Abstract

http://ssrn.com/abstract=1567075
 
 

Citations (6)



 
 

Footnotes (246)



 


 



The Derivatives Market's Payment Priorities as Financial Crisis Accelerator


Mark J. Roe


Harvard Law School

March 6, 2011

Stanford Law Review, Vol. 63, Issue3, p. 539, 2011
ECGI - Law Working Paper No. 153/2010
Harvard Public Law Working Paper No. 10-17

Abstract:     
Chapter 11 bars bankrupt debtors from immediately repaying their creditors, so that the bankrupt firm can reorganize without creditors shredding the bankrupt’s business. Not so for the bankrupt’s derivatives counterparties, who unlike most creditors, even most other secured creditors, can seize and immediately liquidate collateral, net out gains and losses, terminate their contracts with the bankrupt, and keep both preferential eve-of-bankruptcy payments and fraudulent conveyances they obtained from the debtor in ways that favor them over other creditors. Their right to jump to the head of the bankruptcy re-payment line, in ways that even ordinary secured creditors cannot, weakens their incen-tives for market discipline in managing their credits to the debtor; it reduces their concern for the risk of counterparty failure and bankruptcy, since they do well in any resulting bankruptcy. If they were made to account better for counterparty risk, they would be more likely to insist that there be stronger counterparties than otherwise on the other side of their derivatives bets, thereby insisting for their own good on strengthening the financial system. True, because they bear less risk, nonprioritized creditors bear more and thus have more incentive to monitor the debtor or to assure themselves that the debtor is a safe bet. But the repo and derivatives market’s other creditors - such as the United States of America - are poorly positioned contractually either to consistently monitor the deriva-tives debtors’ well or to fully replicate the needed market discipline. Bankruptcy policy should harness private incentives for counterparty market discipline by cutting back the extensive de facto priorities for these investment channels now embedded in chapter 11 and related laws. More generally, when we subsidize derivatives and repos activity via bankruptcy benefits not open to other creditors, we get more of the activity than we oth-erwise would. Repeal would induce the derivatives market to better recognize the risks of counterparty financial failure, which in turn should dampen the possibility of another AIG/Bear/Lehman financial meltdown, thereby helping to maintain financial stability. Re-peal would lift the de facto bankruptcy subsidy. Yet the major financial reform package Congress just enacted lacked the needed cutbacks.

Number of Pages in PDF File: 52

Keywords: safe harbors, bankruptcy, financial crisis, contagion, bank run, qualified financial contracts, derivatives, repos, Dodd-Frank, orderly liquidation authority

JEL Classification: G20, G28, G32, G33, G38, K22

Accepted Paper Series


Download This Paper

Date posted: March 9, 2010 ; Last revised: June 9, 2013

Suggested Citation

Roe, Mark J., The Derivatives Market's Payment Priorities as Financial Crisis Accelerator (March 6, 2011). Stanford Law Review, Vol. 63, Issue3, p. 539, 2011; ECGI - Law Working Paper No. 153/2010; Harvard Public Law Working Paper No. 10-17. Available at SSRN: http://ssrn.com/abstract=1567075 or http://dx.doi.org/10.2139/ssrn.1567075

Contact Information

Mark J. Roe (Contact Author)
Harvard Law School ( email )
Griswold 502
Cambridge, MA 02138
United States
617-495-8099 (Phone)
617-495-4299 (Fax)
Feedback to SSRN


Paper statistics
Abstract Views: 12,701
Downloads: 2,061
Download Rank: 3,135
Citations:  6
Footnotes:  246

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.593 seconds