Asymmetrical Information

From the desk of Jane Galt:

What about Chapter 11? Isn't that a big fat government giveaway?

Er . . . no. There are arguments against Chapter 11, chiefly that it can sustain overcapacity in an industry, forcing serial bankruptcies as companies that were clinging to profitability find themselves unable to compete with competitors who have shed debts, expensive union contracts, and so forth. But this is a practical objection, not a moral one. It's still not "corporate welfare" in the sense that the governthatment gives money to corporations, or releases them from the tax obligations facing the rest of society.

Chapter 11 may in some cases take from private creditors and give to the company, though it's my understanding that in most cases the creditors do better in the long run by having an operating company paying their bills, than collecting the pennies-on-the-dollar that one usually gets out of liquidation. It's more likely to rearrange payments between creditors, favoring those with secured debt (companies usually try to keep making full payments on their equipment loans and mortgages) and vital suppliers over, say, the guy who decorated the corporate headquarters. But as I say, my understanding is that, over the long run, the creditors are actually generally better off. And even if the weren't, this too would not meet the definition of corporate welfare, which has to do with giving public funds to companies.

Far from being "corporate welfare", in fact, Chapter 11 is to the benefit of Uncle Sam. A liquidated company pays no taxes; nor does one that is losing money. The tax man is senior to all but secured creditors, but from what I understand, in most bankruptcies, there is precious little left after the secured creditors have gotten theirs. Chapter 11 ensures that Uncle Sam gets his back taxes, and then some.

Certainly, in United's case, a forced liquidation doesn't look like it would do the pensioners any good; if you can read a financial statement, go take a look at United's 2004 annual report. You'll observe that after senior creditors and Uncle Sam are paid, there will be precious little available for the pensioners--who, if Battlepanda et al had their way, would be out of a job as well as a pension.

But what about the market says Battlepanda. Don't I care about the market? Why, yes, with a passion seldom found in one so young. But the market is not some abstract entity, a platonic capitalist ideal that exists independant of human thought or action. It operates in a framework of law, which has to decide things like what to do with companies that are unable to pay their bills. There's no shiny libertarian answer to this question, any more than there's a libertarian code governing what to do with people when they die. One has to ask, what's best for society? Which encompasses questions like "What makes creditors best off?" "What is most likely to foster economic growth?" "What causes the least disruption to the lives of everyone who has been involved with this company?" and "What expresses our social values?" I think that "Chapter 11" is, in fact, the best answer to all of these questions. It makes our companies more competitive, and our recessions less violent; it helps creditors, workers, and suppliers; and it expresses the fundamental American belief that past mistakes, or bad luck, should not spell everlasting future doom. We have the easiest corporate and personal bankruptcy in the world, and no coincidentally, we also have the most successful entrepreneurial culture. I think most Americans, left and right, agree that it is a good thing that American citizens and corporations feel free to strike out in new directions without the crippling fear that one mistake could sink them forever.

Forced liquidation, which is common in other countries, is an expression of a social value that I find oppressive: that one must pay for past mistakes no matter how innocently made. In Germany, for example, managers of companies that go bankrupt are liable to be prosecuted for breach of trust; in Britain, managers that allow their companies to stay in business one minute past the point of perfect solvency are personally liable for any debts so incurred. These things are certainly fair, if you look at them one way, but they are also personally, and economically, stifling.

Moreover, they produce an attitude towards personal bankruptcy that most of the liberals getting excercised about Chapter 11 would find horrifying: there is no such thing as Chapter 7 anywhere else in the developed world. In every other country, everyone, no matter how unfortunate, poor, or unworldly, must strip their budgets down to the bare bones in order to pay a portion of their debts over periods that can last ten years or more. If your conduct is less than perfect during that time, the administrator can, and will, deny you a discharge. In Northern Europe, they'll deny you a discharge if they think you ran up the original debt in a profligate or immoral fashion. And all of these laws, draconian by American standards, result from a substantial loosening of the laws -- until about ten years ago, personal bankruptcy didn't exist at all outside of the countries whose legal systems were based on the English Common Law.

So no, it isn't corporate welfare; it's an attempt to deal with the difficult, but inevitable circumstance of companies whose fortunes take an irreperable turn for the worse. It may not be perfect. So few human laws are. But having studied the matter a little, it looks a lot better than the alternative its critics are offering.

Posted by Jane Galt at May 14, 2005 6:59 AM | TrackBack | Technorati inbound links