The Bankrupt Bankruptcy Business Model

bankerOne of the perpetual refrains from conservatives is that we should “run our government like a business.”  This is wrong at all levels, but given the current reign of the financialists it’s dangerous, and ought to be labelled as such.  Let’s start with the old, familiar, axiom: One man’s debt is another man’s asset.

The Basics and Bankruptcy

If you lend me $X it is my debt and your asset (receivable). If I cannot repay you then I can only unburden my indebtedness by declaring bankruptcy.  Let’s take this above the personal level.  If you lend my business $X and I cannot repay it, then bankruptcy is the last option.  Now, moving up another step.  Corporation A issues bonds (debt) which are purchased in the bond market.  If there is “too much” debt, it’s time for bankruptcy.

In a corporate bankruptcy the first claimants are the firms handling the bankruptcy – the law firm guiding the bankruptcy; the accountancy firm doing the final postings for the bankrupt company; and, the company handling the sale of the company assets.   This is a lucrative part of the process for these first claimants.   One recent bankruptcy, that of Kodak Inc., started with an almost startling amount of associated fees: “Fee examiner Richard Stern recommended approval of about $235.8 million in fees and another $7.2 million in expenses, according to an 87-page report in U.S. Bankruptcy Court in Manhattan.” [Reuters, Nov. 2013]

After the corporation, such as Kodak, has paid the fees associated with the bankruptcy, the secured creditors are the next claimants.  A secured creditor is one who lent the company money for physical assets.  These might be company buildings and furnishings, leases for equipment and vehicles, or loans for equipment which have not been paid in full.

Funds remaining after the fees and the secured creditors are paid go to the next level of claimants — the unsecured creditors.  Here’s the part where the bondholders come on stage.

“The rights of the bondholders are stronger than the equity holders of the firm. Bondholders get paid off before the equity holders in liquidation and they are first in line to receive new securities, cash or a mixture or both should a reorganization occur. Within the bondholder’s group there is also a pecking order based on the seniority of each claim. Bondholders with more seniority, set forth in the indentures of the various classes of securities issued by the bankrupt firm, will receive their shares before the more junior holders.” [Investopedia]

And now the stage is set, and we need to take a look at the theater of the economics of bankruptcy.

Voluntary and Involuntary Vultures

There are two forms of bankruptcy, voluntary and involuntary.  In the  involuntary form the creditors  force the business into the process by filing for its bankruptcy.  In its most nefarious incarnation, this type of involuntary bankruptcy is referred to as Vulture Capitalism.   A classic example of Vulture Capitalism comes to us compliments of Bain Capital Management which purchased a Kansas City  steel mill and promptly loaded the reorganized company with …. more debt.   A toxic combination of poor management and debts which had skyrocketed to $387 million by 1995 meant the company had little choice but to declare bankruptcy in 2001.   And guess what?  In 2002 it was discovered that the company had underfunded its pension plan by approximately $44 million.  Workers laid off in the aftermath of the bankruptcy received the basic retirement but NOT the supplemental retirement package they’d negotiated with management in case of the mill’s closure.  [MJ]

An even more egregious example comes from the land of Twinkies.  The corporation faced bankruptcy in 2004, secured all manner of employee give-backs, and as in the steel mill example went on to incur even more debt. Two firms, Silver Point Capital and Monarch Alternative Capital, ended up owning some 60% of the firm’s debt.  Enter the Ripplewood factor:

“Following these massive givebacks, a private equity company called Ripplewood Holdings brought the company out of bankruptcy in 2009 for $130 million and rechristened it Hostess Brands. The hedge funds and other lenders forgave some old debt and extended some new debt. Ripplewood convinced the other stakeholders that it could turn the company around and, apparently, convinced them so completely that only Hostess Management and Ripplewood had seats on the board. Neither the unions nor the hedge funds acquired voting seats as part of the deals struck to keep the company afloat. They just trusted Ripplewood to turn things around, implement new technologies, introduce new products, and rebuild aging infrastructure.” [Salon]

Now we had “Hostess Brands” under Ripplewood Holdings domain, and the results weren’t pretty.  Suffice it to say that Ripplewood didn’t know what it was doing.  No new or much improved products were created, the company took on yet more debt, plants weren’t modernized, and eventually the edifice collapsed in a heap of finger pointing at the workers and their union, although the hedge funds and the unions had no effective representation under the Ripplewood Holdings management scheme.

IF we want a government run like a “modern” business then it would be subject to the same kind of manipulation by the financialists as the producers at the Kodak plant, the Kansas City steel mill, and the cupcake factories.

Detroit City

Call it Shock Doctrine Disaster Capitalism or Austerity Politics as you will, the outcome is essentially the same:  An elected government is “bankrupted” by its creditors.  Remember — One man’s debt is another man’s asset — so if corporations aren’t issuing as much debt because of low interest rates from the Federal Reserve, where’s a poor hedge fund supposed to find new sources of debt to buy up?   Municipal debts.  Some players are familiar.

“Monarch Alternative Capital, which played a major role in the bankruptcy of Twinkie-maker Hostess Brands Inc, and several other funds have scooped up more than $600 million of debts of Jefferson County, Alabama, according to court records.”  [Reuters]

And, the vultures were circling Detroit last May:

“With $8.6 billion in long-term debt, Detroit would be comparable to the biggest corporate failures if it eventually files for bankruptcy, a major advantage for big hedge funds that are used to investing hundreds of millions of dollars at a time.

The sheer size of Detroit’s debt should make it easier for the funds to track down very large chunks of bonds, magnifying their profit potential, cutting their research and advisory costs and giving them leverage when it comes to restructuring talks.”  [Reuters]

In case the trail is getting a bit tangled to follow — a municipality like Jefferson County, Alabama or Detroit, Michigan takes on debt by issuing bonds.  The bond holders are creditors, and in the great arc of mismanagement pension plans are underfunded, the creditors determine there is “too much” debt and it’s time to swoop in and pick the carcass — for fees, of course.   Refer back to the $238.5 million in fees collected in the bankruptcy of just one corporation, Kodak.

This is privatization on steroids.  A municipality is encouraged to issue bonds to improve or supply government services.  In the Jefferson County example it was for necessary improvements and renovations to its sewer system.   The firm underwriting the sale of the bonds “makes a market” for them, i.e. sells them to investors (perhaps hedge funds.)

If the municipality can be convinced to issue yet more bonds — by bond marketers who want to make “more markets,” the underwriters profit, and the creditors (investors in those bonds) until the creditors become sufficiently nervous and create enough panic to force the municipality into involuntary bankruptcy.  Then the story continues — the municipal assets are sold off to private investors, (such as the Detroit Institute of Art’s collection, or the assets of Jefferson County, AL)  the creditors may or may not be made whole, the “government” is reorganized and the bankers are pleased as punch.

Dis-utopia

The logical outcome is an ultra-libertarian wet dream.   There is no remaining communal property — the art collections are sold off to people who “will appreciate them,” or the school buses will be purchased by the highest bidder.  The water system will be taken over by a private company; the roads and bridges are now able to collect tolls for their use.  All the schools are run by private corporations, the parks are restructured into “fee for use,” and the libraries are “by subscription only.”   And, if a “service” cannot be performed at a profit it will be discontinued.

But, the bankers will be pleased.  The “government” is now being “run” just like any other corporation — any other corporation vulnerable to the manipulations of the financialists who would create their wealth from the indebtedness of others be it  personal (car, student, and mortgage loans), corporate (bonds), or governmental (bonds.)   It’s all just money to them. The real bankruptcy here is moral.

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