Wednesday, April 21, 2010

Comment On Bankruptcy Reform Will Limit Bailouts Article In Wall St. Journal

A comment I posted to the Wall Street Journal article, "Bankruptcy Reform Will Limit Bailouts" by Thomas Jackson And David Skeel.
This is an old issue. The 1982 revision to the Bankruptcy code put in place exemptions for derivative contracts from the automatic stay provisions of Bankruptcy law. The automatic stay of filing for bankruptcy gives a firm time. It means a firm does not have to pay its debts immediately. The exemption to the stay means that going into bankruptcy does not prevent a firm from having to pay its derivative debts immediately even while it is in bankruptcy proceedings.

At least two professors, Columbia Business School Prof Franklin R. Edwards and Columbia Law School Prof Edward R. Morrison believe this provision increased the systemic risk of the Long Term Capital Management hedge fund collapse in 1998 and created the need for the Federal Reserve to step in after LTCM suffered investment losses.

See their 2005 paper, "Derivatives and the Bankruptcy Code: Why the Special Treatment?" at:
http://www1.gsb.columbia.edu/mygsb/faculty/research/pubfiles/1666/Morrison%20%26%20Edwards%20Yale%20Rev%20final.pdf

It is ironic because the derivative exemptions to the bankruptcy stay were added to do just the opposite and decrease systemic risk.

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