Posted by Carl Icahn January 13, 2009 : 12:44 PM
As seen in the Wall Street Journal
The epic financial crisis afflicting the banking industry in the last 18 months is largely the result of cratering values of loans and other assets stuck on bank balance sheets. When the market for such loans stalled, banks couldn’t sell them and were forced to take billions of dollars in writedowns.
Fearing the worst, the government pumped hundreds of billions of taxpayer dollars into these institutions, with questionable long-term results. Though it is early days in the rescue, the economy has shown few signs of improvement, which was one intended result. And the bank losses continue.
Why should taxpayers foot the bill when there are trillions of dollars in private money on the sidelines in the world financial markets? Private investment is a far more appropriate agent to revive these institutions, yet little is coming in.
One reason for this is that the distressed assets on bank balance sheets are being priced at artificially low levels as a direct result of federal bankruptcy laws. With a few changes, the banking system could face a financial revival backed by private investment, not public funds.
Convoluted bankruptcy laws keep loan prices artificially depressed because in this bear market, the prospect of a bankruptcy puts a huge damper on investor appetite for debt securities in overleveraged companies. This includes hundreds of billions of dollars in bank and bond debt issued for scores of leveraged buyouts in recent years.
This sorry state of affairs could be improved by the elimination of one key bankruptcy rule: the “exclusivity” period. This rule unfairly gives managements, with court approval, a monopoly to formulate a reorganization plan for a minimum of 18 months and sometimes more. Such a plan generally includes proposals to restructure debt, sell assets and void onerous contracts.
But during this period non-trade creditors like bank debt and bond holders languish in significant uncertainty as to what will happen to their investment.
The exclusivity rule mainly benefits equity holders and managements, not creditors. But why should the same managements that got the company into trouble be given the right to lock-up its assets for an extended period of time?
Without an exclusivity period, different classes of creditors and equity holders could immediately propose different restructuring solutions, including the sale of assets overseen by a bankruptcy court.
The biggest impact of such a rule change is that the assets in a company operating in Chapter 11 would be priced as though they could be sold, in effect giving them a ‘mergers & acquisitions premium’ unshackled by what amounts to federal intervention into company affairs.
This small change would cause distressed loan prices to rise in many cases – having the effect of bolstering balance sheets of banks and other companies that hold them – without public money.
Furthermore, it would slash the need for expensive bankruptcy lawyers, restructuring firms, consultants and others advisors, which can reap tens of millions of dollars in fees – often at the expense of creditors and company treasuries. These operatives would likely be the biggest opponents to such a change, besides entrenched company managements who benefit from the exclusivity monopoly.
It is one thing to apply the exclusivity rule to small businesses in the hopes that an individual who has spent his life building a business has a chance to keep it. But it makes no sense that huge private equity players can use these same rules to crush billions of dollars of debt that banks lent to finance once-healthy companies.
If equity holders bet and lost, then debtholders should be able to come in quickly and salvage the company and their investment. In the long run, this would be good for the company, the credit markets, employees and the communities in which companies are located.
Few are helped by the exclusivity rule, other than the desperate equity holders and top managers clinging to the helm of the companies that faltered under their watch. And eliminating exclusivity would not necessarily lead to more company liquidations, but would take away the monopoly management has on formulating restructuring proposals. It would also force managements to redouble their efforts to find ways to stay out of Chapter 11 – which can only be a good thing. Chapter 11 is often a crutch to lackluster and unimaginative managements. Changing the rules would put them under more pressure to keep their companies healthy to avoid it.
I have long argued for increased shareholder rights and last year initiated United Shareholders of America to advocate strengthening those rights. In this case I argue for increased creditor rights.
But the economic philosophy behind both initiatives is identical. In both cases it allows market forces to work better, both in pricing securities and also eliminating management monopolies in the affairs of companies.
We must allow market forces to do their job, which includes promoting the ability of the rightful owners of assets – not just managements - to control their fate to the maximum extent practical. The idea is to efficiently maximize the value of the assets through operational changes, restructuring or sale to third parties.
Today, troubled assets are often frozen in a quagmire and will be for years to come unless bankruptcy laws are changed.
The capitalist system is the most efficient wealth-producing machine in existence. We must strive to remove barriers that thwart this efficiency.