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Cleveland Fed Goes Che: Advocates Debt Forgiveness Over Bankruptcy For Corporate Debtors

Tyler Durden's picture




 

The Cleveland Fed has spent another boatload of taxpayer money analyzing a topic so simplistic even a 5 year old would know the answer in advance, to wit: "Is debt overhang causing firms to underinvest?" Let's see here... Uh yeah. And you can keep the $1,000,000 "research" cost. While the paper is sufficiently entertaining courtesy of a few graphs, flow charts and general widgets, the conclusion is startlingly absurd. In essence the authors conclude (in less than definitive terms) that debt forgiveness may be the best outcome for highly leveraged companies: "The debt-overhang problem may be so severe that creditors can actually benefit from forgiving a portion of the debt. With excessively high levels of debt, the risk of default is large and the market value of debt is well below its face value. If the creditors forgive part of the debt in this situation, the lower debt burden helps realign the interests of the equity holders and the creditors. The firm’s effort and investment will rise, increasing the total value of the firm and the market value of the remaining debt. If this effect is strong enough, the market value of the remaining debt may be even higher than the market value of the total debt in the absence of debt forgiveness, in which case debt relief will ultimately benefit the creditors themselves." Well, now we know the reason for the financial cram up, in which stockholders were spared while preferred and sub debt was being raped back in 2008. Yet if this thinking is indicative of prevailing Fed ideology, the move for a wide-reaching, Federally-mandated debt repudiation may be just steps away. And just in case you note that the Chapter 11 process, in which existing underwater debt is converted into post reorg equity, is a perfectly logical, viable and working alternative, the authors will have none of such dogma: "A creditor takeover of the firm after it defaults is another potential solution to the debt-overhang problem. Creditors would have an incentive to undertake all profitable investment
opportunities. However, this solution is not satisfactory either, since
most investment opportunities depend on business continuity and
disappear or lose substantial value when default occurs and the equity
holders lose control of the firm.
" Because creditors obviously have no idea how to preserve business continuity if they end up being the equityholders....And in case you were wondering, author Filippo Occhino does have a Ph.D from a (semi) respectable institution.

Full paper can be found here

 

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Fri, 07/23/2010 - 12:03 | 485440 wiskeyrunner
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Just make sure there credit rating is trashed like the US consumers has been.

Fri, 07/23/2010 - 14:18 | 485859 outamyeffinway
outamyeffinway's picture

A jubilee for the corporations and a jubilaint for the plebes.

Fri, 07/23/2010 - 16:27 | 486110 Missing_Link
Missing_Link's picture

Just make sure there credit rating is trashed like the US consumers has been.

Shhhh  ...  Don't give the "little people" any big ideas!

Fri, 07/23/2010 - 12:06 | 485444 Hondo
Hondo's picture

Completely insane......Screw the equity holders give me (the debt holder) the damn company and I'll manage it correctly......equity is toast (just what the Fed doesn't want to happen).  Why in the world would the debt holder forgive debt and keep any equity around.  The debt holder will be the equity going forward.....that's what bankruptcy is for.

Fri, 07/23/2010 - 12:42 | 485581 John Self
John Self's picture

Sorry debt holder, but we have word that you're going to be entitled to only 9% of future equity.  The remaining 91% has been apportioned to the UAW.

Fri, 07/23/2010 - 12:45 | 485597 John Self
John Self's picture

Sorry, I see that the same point was previously made by others below.

Fri, 07/23/2010 - 18:31 | 486244 Bartanist
Bartanist's picture

Banks lend money to companies with an understanding that the banks then have the privilege of telling the company under what financial conditions they must operate and also with an understanding that the banks get the company's assets in the event that the debt cannot be serviced. However, in lending the money, the bank did not actually use any of its existing capital. It created new money that is offset on its books by a pledge of the assets of the company.

This is different than you or me loaning money to a company. We do not have the privilege of creating fiat from thin air. We must use what we have collected or what we can borrow from a bank that creates it out of thin air.

Under such circumstances Chapter 11 appears to be a means of asset transfer from the owners of the assets to the bank that at one time had decided that the company was a worthy investment. (maybe the bank should just take the hit for making a bad investment). I do not understand all of the subtleties, however from a laymans viewpoint, if debt can be created out of thin air and when it is retired it simply disappears, then debt can be forgiven and disappear just as simply ... other than possibly this violates the artificial rules of the game that we have been lead to believe we are playing.

If that is the case, why does it make sense to give a bank the assets if creating the money cost them nothing and they took no real risk (other than bending a few artificial rules). I just don't get why the banks get to be the beneficiary on every company life insurance policy.

Fri, 07/23/2010 - 12:08 | 485459 glenlloyd
glenlloyd's picture

More silly shite from ass clowns.

Fri, 07/23/2010 - 14:17 | 485856 Problem Is
Problem Is's picture

Where is "I need more asshats" when you need him?

Fri, 07/23/2010 - 12:11 | 485471 Bam_Man
Bam_Man's picture

So this is why you must have at least one PhD to be a Fed economist.

Patients are running the assylum and going APESHIT.

Fri, 07/23/2010 - 14:18 | 485860 Problem Is
Problem Is's picture

Maybe Ben prints those economics phd diplomas too...

Fri, 07/23/2010 - 12:12 | 485475 Cognitive Dissonance
Cognitive Dissonance's picture

"Cleveland Fed Goes Che: Advocates Debt Forgiveness Over Bankruptcy For Corporate Debtors"

I'm still waiting for the following headline.

Federal Reserve Bernanke: Advocates Truth and Reconciliation Commission in lieu of Public Hangings.

http://en.wikipedia.org/wiki/Truth_and_Reconciliation_Commission_(South_Africa)

 

Fri, 07/23/2010 - 23:50 | 486470 RockyRacoon
RockyRacoon's picture

Maybe we'd all be better off if the inmates actually were running the asylum.

Fri, 07/23/2010 - 12:13 | 485482 carbonmutant
carbonmutant's picture

 How do you do business without a contract?

Sun, 07/25/2010 - 03:57 | 487364 fxrxexexdxoxmx
fxrxexexdxoxmx's picture

Hope and change. Not the kind of business  done between honest entities.

Hope Soros gets one of guys elected. Change when and with whom laws are enforced.

A great business for guys from Chicago that have never ran anything except community activist rackets and tax dodges

Fri, 07/23/2010 - 12:16 | 485495 LoneStarHog
LoneStarHog's picture

This reminds me of a $250,000 U.S. Government grant that was given to understand Why Children Fall Off Bicycles.

Research Conclusion:  Loss of Balance

Fri, 07/23/2010 - 12:51 | 485614 Plainview
Plainview's picture

LOL

 no way!

Fri, 07/23/2010 - 12:18 | 485501 Internet Tough Guy
Internet Tough Guy's picture

Dear Cleveland Fed, don't you know that a ponzi has to expand infinitely? Debt forgiveness topples the pyramid.

Fri, 07/23/2010 - 12:44 | 485587 John Self
John Self's picture

As I understand him, Todd Harrison has also occasionally suggested that debt forgiveness is where we'll end up.  That's not the same as to say he's advocated for it, though.

Fri, 07/23/2010 - 13:34 | 485748 Cognitive Dissonance
Cognitive Dissonance's picture

Todd has said this, repeatedly as a matter of fact.

While I have great respect for Todd, has has a tremendous fear of mass riots and social unrest. And he seems to always be searching for ways to avoid this. But he also knows that the people who have the wealth and power will never let go willingly. Rather than confront the basic inequality of the current social compact, he looks for simplistic solutions that sound great but won't be implemented if it requires the powerful to relinquish (even some) power, something he admits won't happen.

From my point of view after reading him over the past 5 years is that this means he also has a tendency to think along the lines of "Let's just stop fighting and basically go back about our business after we clean up this mess". Meaning the haves still have and the have nots are still being screwed by the haves. No, he doesn't actually say this, but his view is one that comes from someone who already has something and the way down is more frightening than the way to neutral corners and maintaining the current status quo.

Fri, 07/23/2010 - 14:55 | 485942 traderjoe
traderjoe's picture

How messed up this all is becoming more and more clear. The media, the mega-corporations, the politicians, etc. If the elites bury themselves further and further - it will only end more badly for everyone. I think that a peaceful solution might still be possible, but worry that we are crossing/have crossed the Rubicon. It seems so myopic to me. 

Fri, 07/23/2010 - 19:54 | 486307 steve from virginia
steve from virginia's picture

Steve Keen has said the same thing.

There is no real alternative. 'Inflating' won't work (because of indexing and duration issues) so default it is.

Fri, 07/23/2010 - 19:54 | 486308 steve from virginia
steve from virginia's picture

Steve Keen has said the same thing.

There is no real alternative. 'Inflating' won't work (because of indexing and duration issues) so default it is.

Fri, 07/23/2010 - 13:00 | 485650 DavidRicardo
DavidRicardo's picture

Answer: what Ponzi scheme are you talking about?  As Beaumarchais wrote in Figaro: There are Ponzi schemes and Ponzi schemes. 

Fri, 07/23/2010 - 12:27 | 485523 Mercury
Mercury's picture

If the creditors forgive part of the debt in this situation, the lower debt burden helps realign the interests of the equity holders and the creditors.

The interests of debt holders and equity holders aren't exactly aligned in the first place being that the default debt holder position essentially boils down to 'Keep those coupon payments coming and the principal after that or we'll take it out of the hides of the equity holders.'

Or at least that used to be the deal before Obama made up his own rules in the Chrystler bankruptcy.

Fri, 07/23/2010 - 12:35 | 485559 knukles
knukles's picture

And sure as shit aren't aligned any better after the screwing of the GM and Chrysler debt holders.... especially Giving Away ownership to a non-debt or equity holder, the UAW.

Abrogation of contract law, pure and simple.  Foreign capital will seek other more hospitable environs.

Fri, 07/23/2010 - 12:32 | 485547 knukles
knukles's picture

Clearly establishing, this the trial balloon, of partial remediation of the entire financial system, officially introducing a methodology, a paradigm for debt issuers including the US Government to have "non-default" defaults of onerous debts.

Fri, 07/23/2010 - 12:47 | 485604 traderjoe
traderjoe's picture

That's what I was wondering too. Doesn't seem that this stuff gets written for no reason. 

As someone mentioned above, the question of letting the equity holders - the one's that ran the company into insolvency - continue to run the company with just the bondholders taking a haircut is just scary. 

Really does make me wonder what direction we are headed. I think I'm going to rent 1984 this weekend. 

Fri, 07/23/2010 - 13:16 | 485701 wcvarones
wcvarones's picture

I think Fed stuff does get written for no reason.

Look at the Kartik Athreya "bloggers are stupid and only Iowa Ph.D.s know what they're doing" paper.

There is no way that was vetted by that boy's superiors.  There is no upside to publishing such risible nonsense.

Fri, 07/23/2010 - 14:50 | 485929 ATM
ATM's picture

DP

Fri, 07/23/2010 - 14:49 | 485930 ATM
ATM's picture

On the contrary. The upside to writing such useless drivel is it places that fraud in the public sphere. It will get picked up again and used as a reference somewehere else, then again and again until it becomes ingrained in the public psyche and assumed as true.

As for being vetted by his superiors, I would assume it was instructed by his superiors much as this ass wipe paper from the Cleveland Fed was.

Fri, 07/23/2010 - 20:04 | 486316 steve from virginia
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I don't think too many people read Fed papers. There are a lot of Fed economists doing little but surf the web (child porn) and play Spider solitaire. What do you think a Fed economist does?

They are in the Fed's 'old boy' network which is why they were hired in the first place.

The only Fed bank that comes up with anything new and important is Fred @ St. Louis Fed. I get Chicago Fed papers and every once in awhile there is something interesting, but the independent economists all have blogs. Who needs the Fed, anyway? They are like BP, they never really tell you what you need to know.

Better to subscribe to Master Resource Report from Jim Hansen.

jim.hansen(at)kmsfinancial.com

Put 'Subscribe' in the subject line.

Fri, 07/23/2010 - 14:48 | 485926 knukles
knukles's picture

Generally, a position assumed such as this, representing an officially sanctioned departure from the base code, the laws upon which our society functions, has been blessed by the powers that be and is deployed as foreshadow to further official exploration of said topic.

Fri, 07/23/2010 - 12:46 | 485598 wcvarones
wcvarones's picture

The problem is the banks are all levered up more than 10-to-1, so if they wrote down even 10% of their debt, they'd all be insolvent.  Another moron like Kartik Athreya.

That's why devaluation is a less problematic solution than forgiveness.

Fri, 07/23/2010 - 12:58 | 485642 DavidRicardo
DavidRicardo's picture

It's worthwhile taking a look at not only who Occhino is, but also at the way the Fed has been slowly staffing itself with liquidationists.  You would think that debt haircuts would not serve the interests of the oligarchy.  You would be wrong.  It's a wonderful way to consolidate power.  Fascists love it.

 

Occhino is straight from the Mussolini school of economics.  You remember.  That's the school that Sraffa was kicked out of when he wrote about fascist looting.

 

And that's what you're talking about in this article: fascist looting.

 

By the way, is Leo still alive?  If so, why?

Fri, 07/23/2010 - 12:59 | 485648 Greater Fool
Greater Fool's picture

Ochocinco is an economist, too?

Fri, 07/23/2010 - 13:38 | 485763 NUREG
NUREG's picture

If there were a widely followed Dow or S&P index that tracked debt, and which the powers-that-be felt had an outsized effect on the public mood, this paper wouldn't have seen the light of day.

Fri, 07/23/2010 - 14:07 | 485838 Problem Is
Problem Is's picture

"If the creditors forgive part of the debt in this situation..."

The Bankster Can't Admit Loses... The Bankster Is ALREADY Bankrupt...
There are only two things keeping the TBTF Bankster from Bankruptcy and Liquidation:

1. Fraudulent Accounting rules delivered from a political hack named Obummer...
2. A Multi $$Trillion game of 3 Card Monte from a bald fuck named Ben...

Under these circumstances, any discussion or premise like this is erroneous...

As Jesse likes to say:

"The Banks must be restrained, and the financial system reformed, and the economy brought back into balance, before there can be any sustained recovery."

We have just witnessed another CLASSIC Obummer NO REFORM "reform." Don't hold your breath...

Fri, 07/23/2010 - 14:06 | 485840 hbjork1
hbjork1's picture

"And in case you were wondering, author Filippo Occhino does have a Ph.D from a (semi) respectable institution. "

I am beginning to think  that, for economics, there is no such thing as a (semi) respectable institution.

 

Fri, 07/23/2010 - 14:27 | 485875 Catullus
Catullus's picture

The thing that sucks the most about bankruptcy is that the elite lose control over property. I mean, for some reason it's not just a simple move the numbers around on a balance sheet exercise. It's like these other non-elite people can just take control of this stuff. And they don't even weapons to do it. This is just not going to work. Let's call them liquidationists and claim their racist for suggesting it. Or we can just pretend they're not bankrupt by never telling anyone that they are.

Fri, 07/23/2010 - 14:35 | 485892 Hephasteus
Hephasteus's picture

Ya but the FED never forgives. It just moves around who's responsible for the debt.

Fri, 07/23/2010 - 14:43 | 485912 Caviar Emptor
Caviar Emptor's picture

With high levels of debt the risk of default is large

THERE is the fallacy in the logic loop: who beside Lehman defaulted? For large and systemically important companies the government will step in, either as lender of last resort, "honest" broker of a merger or takeover, equity holder, or engineer of a restructuring agreement where debt holders don't take a haircut. 

The perception is not like it was pre-crisis. Nobody really stays awake at night worried about a large debt holder bankruptcy.

Fri, 07/23/2010 - 14:52 | 485934 ATM
ATM's picture

Bingo

Fri, 07/23/2010 - 14:45 | 485919 Remington IV
Remington IV's picture

chimp city

Fri, 07/23/2010 - 15:01 | 485958 Rick64
Rick64's picture

Why don't they try this with soveriegn debt first and let us know how it goes. That would benefit whole countries.

Fri, 07/23/2010 - 15:05 | 485962 proLiberty
proLiberty's picture

I consider the printing of air-backed money to be theft of private wealth by dilution. So, to have a member of Federal Reserve's management suggest that the loan contract should be treated lightly and that the lender forgive debt outside of a legal finding of bankruptcy is doubly alarming. I find it just one step removed from proposing this as a matter of government policy.

Socialism is based on the three sins of lies, coveting and theft. Some forms of socialism are more open than others.

November or Never!

Fri, 07/23/2010 - 16:25 | 486107 denarii
denarii's picture

isnt this just TARP without new money?

Fri, 07/23/2010 - 17:27 | 486180 win
win's picture

Is the idea scalable?

Hop a plane, land in China. Present your plan to the finance minister. Creditors benefit from forgiving debt.

Ask the finance minister how much he would like to benefit today.

This is called an "Aunt Sally" - a straw man proposal designed to get the ide out on the street and begin the discussion - discuss away but be aware that this is one of the alternatives that Bernanke was referring to this week.

 

Fri, 07/23/2010 - 18:08 | 486225 GoldSilverDoc
GoldSilverDoc's picture

Where do I get in line?

 

Fri, 07/23/2010 - 20:20 | 486331 doolittlegeorge
doolittlegeorge's picture

How about that price of gold.  What's that old Springstein saw?  "I'm going down, down, down, down, down, down, I'm going down, down, down, down, down."  Was that from "Lucky Town"?  I forget...

Fri, 07/23/2010 - 21:50 | 486394 grunk
grunk's picture

But you don't understand; economics is HARD!

Kartik Athreya, Richmond Federal Reserve

 

Sat, 07/24/2010 - 10:02 | 486681 Grand Supercycle
Grand Supercycle's picture

DOW/SP500 daily chart is bullish for now ...

http://stockmarket618.wordpress.com

Sat, 07/31/2010 - 08:32 | 497635 Downtoolong
Downtoolong's picture

Look Fillipo, we know what we want. What we need you to do is explain to us why.

 

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