Bankruptcy Markets: Making Sense of Claims Trading

Abstract

The creation of a market in bankruptcy claims is the single most important development in the bankruptcy world since the Bankruptcy Code’s enactment in 1978. Claims trading has revolutionized bankruptcy by making it a much more market-driven process. The limited scholarly literature on claims trading, however, while recognizing its radical impact, has either focused on doctrinal issues or used claims trading as a touchstone for the “Great Normative Bankruptcy Debate” about whether bankruptcy should be a market process or a safe-harbor from the market. The result is that scholarly treatments of claims trading have operated with a high level of generality and scant evidentiary basis.

This Article argues that a more productive approach to claims trading must begin with a better understanding of its nuances. It shows that claims trading is a complex, multi-dimensional, and dynamic market with tremendous variation by timing, asset class, and trading motivation, and with different impacts on the bankruptcy reorganization process. Accordingly, the Article challenges the claim of Professors Douglas G. Baird and Robert K. Rasmussen that claims trading, along with other financial innovations, is detrimental to the bankruptcy process by creating an anticommons problem. The Article questions key assumptions underlying Baird and Rasmussen’s argument and suggests that rather than wreaking havoc on the bankruptcy process, claims trading might facilitate more efficient bankruptcy negotiations and help reorganizations.

In the abstract, however, claims trading’s net social welfare impact is indeterminate, and empirical examination is not possible because of the incomplete nature of claims trading disclosure requirements, which expose only changes in legal title, not economic interest. Given the complexity of the claims trading market and our limited knowledge of its operations and impact, regulatory approaches to claims trading should be narrowly targeted and noninvasive. A start would be to improve market efficiency by increasing unsophisticated creditors’ awareness of their claims trading options and by enhancing price disclosure to market participants through mechanisms like electronic quotation bulletin boards.

Keywords: bankruptcy, claims trading, distressed debt, hedge funds, total return swaps, TRS, empty core, core theory, anticommons, reorganization, bankruptcy claims

JEL Classification: G33, K12, K22