Systematic Risk & Chapter 11
27 Pages Posted: 10 May 2009
Date Written: May 4, 2009
We are in the midst of the most significant financial crisis since the New Deal, yet chapter 11 is notable mostly for its absence. Chapter 11 is thing that wrecked Lehman Brothers, and perhaps the credit markets. And the thing that the Federal Reserve and Treasury worked so hard to keep AIG and Bear Stearns away from. The thing that General Motors and Chrysler were working so hard to avoid.
In this short paper I examine the role of chapter 11 in a time of widespread financial distress. I argue that Lehman’s chapter 11 filing did not cause the current credit crisis, but rather Lehman’s failure caused the crisis. That failure was likely to occur with or without chapter 11, unless the government prevented it or mitigated its consequences, as in the case of AIG.
Chapter 11 has a role to play in a systemic crisis, by providing a framework for government intervention that avoids the need for the kind of intervention we have recently been seeing on an ad hoc basis. But I also argue that the growth of exceptions to chapter 11 -- like the safe harbor provisions for derivatives -- have reduced chapter 11's efficacy. It is time to reconsider the piecemeal erosion of chapter 11, and return to the more inclusive bankruptcy process that Congress enacted in 1978.
Keywords: Chapter 11, systemic risk, TARP, safe harbors, dervivatives, bankruptcy, AIG, Lehman, GM
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