Yesterday's Wall Street Journal tells how the Obama administration forced J.P. Morgan Chase and other senior lenders to accept $2.25 billion on Chrysler's $6.9 billion in debt. "Senior secured lenders usually get paid in full before lower-priority lenders get anything," fretted the Journal. "Not this time."
"In its rush to save Detroit," argues our sister publication, The Economist, "the American government is trashing creditors’ rights."
Yes, bankruptcy law is the crown jewel of American capitalism and secured lending should be inviolate. It's also unfortunate that this "gerrymandering the rules," as Big Sis calls it, benefits Detroit and its unions, an easy target for critics.
But let's get real. This is an extraordinary move by the government, not an ongoing campaign to subvert bankruptcy.
For that, you'd have to look to the banking industry itself, which has waged a tireless effort to gerrymander its way around bankruptcy.
In fact, that's a good definition of securitization: it is a method of gerrymandering a loan such that the assets by which it is collateralized are removed from any future bankruptcy estate.
That's why banks were able to pass off subprime mortgages — not to mention trade receivables from BBB companies — as AAA credits. Because the (toxic) assets had been "sold" to an imaginary company, they were no longer affected by the risk that their originator might go bankrupt. (No one bothered to wonder if the assets themselves carried underlying insolvency risk.)
Even so, banks for many years sought a safe-harbor provision for securitization in bankruptcy, particularly after the bankruptcy of LTV Steel threw a scare into the industry. When the current bankruptcy law was being debated in 2005, banks felt more secure about securitization, and dropped the provision to avoid attracting opposition to an otherwise bank-friendly bill.
Still, the final law gave banks many end-runs around bankruptcy's "automatic stay," which prevents creditors from seizing collateral or terminating contracts from once a company files for bankruptcy. The law removed every conceivable type of financial instrument from the waterfall, and allowed banks to immediately net out their positions with an insolvent debtor — without court approval — and without consulting secured lenders.
"The bankruptcy code grant[s] those who have entered into financial derivative contracts with parties that subsequently become insolvent greater rights than these statutes grant those who enter into most contracts," then-FDIC general counsel William F. Kroener III told Congress in 1999.
The 2005 law expanded those 'rights,' a move that a University of Chicago law professor warned Congress, "would take us farther down the path of allowing sophisticated parties to opt out of bankruptcy."
Those same sophisticated parties, of course, are now complaining they've lost the very protections they've long sought to circumvent.
Here's an idea for the government. Offer to pay the banks the $4.65 billion they stand to lose, but only if they agree to a simple revision of the bankruptcy code: All contracts, regardless of type, are subject to the bankruptcy waterfall.
Almost every week on the defunct TV show "Fear Factor," the hapless contestants would be forced to eat bugs, or larvae, or worms. It was, to put it mildly, gag-inducing — to the viewers (who knows what was going through the minds of those actually doing the deed?). When the show popped up on my screen during channel-surfing, my well-trained finger dashed on by with urgent, electric speed.
It is with similar revulsion that I contemplate a frantic, mid-life search for work following a job elimination. It's something most people would prefer not to think about. But very often these days, the unthinkable happens.
This week I spoke with a gentleman who recently found an executive finance position after searching for the better part of a year. He had the required experience — public accounting, controllership, treasury, financial planning and analysis, compliance, risk management. The company he landed at is larger than his previous one, but he's got a lesser title.
Speaking on condition of anonymity, he displayed his frustrations vividly, leveling both barrels at employers' current human capital mindset. His insights seem quite well-informed, since he claims to have spoken with at least 150 companies and 30 recruiters during his job-seeking sojourn. Here are the highlights:
"This should be a big time for companies to build up human capital resources. When times are tough and people are worried about their jobs, if you go out and invest in the right people who you want to remain with the company, they will remember that loyalty. But what is happening is the opposite. Many times I witnessed companies trying to consolidate roles. Maybe they had people heading SEC reporting, controllership, and financial planning and analysis, earning maybe $120,000 to $150,000 each, and they decide to combine two or all three of those roles and hire one person to do it.
"But they're trying to get away with paying $130,000 to $140,000 for that one person. People in current positions will not move for that. Those who were laid off or had roles eliminated will do it, but as soon as the economy turns around they're going to leave. Companies are being very short-sighted in their cost-cutting efforts by trying to get a bargain on human capital.
"The other thing is that companies are afraid to make decisions. You talk to them for the first time and they talk about their great, urgent need to hire someone. And then they delay the process for a month, or two, or four, or they don't make the decision at all, as a cost-cutting initiative. What does that do? The person looking at the company says, is this a management team I really want to work for? One that will not invest in people?
"That's my personal experience. There's huge levels of disappointment. There are hundreds of candidates for each role. It might take weeks or even months to get down to two or three, and at that point it's a flip of the coin — it has nothing to do with whether I can do the job. I was in that position a number of times."
As if they needed any, the critics of fair value got a fresh new example of the craziness of an oft-decried provision in FAS 157, paragraph 15 of Fair Value Measurements. The provision rewards companies whose credit spreads on their debt liabilities have widened and punishes those who have become more creditworthy.
On Wednesday, Morgan Stanley reported that it had to cut its first-quarter net revenues $1.5 billion because the credit spreads on some of its long-term debt had narrowed. What happened was that as the investment bank grew more reliable to its creditors over the first part of the year, its debt became more valuable. And under the dictates of mark-to-mark accounting, the firm had to take a writeoff because of this very positive occurrence.
Sound nuts? It has sounded so to many observers. In the 15th paragraph of 157 FASB says, nevertheless, that "the fair value of [a company's] liability shall reflect the nonperformance risk relating to that liability." Thus, as the nonperformance risk--as reflected by slimmer credit spreads—narrowed, Morgan Stanley had to reflect the decreased value of its debt as a decrease in sales on its income statement.
Like the alleged evils of mark-to-market accounting in illiquid markets—although to a lesser extent—the irrational practice of forcing improved creditworthiness to be reflected in revenue decreases has become fodder for fair value’s enemies. When FASB made its recent amendments to 157, it neglected to attack the provision. If only to preserve fair-value accounting from more political attacks, it should do so now.
There's something about a global economic crisis that takes all the satisfaction out of having an "I-told-you-so" moment. Not only does it seem tacky to point out that you warned about securitization and the dispersion of risk years ago, but it's hard to feel smug when, like everyone else, you still managed to lose a huge chunk of your 401(k).
So imagine my delight at reading in Felix Salmon's Reuter's blog his notes from a speech to the Regional Bond Dealers Association, in which he appears to admit that he was wrong about securitization. Even better, he appears to admit that he and Alan Greenspan were both mistaken about the benefits of risk dispersion:
"[L]ike most of us, he writes, I’ve changed my view on risk considerably over the past couple of years. . . . I believed along with Alan Greenspan that when it comes to debt instruments in general . . . 'These instruments enhance the ability to differentiate risk and allocate it to those investor most able and willing to take it.' But if you look at what happened in practice, the art of securitization always seemed designed to create ever-increasing quantities of risk-free debt.
Ahhh. Now that seems like something I can enjoy.
Admittedly, I'm pinging Salmon for a critique he wrote of my position two years ago, but since taking swipes at others (including, on occasion, CFO) is his stock in trade, returning the favor seems appropriately personal and a lot less like dancing on the grave of America's investment banks.
Of course, Salmon may still think the concept makes sense (note how careful he is to say that it went wrong "in practice"). If so, as I said two years ago, "he's going to win the debate anyway, because, as a $2.1 trillion market, securitization is too big to fail." If I didn't exactly predict the existence of the TALF when I wrote that in 2007, I still probably came closer than anyone could have imagined.
So what about it, Felix? Is TALF perpetuating our addiction to cheap, repackaged junk debt, or can Tim Geithner walk the fine line between securitization on life support and securitization on steriods?
But given the choice between surfing YouTube for accounting songs or reading comment letters from banks about FASB's financial statement presentation discussion paper, we quickly uncovered several instances in which accounting has inspired people to burst into song. (Yes, the banks are singing the blues about financial statements, but we probably won't finish that article until tomorrow).
We're prejudiced, of course, but we're partial to "My CFO," written for finance chief Bob Wayman upon his retirement from Hewlett-Packard, although the audio track makes it clear that the company's troubles with harmony weren't limited to Compaq. (Can anyone out there send us all the lyrics we can't quite hear?)
Still, perhaps the best of YouTube's accounting music videos is this "Accounting Love Song." The audio isn't the best, so I've included the lyrics below.
Accounting Love Song
I'm feeling lonely, I know you are too
'Cause every time that we're apart my love it accrues
And it's so taxin' when you're not around
I can't defer my feelings, girl, I get so down
I can't stop thinkin' 'bout you, girl I've tried
But my opinion of you is unqualified
I like the way you make your assets move
You make me want to crunch some numbers with you
Accountants in love (4X)
Now I'm side steppin' so I'll get to the point
If my name was Touche you would be my Deloitte
And I think that you really should know
How bad I want to check your internal controls
Accountants in love (4X)
Girl I hate to be cliche
But you're the one that I've been dreaming of
I could sit here and itemize
All the reasons that I fell in love
Know other finance and accounting ballads? Send them in and we'll post them. You could be as famous as Susan Boyle. But probably not.
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