Super-Bankruptcy

Old ideas get recycled, including bad ones. One such idea is the adoption of “super-bankruptcy,” a temporary tool to be used when a country faces systemic bankruptcy brought on by large macro-economic disturbances. Read paper on bankruptcy regimes during financial distress.

The super-bankruptcy approach was advocated by Joe Stiglitz during the early stages of the East Asian crisis.  The basic presumptions of the super-bankruptcy are that management stays in place and that there is a forced debt-to-equity conversion. The existence of such a bankruptcy option will likely result in higher interest rates in normal times. However, in a systemic crisis it can preserve the going concern value of firms by preventing too many liquidations and keeping in place existing managers, who sometimes know best how to run the firms. Sounds very much like today's announced rescue of Citigroup, albeit what Stiglitz had in mind was a procedure for the whole economy.

An important issue is when to call for super-bankruptcy. When is the crisis of a systemic nature, and who has the authority to call for such a suspension of payments? Also, as wealth is often concentrated in emerging markets and some debtors stand to gain disproportionately from a suspension of payments, this could lead to social upheaval.

The evidence from East Asia suggests that adopting a temporary super-bankruptcy is unnecessary. While corporations and banks moved slowly to restructure outstanding debt, in the hope that economic recovery will obviate the need for write-offs (for banks) or surrendering of equity control (for large shareholders), few firms appeared to be prematurely liquidated. If anything, too many firms continued to operate for too long, as was the case with several chaebol-related firms in Korea, and that equity holders bore too little of the costs of restructuring.