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Bankruptcy and the financial crisis. Andrei Shleifer IMF presentation May 26, 2009. Reorganization of insolvent firms is a crucial institution of a market economy It works poorly in most countries, especially developing ones The problem is critical now, in the middle of the crisis.

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Bankruptcy and the financial crisis

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Bankruptcy and the financial crisis

Andrei Shleifer

IMF presentation

May 26, 2009


  • Reorganization of insolvent firms is a crucial institution of a market economy

  • It works poorly in most countries, especially developing ones

  • The problem is critical now, in the middle of the crisis


  • Discuss a study of insolvency in 88 countries conducted with S. Djankov, O. Hart, C. McLeish (JPE 2008)

  • Consider some implications for insolvency laws


Setup

Hypothetical Case

Respondents: Insolvency Practioners from

International Bar Association Committee on

Bankruptcy

Date: January 2006 (several rounds before)

Total: 344 lawyers

All countries with: GDP per capita > $1000

Population > 1.5 million

Total: 88 countries


Case Facts

Insolvent Firm called “Mirage”

Limited liability, domestically owned, medium-sized hotel

Located in most populous city

201 employees

50 suppliers (each owed money)

Five years ago, borrowed from Bizbank

Loan has collateral, i.e., is secured

Loan has 10 year term

Mirage has met all obligations until now

Loan has seniority


Case Facts (cont’d)

Mirage owned 51% by Mr. Douglas

No other shareholder has > 5%

Mirage has a manager, with no special human capital

Mirage has 136 units of debt

Suppliers, Tax Authorities, employees each owed 12

These are unsecured creditors

Bizbank is owed 100

All normalized to country’s GDP per capita


Case Facts (cont’d)

Mirage has been losing money and

is about to default due to industry shock

Assume going forward can cover costs

But cannot cover debt payments

Version A: Going concern worth 100

Piecemeal liquidation worth 70

Version B:Going concern worth 70

Piecemeal liquidation worth 100


Data

Time = T

Cost = C

Whether get the efficient outcome: EO = 1

Efficiency =

Assume zero net revenue during procedure and costs

incurred at end (but robust)

Also get structural features of procedure


Figure 1: Options for Mirage


Limitations of the Case

  • No informal workouts allowed

  • Capital structure does not adjust to law

  • Only one secured creditor

  • Complex conflicts minimized

  • (Indeed, foreclosure has correct incentives)

  • 4. Respondents know what is efficient from the start

  • 5. Do not need new financing

  • 6. No public interest, politics involved

  • 7. No tunneling (looting)


(Tentative) Conclusions

  • Lots of inefficiency in a very simple case: wrong outcome, slow, high administrative costs

  • How to do better?

    • Encourage foreclosure and floating charge

    • Circumscribe Appeals

    • Discourage automatic cessation of operations

    • Don’t allow suppliers/customers to rescind contracts

  • Reorganization seems a bad idea in poor countries, where, arguably, institutions are not good enough to support complex procedures.


  • What are the implications for today?

  • Assume bankruptcy reform cannot be done on short notice

  • Massive bankruptcies would be terrible for efficiency

  • Fire sale liquidations are bad for everyone

  • But also do not want debt forgiveness

  • Suggestion: encourage private renegotiation, perhaps even subsidize it


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