trusteeship -- of supervising the orderly clearing of debts in an economy where trust has vanished, as is often the case in an ordinary bankruptcy."

The global economy has no ready trustee. Ignatius notes that the institution that was supposed to protect the global system, the International Monetary Fund has been "utterly impotent in the crisis." He calls for the establishment of a "Global Clearinghouse, a public-private consortium of the biggest financial institutions and central banks, that can ensure that trades get completed and losses are covered while the system works its way out of bankruptcy."

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