6 ms·

Looting: The Economic Underworld of Bankruptcy for Profit

81 points by cjdrake 14y ago

deleted 14y ago
[deleted]
cjdrake 14y ago
I probably should have posted the link to Tim O'Reilly's Google+ post: https://plus.google.com/107033731246200681024/posts/YCFhTbmfXC9 https://plus.google.com/107033731246200681024/posts/YCFhTbmf...
patdennis 14y ago
This is very interesting. I think it's also worth pointing out that the data tends to show that the use of personal bankruptcy to game the system is actually very low. I find that when the subject is brought up in a political context, this distinction is often not made. Here is a great lecture from Elizabeth Warren on the subject: http://www.youtube.com/watch?v=akVL7QY0S8A http://www.youtube.com/watch?v=akVL7QY0S8A
- Retric 14y ago
  I think it's also worth noting that Risk of bankruptcy enables similar accounting games even for healthy company's. Basically a bank that's leveraged 10x might as well leverage 50x because the upside keeps increasing linearly with more debt but the downside is practically fixed.
  - refurb 14y ago
    The upside would not keep increasing linearly. When leveraging, the current debt burden of the company would be used to determine the level of risk and thus the interest rate. The level is risk is associated with the level of assets of the company (thus the ability to recover in case of default). I would agree that a bailout creates a floor to loss, but then again a natural floor exists anyways (the net assets of the company).
  - meric 14y ago
    That's why if you're lending a bank money, use covenants. http://en.wikipedia.org/wiki/Loan_covenant http://en.wikipedia.org/wiki/Loan_covenant People already do this with bank deposits when there is no government guarantee leading to bank runs.
- anamax 14y ago
  > Here is a great lecture from Elizabeth Warren I wouldn't put too much weight on Warren's work on bankruptcy. See http://www.theatlantic.com/business/archive/2010/07/considering-elizabeth-warren-the-scholar/60211/ http://www.theatlantic.com/business/archive/2010/07/consider... .
  - patdennis 14y ago
    Call me elitist, but I hardly think that a single story from a blogger/editor at the Atlantic is enough to discount all of the work of one of the preeminent scholars of bankruptcy law in the United States. Warren has successfully defended her conclusions in academic circles for years.
    - anamax 14y ago
      > Call me elitist I'll call you overly impressed by irrelevant credentials. (She's not an economist or statistician.) As for me, the validity of her conclusions don't depend on where she works, whether she was wrong about being part Native American, etc. > Warren has successfully defended her conclusions in academic circles for years. The Atlantic story contains cites to some academic eviscerations of Warren's work....
    - MichaelSalib 14y ago
      We could use a bit more elitism. If the best criticism of Warren's work one can find comes from an innumerate like McArdle [1], it's probably pretty sound. [1] http://www.balloon-juice.com/2010/12/23/gastritis-broke-my-calculator/ http://www.balloon-juice.com/2010/12/23/gastritis-broke-my-c...
  - tptacek 14y ago
    I wouldn't put any weight on an analysis by Megan McArdle either. I like Warren as a politician, am deeply ambivalent about her as a policymaker or regulator, have no idea about her credibility as an academic, and read McArdle long enough to know that her issue here is ideological, and that she's not particularly credible on issues that touch that ideology. Preempting the obvious challenge to this comment: it's not that I'm going to point to any particular point in this particular blog post of hers and call BS on it (although I think it covertly lapses into subjectivity several times), but rather that her particular choices of papers and theses to take issue with aren't necessarily a fair representation of Warren, "scholar". Which is what her headline purports the post to be. There was no way McArdle was going to be objective about Warren. That's a little bit like expecting Paul Krugman (not that I'm putting them on the same level!) to be objective about Paul Ryan.
debacle 14y ago
It's not really an underworld if it happens completely out in the open, is it?
- wpietri 14y ago
  How out in the open is it? For years before the banking blowup that preceded the Great Recession, people knew that there was a lot of risk somewhere. It's just that nobody knew where. It turns out that too-big-to-fail banks and fears of systemic collapse meant that the risk was with taxpayers. Or you can look at private equity's privatization of gains and socialization of losses: http://www.bloomberg.com/news/2012-07-15/romney-s-bain-yielded-private-gains-socialized-losses.html http://www.bloomberg.com/news/2012-07-15/romney-s-bain-yield... The finances were out in the open, but what was hidden was that the companies were no longer being run in good faith.
dfragnito 14y ago
I live in Rochester NY, home of Eastman Kodak which is going through a bankruptcy, and looks like it may be coming out of it (probably will go back in it or get sold in my opinion). I an not suggesting that Kodak's downfalls was due to management looting the company but we do see evidence of upper management grabbing all they can get. Just recently upper management asked for millions of dollars of bonuses (earmarked for upper management only) if Kodak successfully pays off its creditors. Bonuses use to be rewarded for turning a profit, apparently now you get rewarded for just paying your bills.
- refurb 14y ago
  Bonuses aren't just rewarded for making a profit. Let's say a company like RIM is losing $500M/yr. If they hire a new CEO who comes in and reduces that to a lose of $10M/yr, should he get a bonus?
  - grey-area 14y ago
    Not till they turn a profit. He still gets a more than adequate salary for his work. A bonus not linked to performance is no longer a bonus, but rather another way of paying wages.
    - hipsterelitist 14y ago
      Then how would you properly incentivize someone to come in to take a company out of such dire circumstances? Someone with the talent to take a 500M loss and reduce it to 10M certainly would command the same salary with more upside at a solvent company.
      - katbyte 14y ago
        uh, correct me if i'm wrong but isn't that her job to do that and typically those jobs pay extremely well? And on the flip side, if there was a large bonus for reducing debt by that much by year end, would that incentivize this person to do anything possible to reduce debt even at the cost of the companies long term survival? Expanding on that it seems reasonable to consider the possibility that bonuses for some year end goal could be causing CEO's and others to do whatever it takes to get their bonus while damaging companies long term survival, because they put their bonus first not the company.
zallarak 14y ago
Another interesting thing to note about profit coming from bankruptcy is the Legal and Banking/Restructuring fees. The restructuring advisors both on the legal and financial side get massive fees from bankruptcy advising (negotiating debt settlements and post-bankruptcy cap structure, and other things like that) and these fees are prioritized over even the most senior liens of debt. These fees can literally be 1-15% of the total debt of the distressed company.

81 points by cjdrake 14y ago

deleted 14y ago

[deleted]

I probably should have posted the link to Tim O'Reilly's Google+ post: https://plus.google.com/107033731246200681024/posts/YCFhTbmfXC9 https://plus.google.com/107033731246200681024/posts/YCFhTbmf...

patdennis 14y ago

This is very interesting. I think it's also worth pointing out that the data tends to show that the use of personal bankruptcy to game the system is actually very low. I find that when the subject is brought up in a political context, this distinction is often not made. Here is a great lecture from Elizabeth Warren on the subject: http://www.youtube.com/watch?v=akVL7QY0S8A http://www.youtube.com/watch?v=akVL7QY0S8A

Retric 14y ago
I think it's also worth noting that Risk of bankruptcy enables similar accounting games even for healthy company's. Basically a bank that's leveraged 10x might as well leverage 50x because the upside keeps increasing linearly with more debt but the downside is practically fixed.
- refurb 14y ago
  The upside would not keep increasing linearly. When leveraging, the current debt burden of the company would be used to determine the level of risk and thus the interest rate. The level is risk is associated with the level of assets of the company (thus the ability to recover in case of default). I would agree that a bailout creates a floor to loss, but then again a natural floor exists anyways (the net assets of the company).
- meric 14y ago
  That's why if you're lending a bank money, use covenants. http://en.wikipedia.org/wiki/Loan_covenant http://en.wikipedia.org/wiki/Loan_covenant People already do this with bank deposits when there is no government guarantee leading to bank runs.
anamax 14y ago
> Here is a great lecture from Elizabeth Warren I wouldn't put too much weight on Warren's work on bankruptcy. See http://www.theatlantic.com/business/archive/2010/07/considering-elizabeth-warren-the-scholar/60211/ http://www.theatlantic.com/business/archive/2010/07/consider... .
- patdennis 14y ago
  Call me elitist, but I hardly think that a single story from a blogger/editor at the Atlantic is enough to discount all of the work of one of the preeminent scholars of bankruptcy law in the United States. Warren has successfully defended her conclusions in academic circles for years.
  - anamax 14y ago
    > Call me elitist I'll call you overly impressed by irrelevant credentials. (She's not an economist or statistician.) As for me, the validity of her conclusions don't depend on where she works, whether she was wrong about being part Native American, etc. > Warren has successfully defended her conclusions in academic circles for years. The Atlantic story contains cites to some academic eviscerations of Warren's work....
  - MichaelSalib 14y ago
    We could use a bit more elitism. If the best criticism of Warren's work one can find comes from an innumerate like McArdle [1], it's probably pretty sound. [1] http://www.balloon-juice.com/2010/12/23/gastritis-broke-my-calculator/ http://www.balloon-juice.com/2010/12/23/gastritis-broke-my-c...
- tptacek 14y ago
  I wouldn't put any weight on an analysis by Megan McArdle either. I like Warren as a politician, am deeply ambivalent about her as a policymaker or regulator, have no idea about her credibility as an academic, and read McArdle long enough to know that her issue here is ideological, and that she's not particularly credible on issues that touch that ideology. Preempting the obvious challenge to this comment: it's not that I'm going to point to any particular point in this particular blog post of hers and call BS on it (although I think it covertly lapses into subjectivity several times), but rather that her particular choices of papers and theses to take issue with aren't necessarily a fair representation of Warren, "scholar". Which is what her headline purports the post to be. There was no way McArdle was going to be objective about Warren. That's a little bit like expecting Paul Krugman (not that I'm putting them on the same level!) to be objective about Paul Ryan.

debacle 14y ago

It's not really an underworld if it happens completely out in the open, is it?

wpietri 14y ago
How out in the open is it? For years before the banking blowup that preceded the Great Recession, people knew that there was a lot of risk somewhere. It's just that nobody knew where. It turns out that too-big-to-fail banks and fears of systemic collapse meant that the risk was with taxpayers. Or you can look at private equity's privatization of gains and socialization of losses: http://www.bloomberg.com/news/2012-07-15/romney-s-bain-yielded-private-gains-socialized-losses.html http://www.bloomberg.com/news/2012-07-15/romney-s-bain-yield... The finances were out in the open, but what was hidden was that the companies were no longer being run in good faith.

dfragnito 14y ago

I live in Rochester NY, home of Eastman Kodak which is going through a bankruptcy, and looks like it may be coming out of it (probably will go back in it or get sold in my opinion). I an not suggesting that Kodak's downfalls was due to management looting the company but we do see evidence of upper management grabbing all they can get. Just recently upper management asked for millions of dollars of bonuses (earmarked for upper management only) if Kodak successfully pays off its creditors. Bonuses use to be rewarded for turning a profit, apparently now you get rewarded for just paying your bills.

refurb 14y ago
Bonuses aren't just rewarded for making a profit. Let's say a company like RIM is losing $500M/yr. If they hire a new CEO who comes in and reduces that to a lose of $10M/yr, should he get a bonus?
- grey-area 14y ago
  Not till they turn a profit. He still gets a more than adequate salary for his work. A bonus not linked to performance is no longer a bonus, but rather another way of paying wages.
  - hipsterelitist 14y ago
    Then how would you properly incentivize someone to come in to take a company out of such dire circumstances? Someone with the talent to take a 500M loss and reduce it to 10M certainly would command the same salary with more upside at a solvent company.
    - katbyte 14y ago
      uh, correct me if i'm wrong but isn't that her job to do that and typically those jobs pay extremely well? And on the flip side, if there was a large bonus for reducing debt by that much by year end, would that incentivize this person to do anything possible to reduce debt even at the cost of the companies long term survival? Expanding on that it seems reasonable to consider the possibility that bonuses for some year end goal could be causing CEO's and others to do whatever it takes to get their bonus while damaging companies long term survival, because they put their bonus first not the company.

zallarak 14y ago

Another interesting thing to note about profit coming from bankruptcy is the Legal and Banking/Restructuring fees. The restructuring advisors both on the legal and financial side get massive fees from bankruptcy advising (negotiating debt settlements and post-bankruptcy cap structure, and other things like that) and these fees are prioritized over even the most senior liens of debt. These fees can literally be 1-15% of the total debt of the distressed company.