Warren Graham's Legal Blog

A Special Word to Clients and Prospective Clients

2009-01-02T23:57:00.000-08:00

From: Warren R. Graham

I am, as you can see from my profile, an attorney specializing in bankruptcy and creditors’ rights, although my firm, Cohen Tauber Spievack & Wagner LLP, is a full-service commercial firm which can help your business solve your problems efficiently, economically, and with a practical understanding of your business needs. I invite you to e-mail me or contact me by phone in connection with any legal needs that you have. Consider the following:

What can my colleagues and I do to solve YOUR problem?

Our bankruptcy and creditors’ rights practice has several components:

--In representing distressed enterprises, we partner strategically with ailing, closely-held or family-owned businesses to save their companies, by keeping the ‘wolves from the door’ while working to recapture the value that made the companies succeed in the first place.

--In representing creditors, we help develop strategies to assist creditors caught in the bankruptcy/restructuring maze to recover on their claims quickly and to minimize their problem receivable.

--In representing Landlords, we help real estate owner/developers minimize, or even eliminate the risk of getting stuck in protracted tenant bankruptcy cases, in which the owner/developer frequently has to deal with uncertainty, while ultimately realizing little or none of the leasehold value.

--We help develop strategies for buyers of distressed assets to maximize the realization of value while defraying legal and due diligence expense through the vehicles of ‘break-up’ and ‘topping’ fees.

If any of these solutions sound right for your particular issue, please feel free to contact me to schedule a complimentary consultation. Also, feel free to request your absolutely free subscriptions to the two e-books I have published, one crafted especially for the creditor and landlord who need to understand their rights under the new bankruptcy laws and the other directed at owners/managers of closely-held family businesses in financial distress. Feel free, at the same time, to ask to be placed on our list for monthly updates and bulletins from our bankruptcy and creditors’ rights practice. There is no obligation, of course, and you can always “opt out” at any time. All you need to do is leave your name and contact information with us, and we will take care of the rest.

Also, let us know whether your organization might be benefited by receiving an in-person presentation or seminar by attorneys from our creditors' rights and bankruptcy department at our firm to help you understand these changes, and what they might mean to your business. You simply cannot afford to rely on your understanding of the bankruptcy laws as they existed before October 17, 2005. The changes are, quite simply, too profound and wide-ranging. Please do not hesitate to bookmark this site, and check back regularly for recent developments and reports which will, I expect, be of value to you in your business. I look forward to hearing from you.

Warren

The Harvest of Failure: Why We Need to Re-plant Now!

2009-01-01T08:00:00.000-08:00

In the midst of the economic downturn and chaos, our Government (and, most likely our Government-in-Waiting), is pinning its hopes for recovery on a seemingly endless stream of bail-outs and stimulus packages. In short, the same old failed ideas are being trotted out to address our problems. Predominant among these ideas is that, if only the public could once again begin to spend, everything would be alright. To date, the consumer, plagued by fears of imminent layoff, has failed to take the bait. The solution, according to the conventional wisdom, is to “fund” the spending spree by printing more money, sending it to Joe/Jane Sixpack, and expecting him or her to revert to the old habit of spending more than is affordable. At the same time, the Government is embarked upon what appears to be a bail-out of nearly every type of business in America. It started with the banks (which prompted nearly every financial institution to “become” a bank), and expanded to the automobile industry. Now, calls for bail outs are, predictably, coming from the retail and real estate industry. Where does it stop? The answer is that it doesn’t. This was, from the outset, an idea doomed to failure and a slippery slope, indeed.

What led us, in large measure, to the current pass in the economy was overspending and over-consumption by the consumer. The result of this was far too much debt. The consumer, in turn, used increasingly appreciating home values as a “piggy bank,” by serial refinancings to retire high-interest, non-tax-deductible credit card debt. This “system” worked fine until home values started to fall, as a result of over-development and over-leverage. This was inevitable, and was precipitated mostly by a false sense of security by the public in its ever-increasing income, asset values, and a steady rise in the financial markets. Never mind Madoff; the entire American economy, before recent events took their predictable toll, was built upon a house of cards and a giant Ponzi Scheme.

Now, the Government offers us more of the same as an antidote. It proposes to flood the economy with dollars, hot off the presses, so as to “encourage” (meaning: force) consumer spending. There is talk of governmental rewriting of mortgage obligations, even to the extent of reducing principal balances (the constitutionality of governmental interference in private contracts notwithstanding). Let’s not worry about inflation, our leaders say; we will cross that bridge when we come to it. In the meantime, let’s prop up failing (and doomed to fail) businesses by incentivizing consumer spending, guaranteeing asset values and rescuing everything from General Motors to Sal’s Pizza Parlor. But make no mistake about it: there will be a day of inflationary reckoning, and we will have to “cross that bridge” sooner than most of us think. The flooding of paper money into this economy can only end in a disastrous inflationary spiral at some point down the road. Moreover, the issuance by government of an endless supply of money, and assumption of unlimited debt by loan guarantees and sale of debt instruments will encumber several generations of Americans, at least.

No, the last thing this Country needs is to return to a day when more than two-thirds of its economy was driven by extravagant, excessive irresponsible consumerism. That, friends, is what got us in this fix to begin with. Our consumerism is a weapon, though, which, if properly used, can do what is necessary to improve our economic lot. I speak, of course, of the creation of industry and jobs. For too many years, this Country has failed to manufacture almost anything within its borders, and for the benefit of domestic owners. The so-called “Global Economy” has served as a mechanism for exporting jobs to take advantage of cheap labor in the developing world, or to allow foreign companies to operate freely here, unencumbered by, among other things, our labor costs. This has all been justified by the illusion of “free trade.” Free trade, you see, implies a two way street. Does China allow us a level playing field for our exported goods? Does Japan? The EU? Of course not. The result, then, is that we are “free trading” only with (and against) ourselves.

We have one economic weapon, and one only, in our arsenal: our rampant consumerism. So long as foreign manufactured goods can be made more cheaply overseas, and sold here in such a manner as to make American industry non-competitive, it is naïve to suppose that we will buy American-made goods out of a sense of patriotism. We have to level the playing field HERE, and for our own benefit. China will not stop selling here no matter what we do. The Chinese consumer base is too small to purchase all those goods, notwithstanding all that overblown talk about a burgeoning Chinese middle class. The same goes for all our trading partners. They must, and will, sell to us, even if the cost of doing so rises, and as we begin to protect our labor force and industry by (yes, I said it), protectionism. Foreign business should be made to “pay to play.”

Once the economy improves, we will no doubt return to our over-consuming natures. One hopes, of course, that this conduct will be somewhat tempered by recent events, much as the spending and saving habits of our parents and grandparents were informed by the Great Depression in the 1930’s. But no matter what, we will still be a consuming nation. Let foreign countries export to us. Let U.S. companies move their jobs overseas. But let’s at least charge them for the privilege. And for God’s sake (and America’s), let’s start consuming our own stuff for a change.

Unlimited government interference in our markets, in the form of printing more money, throwing it at consumers and businesses to induce us all to wallow even more in a sea of debt is a short-sighted and ultimately a destructive policy. Aside from its ultimate inflationary consequence, and creation of a debt burden which will long outlive us, it virtually guarantees the destruction of private industry as we know it. Government will have a share in nearly all U.S. business, leading to over-regulation, and a commitment by John Q. Taxpayer to throw good money after bad, in an attempt to protect our nationalized “equity” in dying businesses. When the smoke clears from this orgy of easy money, and staving off of natural business failure, I fear that the America we all love will be unrecognizable. This would be the biggest tragedy, indeed, especially given that a real, long-term solution is right under our noses. Let’s hope that our elected representatives, for once, have the sense and intestinal fortitude to see it, and to implement it.

The future of this nation depends on it!

Warren R. Graham
Copyright 2008

Hey, Dude, Where's My Bailout?

2008-12-16T15:24:00.000-08:00

*****NEWEST*****

Yesterday, the Federal Reserve Board revised its target rate for the Fed Funds Rate down to 0% to ¼ %. This represents an historic low (in more ways than one) for a quasi-governmental entity charged with exercising independent monetary (as opposed to fiscal) policy of the United States. The Fed, in addition to the reduction of an interest rate already priced in to the government paper yields, took the unprecedented step of issuing a statement to the effect that it would keep its rates low for the foreseeable future in order to fight the endemic weakness in the economy, and that it would use “quantitative easing” (whatever that means) to implement emergency measures to stimulate the economy. It has now thrown everything but the kitchen sink at this problem. I can’t imagine what the additional measures might be. I daresay that I would not be much surprised to see the Fed soon offer to hand every American a bag of cash, rewrite all our mortgages, give us all new, higher paying jobs, offer us unlimited credit lines (guaranteed by Uncle Sam), so that we can go back to decadent overspending, re-grout our bathroom tiles, sweep our floors and pleasure our wives.

I live in New York; yet I could smell the sweat pouring from Mr. Bernanke’s pores all the way from Washington. The desperation implicit in all these statements, which have no precedent in the Fed’s 95-year history, is shocking to behold.

The upshot of all this is a recognition that everything has been done to date by the Fed and its partner, the Treasury Department (more about that later), has utterly failed to alleviate an economy in serious recession.

In addition to the near-certainty that these measures (even the ones we can, at this juncture, only guess at), will fail, nobody seems to consider the long-term effect, both financial and yes, constitutional, of these endless attempts to rescue this economy from the natural, and indeed, necessary difficulties occasioned by the outrageous excesses of the last ten years. I have written extensively on this topic, and will not bore my readers with a rehash here. I must say that it pains me to advance this argument, as I have many friends and family members who are suffering from the financial turmoil in which we find ourselves. Nevertheless, the only way back is to swallow the bitter pill and wait for the inevitable recovery. The longer the government tries to ameliorate it and stave off the agony, the longer that recovery will take. Moreover, when the dust clears, we may well find that America, as we know it and loved it is no more.

Anyone paying attention has long since realized that capitalism as an ideal is something of a quaint and nostalgic concept in 21st Century America. I am not overly troubled by that; the robber barons of the 19th Century and unregulated securities markets never served us well, and need to be reined in. Nevertheless, until recently, we still recognized a concept known as private enterprise. Corporations, even public corporations, were expected to succeed or fail based upon the competence of management and the desirability of the product or service offered to its buyers.

Nobody, a century ago, would seriously have advocated a governmental salvation of the buggy whip industry for the purpose of saving jobs. Yet the President and his minions, in the waning days of an otherwise listless and sleepy (if that’s not oxymoronic) administration, propose to throw money at failing industries, so that it can pass off the mess to Messrs. Obama & Co.

Our Treasury Secretary, Mr. Paulson, making no pretense at acting in concert with the Fed, (presumably with the President’s approval—although who knows these days?) has thrown sacks of money at financial institutions, without any meaningful conditions. These institutions, our officials say, were “too big to fail,” even though their conditions were entirely of their own making. These disasters were a result of unprecedented financial gluttony at all levels, and of the SEC’s and other regulators’ mind-boggling ineptitude (perhaps also with the President’s approval) at questioning transactions which, on their face, violated fiduciary responsibilities to shareholders.

What have these financial institutions done with the money that John Q. Taxpayer has “leant” to them? Have they started making loans to the public? Not a chance. Rather, they’ve borrowed the money and put it in the drawer, so they might say that they are “adequately capitalized,” given the current “mark to market” accounting standard.

Exactly how has this benefitted the American Public?

Now, in the face of overwhelming public opposition (some polls put it at 90%) and the refusal by our duly elected representatives, the executive branch of our government, acting on its own, has determined that it must unilaterally save us all from ourselves, and bail out the “Big Three” automakers (I put “Big Three” in quotes, because their combined net worth is a small fraction of that of Yahoo).

Let us first ask ourselves the question of whether such a scheme will succeed: Any attempt to pump taxpayer dollars into an industry that (whether we like it or not) is not selling its products is an exercise in futility and, moreover, a complete and utter waste of what little remains of the public weal. It may be a hard truth to face, especially given the potential for the substantial loss of jobs, both in the auto industry, and those other business who depend upon it. Nevertheless, it is also true that a number of foreign owned auto companies, which also provide employment and benefit to other businesses, are holding their own, in an environment which is, to say the least difficult. None of them, to the knowledge of this writer, is on the verge of bankruptcy or of exhausting its cash. The distinction if, of course, obvious: labor costs. And while one might be hard-pressed to blame the UAW for looking out for the interests of its constituency, one has to wonder whether its leadership has a clue as to what those interests are. The conventional wisdom (which, for a change, is probably correct), is that the UAW has confidently called the government’s bluff—a “no-brainer,” to be sure—in the expectation that, come late January, a more labor-friendly administration will be on the job. But the inevitable conclusion is, that in an environment of increasing unemployment and fear of unemployment, coupled with the general unavailability of credit terms, the public is simply not about to start buying cars, especially given the $2000 labor cost differential and the uncertainty about the future of the “Big Three.”

The second question is whether this scheme is appropriate. One has to start with the problem of the Fed and the Administration exceeding their respective briefs. The Fed is not supposed to be in the business of “rescuing” the economy. Rather, it is charged with the responsibility of adjusting rates and increasing or decreasing the money supply to walk the tightrope between inflationary pressures and a weakening economy. Instead, the Fed has decided to become the lender of last resort, pouring vast sums of money (which remains unaccounted for) into financial institutions with no obligations to put that money out as loans either to business or to the public.

The Treasury Department’s conduct is even more outlandish. In blatant defiance of the will of the public and of Congress, the Administration is determined to ram the auto bailout down our throats. It’s easy for the government to do this; it has, after all, a printing press. You and I, alas, do not. What is the consequence of this proposed bailout (the details of which, as of this writing are either unresolved or being kept under wraps)? Endless sums of freshly minted money being thrown at financial institutions and the auto companies can only have two results: ultimate hyperinflation (caused by an excessive money supply), or the mortgaging of our future and probably that of our children and grandchildren for what is doomed to be a futile, though well-meaning gesture.

It may be trite and cliché to say so, but this kind of governmental meddling is a “slippery slope.” Firstly, it justifies nearly every kind of business is justified in asking for a governmental bailout, if it can successfully argue that significant numbers of jobs are at stake, and that it represents a “vital” American industry. Secondly, in taking a stake in those companies it chooses to save, the government has cynically relegated the idea of private enterprise to an illusion. The nationalization of American enterprise, believe me, is not what we want. The Government is already far too intrusive in our lives. It should, rather, make do with the regulatory powers it already has, and actually enforce them.

Larry Kudlow, on CNBC, daily argues for a “prepackaged” bankruptcy for the automakers, followed by a termination of the union contracts, but, as is usually the case with the fatuous gasbag (in this writer's opinion) that is Larry Kudlow, he does not have any understanding of what a “prepackaged” bankruptcy is, how long it takes to put one together and what is required to terminate union contracts.

Once all the “important” industries are bailed out with increasingly valueless currency, we can all get on line for a bail out. But be warned: there’s no such thing as a free lunch; especially when Uncle Sam is “buying.” At the risk of quoting the villain John Wilkes Booth: Sic Semper Tyrannous!

Warren R. Graham

The American Consumer as Bankruptcy Roadkill

2008-11-17T11:36:00.000-08:00

In the midst of the recent around-the-clock, 365 day-a-year, 4-year presidential campaign cycle, it is nearly impossible to hear anything over the din of paid chatterers and candidates’ spinmeisters posing as news analysts. But recently, and finally, there has been some small and largely unnoticed public discussion about a subject which has flown below the radar screen for years, except, perhaps, among certain lawyers, judges and academics. I refer to the Federal Bankruptcy Code, as substantially rewritten and enacted in 2005.

This despicable piece of anti-consumer, anti-middle class legislation kicked around in Congress for a number of years. President Clinton, to his credit, pocket vetoed it several times. The law, which Congress was please to call, without embarrassment, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, or BAPCPA, was ultimately signed into law by President Bush. In a perfect world, and for the reasons discussed here, it should be a legitimate subject of public discourse in the current political and (especially) economic climate. But here’s the rub: both political parties are equally to blame for this outrage masquerading as “reform,” foisted upon an unsuspecting public and on the middle class, in particular.

BAPCPA is, first and foremost, a calculated attack by the credit card industry on consumers. It imposes a “means test” in order to qualify a debtor for bankruptcy relief and discharge of debt. If a debtor flunks the means test, he or she must file, under Chapter 13 for what can be a long-term, onerous debt repayment plan. The means test, which references, on a state-by-state basis, median income, ends up excluding nearly all but poor people (as we all know, the “middle class” ain’t what it used to be). There are numerous other obstacles, too technical and extensive for this treatment, to simple discharge in bankruptcy for the “average Joe.”

In the halcyon days of 2005, when everyone in America, it seemed, was a real estate mogul, gaining paper wealth from unprecedented appreciation of home values, the ever-increasing credit card debt load did not really pose a problem, except for the poor and assetless. After all, virtually anyone who owned a home could use it as a “piggy bank” to retire credit card debt periodically through serial refinancings, which was made unbelievably easy by lenders, mortgage brokers and charlatans. The charlatans, of course, cheated both the borrowers and the lenders, by arranging for no-verification loans for unreliable borrowers, to the ultimate detriment of lenders, while simultaneously building in adjustable variable rates or balloons, which set traps for the unwary homeowners, but which could be evaded by yet more serial refinancings. This system worked just fine, on the unsupportable and profoundly naive theory that home prices would continue to rise indefinitely.

We now see, of course, that home prices are, in fact, subject to the vagaries of the business cycle and, in our current case, the irresponsibility of the lending industry, the securities industry (subprime, anyone?), the Federal Reserve Board and yes, the borrowers themselves. As a result, the ballooning credit card debt can no longer be retired with the wave of a refinancing wand. Many consumers cannot make even the minimum payments on the large balances they are carrying on their credit cards, and their houses, in many cases, are not worth the debt they owe against them (especially in the case of owners who bought houses at the top of the market in the last year or two). Foreclosures, as we all know, are at record levels, with no end in sight.

Against this cheerful backdrop, we have a middle class, the perennial losers in nearly all economies in decline, now coming face to face with the cruel realities of BAPCPA. The prime political mover behind this “reform” was Senator Chuck Grassley, of Iowa. One might infer from this that Iowans, who have for years been chowing down on the plentiful pork that is federally subsidized, corn-based ethanol, have no need for bankruptcy relief. The ultimate prime mover, though, was the credit card industry; perhaps foreseeing an increase in default rates down the road, with the ever-ballooning national credit card balance. The legislation was accompanied by some other interesting developments, such as large increases in “overlimit” fees and late payment fees, which, in some cases, exceeded the total balance due on the credit cards. Overlimit fees, moreover, were actually triggered by accrual of interest on balances which were not even over the limit, but which, in and of themselves, took a balance over the limit; a real slap in the face to customers. Another outrage visited on these borrowers, made drunk on free and easy credit pushed on them by credit card companies, could be found in the exorbitantly high interest rates on balances. These rates could be increased, without notice, on the whim and caprice of the lender, even if the borrower had never missed or made a late payment, but simply on the basis of a periodic review of the borrower’s FICO score, or a missed or late payment on a different credit card. Particularly galling is the fact that the highest rates were imposed upon people increasingly most hard pressed to carry the balances. Citibank, in fact, took the unusual step of redomesticating itself to South Dakota, which overtly campaigned for big bank business by eschewing a usury limit. Citibank was thus able to assess against its most financially overextended customers, an interest rate of 32.99%, roughly equal to what one might expect to be offered by someone working the waterfront (except for the knee-breaking).

Unfortunately, and with this swollen credit Sword of Damocles hovering over the head of the American public, Congress allowed BAPCPA to become the law of land; allowed, I say, because Congress did not really write the legislation. It handed over its legislative pen to teams of lawyers working for the credit card industry. The price? Campaign contributions, of course. And the profound shame inherent in this falls equally on both Democrats and Republicans, in both houses, who passed the legislation with sweeping majorities. Chuck Schumer (inadvertently, one assumes), derailed BAPCPA for awhile, by tacking on a rider denying discharge to individuals who were liable for damages due to destruction of property of abortion clinics. This rider forced the conservative Republicans to abandon their support for the Bill. When that provision died in the next version of the Bill, and in the Senate/House reconciliation version, Schumer came around, and voted for BAPCPA. Joe Biden, a Democrat and that party’s current contender in the vice-presidential sweepstakes, presents an even more interesting case. Delaware has long been the home of big Chapter 11 Cases. It is a debtor-friendly jurisdiction, and large companies have traditionally been able to file there simply by virtue of Delaware’s being the state of their incorporation, whether or not that company has an office there, or has ever transacted business there. Of course, such “mega-cases” pay off handsomely for Wilmington, Delaware’s capital city and home to its Bankruptcy Court (an otherwise pretty poor and blighted city), as high-priced lawyers, accountants, and consultants come to town, stay at luxury hotels, patronize the better eateries, and are forced by a very protective local bar to engage local counsel for all court hearings. At the same time, Wilmington is the world capital of credit card companies, and therefore, an important constituency and contributor to Senator Biden’s political coffers. The original iteration of BAPCPA eliminated state of incorporation as a sole basis of venue for filing; in other words, a multibillion dollar Texas company, for example, which had no connection with Delaware other than on its certificate of incorporation (Delaware is a favorite choice for incorporation for reasons beyond the scope of this piece), would have to subject itself to Texas-style rough justice. This did not sit well with Senator Biden, who had vested interests, it seems, on both sides of the bankruptcy street, debtor and creditor. As a condition to his support of BAPCPA, Senator Biden insisted on the removal of the offending venue provision. As a result, Delaware remains the comfortable home for mega-case, complex Chapter 11’s; a sure source of delight to both Senator Biden and the Wilmington Chamber of Commerce.

Both Senator Schumer’s and Senator Biden’s stories are testament to that phrase famously uttered by that well-known wit, and craftsman of the bon-mot, Otto von Bismarck (huh??) to the effect that: “If you like laws and sausages, you should never see either one made.”

BAPCPA also made injurious changes to the business bankruptcy laws, which make reorganizations both more expensive and less likely to succeed. Nobody cared when this legislation was passed, as there were precious few business bankruptcies. Nobody cared about the anti-consumer provisions of BAPCPA either, when the middle class had no need for bankruptcy relief, and only the poor (who, alas, have no political lobby), were nearly the only constituency turning to the bankruptcy courts for help.

Now, our middle class is terribly and visibly squeezed, in a vise of falling home values and exploding debt. Its members will soon learn that bankruptcy may not be a viable course available to them for the discharge of obligations they can no longer meet. Do not feel sorry for the credit card companies; they brought this on themselves and upon their customers. In any case, the losses they will experience from increased defaults will be nicely cushioned by their unconscionably high interest rates and outlandish fees. Do not feel sorry for our politicians who will soon (and rightly) feel the backlash and outrage of their constituents for supporting a law that blocks any path to financial recovery. They have already been compensated for their efforts. By all means, do feel sorry for the overextended, honest working stiff, who has been suckered into the maw of rampant easy credit and gross consumerism. But do not expect this issue to make its way into the public consciousness until after the election, as neither party wants to bring it up. Nearly everyone, in both parties, has his or her dirty paw prints all over the “reform” that is BAPCPA.

Copyright 2008
Warren R. Graham

Never Fear, Paulson's Here!

2008-09-19T05:30:00.000-07:00

Imagine the following scenario: You’re in the “high limit” room of a Las Vegas casino, shooting craps. The table is hot, hot, hot! You’ve got a pile of black hundred dollar chips spread out over the pass line, and the numbers 5, 6, 8, 9 and 10, all with full double odds. The point is 4. The numbers keep hitting, and the pile keeps growing. You continue pressing your bets. Now, you’ve got thousands of dollars riding on every roll of the dice. More numbers hit, more money piles up, and the bets increase. “Press the bets,” you tell the croupier. .“Yes, sir,” says he. “You’ve got a bet.”

“C’mon, little Joe from Kokamo,” you pray, to the gods of chance.

Then, OOPS, the inevitable happens: “Seven out!” says the boxman. “Take the line, pay the don’ts.” The croupier, reaching over the table with his dreaded rake, takes all your chips off the table. After a long hot run, suddenly you’ve given back all your winnings and lost your entire stake.

But, fear not: your luck hasn’t yet run out. You turn around, and there, standing right behind you is Treasury Secretary Hank Paulson. He is beaming with a beatific smile. He reaches into his jacket pocket and pulls out a checkbook.“How much have you lost, my friend, he asks?” When you tell him, he says: “No problem. Here’s a check, courtesy of the United States of America. If you are able, pay it back someday. If you can’t, no worries! Your losses are covered in any case. In fact, why don’t you go back to the table, and play some more? I’ll stick around, just in case you need me again.”

A full understanding of the intricacies of the dice table might make this a more vivid illustration, but I’m “betting” that you get the picture.

Let’s see: Bear Stearns, Freddie Mac, Fannie Mae, AIG and now, the ultimate: your benevolent Uncle Sam is about to backstop all those troubling, nasty, panic-inducing, balance sheet-wrecking, impossible-to-value, junk-rated, securitized pools of sewage, which have generally become known as “subprime mortgages.” At the same time, Sugar Daddy Hank issues orders from on high to those nasty, hateful short sellers: “OK, now there’ll be no more of that! After all, short selling might make the Stock Market go down, and worse, engender public pessimism about the economy. And on the eve of an election, no less.”

Isn’t this all wonderful news?

Remember those Gen-Y, 30 year old investment banking captains of industry who made tens of millions, plus or minus, in each of the last couple of years? They did so, in large measure by packaging as “securities,” pools of subprime mortgages, built on a house of easy money cards, sold by hucksters and bought by people gullible enough to believe that “[y]es, Virginia, there is a Santa Clause;” that they, too, could realize the American dream of owning a home without the pesky nuisance of having to accumulate savings for a downpayment, and earning an income sufficient to support their debt service when the sucker-teaser rates reset. Those same young’uns then sold those gift-wrapped-with-a-pretty-bow securities to financial institutions, who were, in turn, too greedy and stupid to do what financial institutions are expected to do: sell their most valueless assets out to an unsuspecting public.

How about those other barely-old-enough-to-shave hedge fund managers, raking 40% off the top, plus a very handsome management fee, in exchange for producing enormous profits in a spiraling bull market for their well-heeled clients, in the expectation of endlessly appreciating home values and stock prices? Remember how those guys ended up paying taxes on those towering stacks of money at the capital gains rate of 15%? Remember how, at the same time, the sanitation worker continued to pay his taxes at the fully indexed federal income tax level, got socked with a “marriage penalty,” and teetered on the yawning abyss generally known as “Alternate Minimum Tax,” so that his meager and pitiful itemized deductions might be disallowed by that same Sugar Daddy Hank?

Well, folks, the government would certainly love, on the eve of election, to return us to those halcyon days of yore, but it can’t. The housing values won’t support the subprime mortgages, those beautiful gift-wrapped pools of those same mortgages (belying the pieces of coal within) are depriving the financial institutions (who are largely responsible for this financial “Pearl Harbor”) of the capital requirements to allow them to continue in business, and the coupon clipping investors won’t stand for their fund managers taking those big chunks of their money in a foundering market.

So, what is our gang of merry pranksters in Washington to do? The Wall Street “houses” are burning, threatening high six and seven figure bonuses, and in many instances, even jobs themselves, the quasi-governmental “corporations” who had backed up these garbage mortgages are teetering on the verge of bankruptcy, insurance companies, ostensibly in the business of {gasp} selling insurance (a highly profitable business), are discovered to be, instead, in the business of making foolish investments, at the expense of trusting stockholders, not to mention policyholders. So Sugar Daddy Hank fires up the printing presses, opens up the public wallet and agrees to backstop the collapse of Bear Stearns, Freddie Mac, Fannie Mae and AIG. Somehow, poor old venerable Lehman Brothers fell between the cracks and, for some reason was, alas, not “too big to fail.”

Nevertheless, and notwithstanding Hank’s commitment of John Q. Taxpayer to untold billions (and maybe trillions) of dollars to rescue these mismanaged businesses, the infection simply could not, and would not be contained. The Stock Market appeared to be in free fall, and every investment house looked like easy pickings for other investment houses, corporate LBO raiders or vulture funds.So Hank, hankering for more, has apparently agreed to put the national weal behind the entire subprime debacle, thus relieving investment bankers, brokerage houses, banks, insurance companies, and other houses of ill repute, of the inconvenience of having to explain their foolish decisions, or to suffer their punitive consequences. In most cases, it is the unwitting shareholder who will have his or her asset erased. But have no fear. The CEO of AIG is walking away with a $7 Million severance package.

And yet, it gets even better. Now, our kindly own uncle has decided to nip this virus right in the bud: It will shoulder the entire burden of all these reams of valueless paper. The cost of this, as of this writing, is estimated to be in the trillions. The Stock Market is euphoric with the news that its most illustrious (and negligent) denizens will be freed of the shackles of these problem assets.

Still better yet, the cast of characters who brought us this national debacle will be able to hide under Uncle Sam’s skirts, while Americans, already overburdened with soaring fuel and energy costs, will surely foot the bill. Of course, there is another alternative: the government can float more bonds (which might or might sell, given the unattractive interest coupon that all these machinations have engendered), or continue to sell off pieces of our national treasure to such “friends” as Dubai and China.

What a country, eh?

Well, friends, lest this all sound like the rantings of a socialist, don’t be misled; it is, in fact, exactly the opposite. I am a capitalist to the core, and a conservative. Where I come from, those values suggest that risk takers are sometimes rewarded, and sometimes punished. The bigger the risk, the bigger the reward (or loss). Regrettably, our “Republican” administration has forgotten all about that and, instead, has abandoned its “shrink the government and keep its damned hands out of my pocket” mantra in favor of government-as-guarantor of all private losses. This government, which has steadfastly refused to intervene (via the SEC) in enforcing laws already on the books and neglected to seek some oversight over opaque hedge fund shenanigans (remember those capital gains rate tax loopholes?), has now decided to jump into the fray, by lending a parachute to the mismanagers and coddling the malfeasors. In addition, because “a rising tide lifts all boats,” Hank has, yet again, engaged in naked market manipulation by seeking to prohibit short selling (particularly in financial stocks), and releasing news at the end of nearly every trading day, designed to promote glee in the trading pits. Such activity, if engaged in by a private individual, would have the SEC seizing computers and pursuing federal investigations in a New York minute.

If all of these increasingly desperate efforts to prevent Darwinian inevitability in the financial world prove unavailing, as they likely will (after, in passing, tripling the national debt), the government might consider, for example, prohibiting ANY selling of stock, so as to ensure endless price rises. Perhaps, our government will, as the Democrats in Congress are urging, will place a moratorium on foreclosures. This will enable people to continue to live in their homes they cannot afford, and which have no equity without paying for them, while those with better credit ratings and “prime” mortgages continue to meet their obligations, month in and month out. While this moratorium is underway, of course, the government, which will have, one assumes, have bought this paper at a discount, will derive no income whatever from them, thus having laid out trillions for no return. It’s a good thing that Hank doesn’t have to answer to shareholders and a board of directors for his actions as CEO, for he’d surely be canned for that level of non-performance of his loan portfolio; rather, he reports only to the President (and he, in turn, is no longer running for anything).

We are surely on the path of virtual nationalization of each company that is about to fall in the row of dominoes that is our ill-used financial services industry. The solution lies elsewhere, and it’s not pretty and it will hurt. Sick companies must be allowed to sink or swim. Otherwise the concept of any vestige of a free economy is an illusion. It will be painful, indeed. People will lose jobs, the Stock Market will fall (quite a lot, perhaps), shareholders (many of them, sadly, relying on their holdings for retirement) will absorb serious losses and people will have to give up homes they can’t afford. But the government cannot and must not try to solve every problem, stem every loss and plug every hole in a leaky dike. We will pull out of this by mostly letting nature take its ugly course. The current policy of “shifting the deck chairs on the Titanic” will only prolong the agony.

Alas, that is not how Hank sees it. Remember the crap table metaphor? Hank will bankroll you endlessly, but you better not play the don’t pass line. “Wrong” bettors are not welcome here.

Warren R. Graham
Copyright 2008

Our Loss is Abu Dhabi's Gain

2007-11-27T14:06:00.000-08:00

The Stock Market rallied strongly today. The Dow finished up about 215 points, on the heels of a very poor showing during the prior session. What accounts for this burst of optimism? A strengthening dollar? Rampant Holiday Season consumer spending? A revived housing market? Increased corporate profits? An end to the credit crunch? If you guessed any of those, you are dead wrong.

No, my friends, the exuberance exhibited on Wall Street today was occasioned by the formal announcement that we are selling our assets to the Arabs. That’s right. And it bears repetition: We’re selling our assets to the Arabs! And what’s more, Wall Street is excited, because it’s likely that, if we’re lucky, we’ll soon be selling more to them.

This morning, it was announced that an equity fund domiciled in Abu Dhabi, which apparently controls somewhere between several Hundred Billion and One Trillion dollars (apparently, when the numbers reach this magnitude, a few Hundred Billion more or less can be rounded off to the nearest Trillion), has made a $7 Billion investment in Citigroup, which will yield 11% over the next few years, and will then be convertible to stock. The source of the “up to a Trillion” fund is, of course, ourselves, and represents years of transferring our national treasure to the various and sundry royal families of the Middle East, in exchange for the privilege of driving our gas-guzzling monster vehicles. So now, the funds are coming back to this side of the Atlantic, except in the form of foreign ownership of our banks and financial institutions.

This, my friends, is what they really mean by “A Global Economy.”

Our government’s debt instruments are owned by the Chinese, and our real estate by international consortiums (or is it consortia?) of Europeans and Asians. Our labor force has been exported to India (have you called Microsoft Tech Support recently?) and now, we are only too happy to sell off our much-weakened financial institutions to the Leaping Lords of the Levant, who are only too happy to lend us back our (much lower-valued) dollars for a whopping 11% guaranteed return. Indeed, why wouldn’t they?

I don’t know about you, but I am finding it hard to feel exuberant about this state of affairs. By most accounts the economy is on a downward trajectory, and while the pundits can argue daily, as they do, about whether we are going to have a recession or merely a slowdown, it is clear that something is not right about the economic trend here. Larry Kudlow can continue to “believe in a strong America” (God, what a fatuous gasbag!), and the other CNBC chatterers (who, not coincidentally, are in the business of selling securities) can tell us how a collapsing dollar is really good for us, because it enhances exports, but John Q. Public knows better. That’s why the retail industry is quaking and shivering in its fine (unsold) leather boots and cashmere scarves.

The bull market case for today is that if Abu Dhabi is prepared to commit Billions to Citigroup, the situation cannot be so bad. After all, such an investment brings the Citigroup capital reserve requirements back up to snuff, notwithstanding its exposure in the subprime space.

The rationale, therefore, is that the Arabs know something we don’t: that this is merely a short-term blip in the running of the bulls on Wall Street, and that everything is really OK. But does this analysis bear even superficial scrutiny? Nobody really thinks that Citigroup is going under. In the final analysis, the U.S. Government could simply not allow that to happen. So what really is going on is that an Arab investment consortium is making an investment, yielding a fat and juicy 11% return, effectively guaranteed by the Full Faith and Credit of the United States of America. You don’t need to be T. Boone Pickens to spot a bargain like that. All you need is to be flush with Petrodollars.

We all know, in our hearts, that our beloved America has been for sale for quite some time now. The danger to all of us is that this time, it is now ON sale.

Warren R. Graham
Copyright 2007

Irrational Exuberance Redux

2007-10-01T12:59:00.000-07:00

Well, it’s official. The traders (mostly large institutions and funds) who move the Stock Market have now lost all touch with reality. This morning, after new of an enormous write-down and profit warnings by Citigroup, UBS and many economists, near panicky price-slashing by Wal-Mart in anticipation of a lackluster holiday season, the cancellation of several high profile deals, and a public statement by Greenspan expressing concern that a housing meltdown in the U.S. might well hurt the entire global economy, these traders reacted by blowing the Dow right through the previous 14,000 level, and as of the time of this writing, taking it up over 200 points.

The reason, say the generally clueless Wall Street analysts employed by various media outlets is the prospect of lower interest rates to come; perhaps much lower. And they’ll probably get it, now that Ben Bernanke has proven himself unable to stand any pressure from the banks and the hedge funds. The markets, in fact, have been bubbling with pie-eyed optimism nearly every day, since the recent interest rate cuts.

It follows, they say, that with fixed income securities becoming less attractive, and real estate in trouble and generally illiquid, equities will continue to be the only place to be. Never mind oil prices heading up to $100 a barrel. Never mind the increasing prospect of recession. Never mind that stocks are trading at near historically high multiples, and that is based on profits that are nearly guaranteed not to increase, but to decrease in 2008. Never mind that the U.S. Dollar is in free-fall, with no apparent end in sight.

The reason for this buying frenzy, however, is much more basic than a reasoned analysis of the benefits of easy fiscal policy. It is, quite simply, mass hypnosis, short covering hysteria, and outright denial. “Buy now, or miss the party!” “Buy tech, it’s a safe haven.”

Tech, a safe haven??! Have we really gone so off the rails, that the term “flight to quality” now means that widows and orphans should stake their retirement nest eggs on the prospect of endless good times at Cisco, rather than U.S. Treasuries? Is Red Hat the new Municipal Bond?

Apparently so. And, to use a hackneyed metaphor, the financial world is “fiddling while Rome burns.”

Lower interest rates (and remember, we’re talking only about short-term rates. The Federal Reserve has little or no control over long-term rates, which are actually trending higher) cannot, by themselves, enhance home values. They cannot induce lenders to lend to non-creditworthy customers anymore, at least in the near term (presuming that those lenders have learned some kind of lesson from the sub-prime crisis). They cannot really spur consumer spending either. Credit card rates rarely go down much with the Fed Funds Rate, and Americans are already drowning in a sea of unmanageable credit card debt. In fact, the falling dollar is likely to substantially increase the cost to consumers of goods, especially those imported from abroad. Foreign banks and investors are already reducing investment here because they are losing money every day, as the dollar declines against their own currencies. They also do not want to hold dollar denominated instruments for the same reason.

If lower rates do somehow turn out to stimulate the economy meaningfully (a dubious proposition, to be sure), one likely result is, of course, renewed inflationary pressure. And while we are all told that food and energy should be stripped out of the inflation measure, very few of us can get by without food and energy. Food prices have gone up dramatically in recent months, and the suggestion that gasoline and heating oil prices will continue lower notwithstanding $80 a barrel oil is just plain mendacity. Nothing spooks the Fed like inflation. And at the first sign of it, the trend will start to tightening, no matter how much the markets recoil at it.

It may be that lower rates will have a beneficial effect on the Merger and Acquisition business and may reignite the crazed “urge to merge” mania of the last year or two. That remains to be seen. The beneficiaries of those deals, of course, are not Mr. & Mrs. John Q. Public. They are, rather, the same (very few) folks who made tens or hundreds of millions in the last couple of years, in an era of almost cost-free money, charging their clients whopping fees, and paying low taxes. Even for an unabashed capitalist like myself, there does seem a certain excess and decadence in all that. The clients, of course, never complained, so long as their returns were high. Only when the quality of some of these investments came into question, and investors started pulling their money out, did these funds scream for Bernanke to ride to the rescue. Which he has, thus far, done, in spades.

Meanwhile the markets go on in a gleeful upside rampage, blissfully ignoring all bad news, or worse, interpreting all bad news as good, because financial weakness leads, they suppose, to easy money.

Hey, how about those Mets, eh?

Warren R. Graham
Copyright 2007

A Friend Like Ben

2007-08-31T08:14:00.000-07:00

Ben, most people would turn you away
I don't listen to a word they say
They don't see you as I do
I wish they would try to
I'm sure they'd think again
If they had a friend like Ben

From the Song Ben
Copyright 1972 Walter Scharf/Don Black
Performed by Michael Jackson

Beautiful words, right? The tune, if you know the song, is quite lovely as well. The irony, of course, is that Michael Jackson is singing this beautiful song to a RAT. That’s right, a large, hairy, dirty, nasty (and aggressive) rat! The song is the musical theme for the film of the same name.

The “Ben” I wish to speak about, however, is Ben Bernanke, Chairman of the Federal Reserve Board. He is no rat. Quite the contrary, although I do not know him personally, he exudes, to all outward appearance, integrity and professionalism.

The Wall Street Bulls, however, may well view him as a rat. Unlike Alan Greenspan, who bowed (kowtowed, even) to political pressure after September 11 and reduced the Fed Funds Rate aggressively, to prop up panicked capital markets, Bernanke is, for the most part, keeping his powder dry, in order to determine whether the recent turmoil and sub-prime mess is, indeed, a threat to the overall economy.

Greenspan’s actions did, in fact, help to buoy a sinking market, as well as to minimize and shorten the recession of 2001-2002, just long enough for the tech bubble to be replaced by a real estate bubble. The latter bubble was, it seems, almost entirely a function of historically low rates brought to us by Mr. Greenspan. It also was the source of the sub-prime loan fiasco and predatory lending practices, which enabled people with questionable creditworthiness either to purchase homes they could not afford, or to use their existing homes as “piggy banks” for seemingly limitless consumer spending sprees. In the interim, these lenders raked in huge origination fees, and the economy hummed, as the people spent, and spent and spent. All the while, the lenders knew (and the borrowers should have known) that a day of reckoning awaited; a day on which the teaser mortgage rates would reset. Those days are upon us now, and nearly everyone, it seems, from the sub-prime borrower to the lenders, to the hedge fund managers want Mr. Bernanke, Greenspan’s successor to bail them out. Thus far, though under unimaginable pressure from the Bush Administration and the aforementioned business and consumer groups, it appears that Bernanke may not be so willing to play ball.

Bernanke, you see, does not seem to understand the Fed’s brief as being a bulwark against the foolishness of consumers and the greed and irresponsibility of the business community. On August 30, second quarter GDP was revised upward to 4.1%. That suggests robust growth in the economy. Unless the sub-prime situation has totally reversed that trend (and there is simply no data, one way or the other on that point, as of yet), a responsible Fed would certainly have to question the wisdom of lowering rates into such a burgeoning economic engine. Interestingly, many of the “talking heads” of the business community tell us that the economy continues to be strong, and the envy of the world while, in the same breath, frantically urging Bernanke to ease. Why? Are they persuaded that a recession is upon us? Perhaps a few are. But most economists tell us that we should expect growth (slower growth, but growth, nevertheless) through the end of 2008.

No, I believe that the agenda behind these calls to arms is much more parochial and transparent. The concern for marginal homeowners on Main Street exhibited by the very highly compensated denizens of Wall Street is touching, to be sure. But what is really driving this train is that the economic and political power centers want the capital markets saved from their own excesses. They want the bull market to continue its previous meteoric rise, and they want the financial services industry to evade the consequences of its mismanagement and greed. Significant rate reductions will likely achieve these results, but will also trigger a further collapse of the U.S. Dollar and, if the underlying economy is really as sound as the numbers would suggest, such a move risks overheating it, and bringing back that which the Fed claims to detest above all: inflation.

Bernanke is resisting, but the jury is still out as to whether he can take the pressure. What is at stake is not only the potential danger of an overly accommodative Fed outlined above; Mr. Bernanke’s role as the Chairman of an institution supposedly independent of political forces is being put to the test.

So, for the Bulls, the question is, is Ben a Friend or a Rat? Only time will tell.

Warren R. Graham
Copyright 2007

OLE, EL TORO!

2007-08-27T13:26:00.000-07:00

I am certainly no expert on bullfighting, and have no real wish to become one. Despite those who laud it as a legitimate expression of a certain weltanschauung, and its accompanying culture of machismo, I find it hard to watch, as the outcome is inevitable and cruel. What I know on the subject (which may or may not be accurate), is derived primarily from having read some Hemingway and watching the film Blood and Sand repeatedly (more for my appreciation of Rita Hayworth, than of Tyrone Power or of the bullfighting scenes, truth be told).

Most of the cheers in the bullring are, of course, reserved for the bravery and skill of the matador, but there are occasions in which the bull is deemed to be an exceptionally worthy adversary, and is accorded noisy accolades by an appreciative crowd.

Just the opposite is true on Wall Street, and on the airwaves of its most ardent cheerleader, CNBC. In those precincts, the bull and only the bull is celebrated. Try to imagine a world (at least since the days of JFK) in which the major news reporting organizations did everything possible to extol the virtues of government policy, and to squelch any hint of dissent. Unthinkable? Repressive? Un-American? In fact, many have argued (this is a subject for another article, and not this one), that the mainstream media, which sees its role as the Public’s watchdog, is, therefore, nearly always hostile to the incumbency.

For those who have a hard time accepting the prospect of such obeisance in media, I invite you to sample a few hours of the daily fare on CNBC (which, although in my judgment, the most egregious of the business-reporting media, is not alone in its role of hyping the bull).

On a typical day, the morning shows open with a discussion of the current status of stock futures. If they are ahead of “fair value,” all is right with the world, since it augers a strong open. If not, the hosts of those shows either downplay that news, or almost literally try to coax them up, by pointing out those reasons why the market should be going higher. This very morning, for instance, a guest pointed out that she thought the chances of a recession had been increased by the recent market turmoil and credit crunch. After chiding her for “introducing the ‘R’ word” into the discussion, the host, Mark Haines took issue with her assertion that consumer spending would likely suffer, since, he said, the consumer sentiment index (which had, at that hour, not yet been released), would show consumer optimism. He based this on the “consensus” of experts. Under pressure, this guest backpedaled and suggested that the recession (if there was to be one) would be short and mild. Whew!

It must be said that, at the same time CNBC reports the tribulations of the sub-prime mortgage market and the damage it has done to what is “otherwise” a very healthy economy, it continues to provide an advertising forum, both on television and on its website, for companies advertising low cost, easy credit mortgages. Those are the same genre of companies that are being accused of having made predatory loans to innocents, and cajoling them into either buying homes they could not afford, or refinancing to cash out their equity for a variety of purposes.

On today’s website, in his feature “Trader Talk,” Bob Pisani talks about what’s pressuring the markets today, and argues, in essence, that all such negativity is misplaced. After listing all those criteria, such as reduced consumer spending, falling housing values, problems in the financial service industries, Pisani says that “all is not doom and gloom. The key (says he) is to look at the data the right way.” After all, a weakening economy, less consumer spending (unlike Mark Haines, Pisani believes that “consumer sentiment” is unimportant. Only “consumer spending” matters), declining home prices and downgrades of brokerage stocks all have a silver lining: a more accommodative Fed. Taking that argument to its logical conclusion, of course, would suggest that a depression would be REALLY EXCELLENT for low interest rates!

Later this afternoon, after the market closes, and we hear the closing roundup, we can expect to be treated to the whimsical musings of Larry Kudlow, whose insipid mantra “I’m for a strong America” calls for an analysis, to quote Cher Horowitz in the film Clueless, akin to “searching for meaning in a Pauly Shore movie.” Until a few weeks ago, Kudlow shut down every guest who dared express a negative point of view, by inanely going on about our Goldilocks Economy (not too hot, not too cold, but just right!). I haven’t heard that expression recently, but I’m not fretting, because no matter what, Kudlow, for one, is for a strong America!

Follow that up with an hour of “B-B-B-Booyah, Cramer!” and, well, you get the point. At one time, I thought Jim Cramer was an insightful and brilliant trader. According to the most recent Barrons, however, Cramer’s record, based on his stock picking in recent days, was worse than an indexed mutual fund. That’s not so important, though, because one’s stock picking record should be measured over many years, and Cramer’s is fine. The problem is that his persona has become a caricature, and what with his sound effects, and ranting manner, it’s hard to take him seriously.

A fundamental part of the problem may be found in CNBC’s selection of guest commentators on its news segments. The vast majority of those commentators derive their (very high) incomes, either directly or indirectly, from the sale of securities. Although most financial services companies are careful to separate the sales/investment and research aspects of their operations, the financial gurus trotted out by these companies are paid in salaries plus bonuses. Their bonuses, of course, are, in large measure, determined by the profitability of their sale/research divisions. These folks are anything but stupid and they realize this. Hence, I believe that nearly all the guest commentators have, to a greater or lesser extent, an axe to grind. Over the past few weeks, for the first time, business news outlets broke their tacit vows of silence, to discuss, openly, the horrifying prospect that Manhattan residential prices, after years of incredible speculative frenzy, might be due for a correction. And who did they trot out to discuss this? Barbara Corcoran, the dean of high-end Manhattan residential brokerage, who has made a fortune in this ever-increasing wonderland of multimillion dollar condominiums built, it appears, mostly for hedge fund wunderkinds. Barbara Corcoran is to Manhattan real estate, what Abby Joseph Cohen is to the stock market. It’s ALWAYS the right time to buy, and everything will ALWAYS increase in value. This type of “reporting” might be likened to a news outlet which wanted to report on dentistry, but rather than book a dentist, it interviewed only the Tooth Fairy. “Yes, sure the teeth fall out (I imagine the guest saying), but its really good news, not bad news, because they were going to fall out anyway, they fall out gradually, and you get paid every time!”

The result of all this is that much of the business-reporting media has become almost a propaganda mill for Wall Street and for a rising stock market. Its reportage is often little more than spin. This is not its stated mission or its brief, and the point of this piece is to suggest that more attention be paid to objective business news gathering and dissemination.

If the folks at CNBC are fans of undomesticated animals, it might do them well to recall that the bear is one, too. And it has feelings. Anybody remember Winnie the Pooh? The Care Bears? The poor hungry baby bear who was left with no porridge because that nasty Goldilocks took another spoonful every day on Kudlow’s show?

There are people (a minority, to be sure), who are short the markets. Moreover, there are {gasp} benefits to a falling market. Opportunities are presented to buy into equities at more favorable prices. There is a greater impetus for entrenched management to build up businesses through increased sales and product enhancement, instead of spending its spare currency on zero sum game activities such as share buybacks and taking companies private. Declining home prices provides opportunities to more potential homeowners to gain their share of the American Dream.

The gist of this is that it seems to me that a media outlet purporting to report business news ought to do just that. I don’t say that the reportage should be dry and without any entertainment value. After all, ratings are the mothers’ milk of any television media outlet. Ratings for business news are, of course, always better in a frothy and rising market, when every pushcart vendor has a portfolio that he can discuss in detail, but that does not mean that the bad news should be censored or even downplayed. Yet evidence of bias for the bull is omnipresent on CNBC and everywhere on many of its fellow business news outlets. Poor bear! Unloved and unappreciated.

People who know me might well say that I have an axe to grind, too. They are certainly right, but as I am not being paid for writing this, and CNBC is not inviting me to be its guest anytime soon (especially now), I feel quite free to exhibit my prejudices. Oh, and by the way, in my defense, I’m for a strong America!

Warren R. Graham
Copyright 2007

It’s the (Sub-Prime) Economy, Stupid!

2007-08-15T12:29:00.000-07:00

Some months ago, I wrote an article entitled A Sub-Prime Economy? and I urge anyone reading the following piece to revisit that material, both to see what was wrong about it, and what was right. In it, I predicted that the trigger for financial trouble would come either in the form of an overheating economy, which would drive up interest rates and end the era of easy money, pushing marginal companies over the cliff, or, alternatively, that a weakening economy would tighten up lending standards, starving weak companies by blocking their resource to working capital, and increasing business failures. I was wrong.

While even the chronically optimistic must surely now admit that there is a problem in the capital markets, and that it has, in fact, spilled over into equities, the fuse has been lit not by either of the phenomena described, but rather, by the proverbial “tail wagging the dog.” That is to say that while the fundamentals of the “Global Economy”—more about that hackneyed phrase below—remain strong, they threaten to be compromised by an absence of access to credit, hitherto provided by hedge funds and private equity sources, with seemingly endless pools of easy money looking for a home.

Can it be only a few weeks ago that the indomitable cheerleaders for the markets (who, by some magical coincidence, are, for the most part, individuals engaged in the business of selling securities) were telling us that we need not fear, because the world was “awash in oceans of liquidity?” Now, suddenly, central banks worldwide are finding it necessary to intervene almost around the clock in order to inject "liquidity" into the credit markets.

As for this author, I thought I saw the worm turn about two weeks ago, when, in the face of tremendous (and rather scary) volatility in both directions, the folks at Goldman Sachs trotted out Abby Joseph Cohen to tell us that the bull was alive and well, thank you very much. I had forgotten about Abby Joseph Cohen, and last remember her telling us in March, 2000 (the last hurrah for the internet bubble) that that, well, the bull was alive and well. Ms. Cohen has, to the best of my knowledge, never suggested publicly that the market might {gasp!} go down.

Further evidence of a change in mood can be found by anyone who is a regular watcher of CNBC. Gone are most of the smiles, jokes and general bonhomie that could always be found when the expectations were of an endlessly rising market. Gone is that most annoying "cowbell" signal which rang at CNBC to herald any announcement of note in the business world. And although CNBC is supposed to be a source of business and market news, any regular viewer of its programming can have no doubt about the inherent love for bulls and loathing of bears exhibited by its on-air talent. After all, just as sellers of securities want us to think that the markets will always go up, CNBC’s producers understand well that broad, general interest in the markets (and hence, higher ratings) increase dramatically when the markets are rising. But today, the featured guest of CNBC before the U.S. Markets opened for trading was none other than Wilbur Ross, the unchallenged Dean of Distress. Wilbur is an icon in the bankruptcy/restructuring/turnaround world, and, speaking for myself (I have spent over 25 years in this field), I readily acknowledge that Wilbur has probably forgotten more about this subject than I will ever know.

And yet, his observations on the current turmoil in the markets were succinct and remarkably simple. He noted that: “for the past two years, consumers have spent more than they have earned, and the government has spent more than it has earned (sic).” He pointed out the obvious: that such a situation cannot continue indefinitely. He attributed some of the recent difficulties to what he called the two most dangerous words in the English Language: “Financial Engineering,” which, according to Ross means that “someone has figured out a way to underprice risk.” Ross noted that many people had relied entirely, and to their detriment, on ratings agencies and bought products that were designed to sell a “risk-ignorant rate of return.” According to him, such a practice “always has a bad end.”

Yet, the purveyors of promised profits will, undoubtedly, continue to tell us that this is a mere “blip on the radar screen,” and that the indestructible “Global Economy” will save the day. If one has a memory that reaches back to before yesterday afternoon (not, by any means, a given in an industry marked by twenty-something wunderkinds), one might easily substitute the words “Global Economy” for the words “New Economy” that was so prevalent during the internet bubble. One might also easily realize that the recent and massive spate of private equity deals, in which private equity groups acquire public companies, and fund their acquisitions with either low-cost loans or investor capital financed with assets of the target company are (not-so) strangely reminiscent of the leveraged buy-out boom of the late 1980’s, so well-exhibited in the film Wall Street. Those deals certainly came to a bad end. Show of hands….who remembers the early ‘90’s?

The difference now, the starry-eyed optimists tell us, is that the defaults in these deals are much more difficult to trigger. In fact, some of these private equity deals have provisions in which, if the borrower cannot pay, in cash, it has the option of merely issuing more stock to the lender. That system works fine, until and unless the borrower is in genuine financial difficulty. It may not be in default, because it retains the right to issue more stock (of ever-increasing worthlessness) to its lender. So what has been accomplished? The risk of financial disaster has merely been transferred from the borrower to the investors in the private equity deal. To my knowledge, nobody has, as yet, figured out a mechanism to generate “junk bond” level returns with “treasury instrument” credit quality. And yet, the investors in many of these vehicles have somehow allowed themselves to be bamboozled into thinking that someone had. And they were willing to pay astronomical fees for it. Now, of course, many investors are running for the exits, shocked at having actually lost capital! And the “Financial Engineers” are begging the Federal Reserve to ride in to the rescue and reduce the Fed Funds rate. Who would benefit by such action? Well, the stock market would likely go up, at least for a while. Is the Fed supposed to be in the business of propping up the stock market? On the other hand, there would almost certainly be run on the already battered U.S. Dollar, as foreign investment capital opts for currencies tied to more friendly central bank yields. The Sub-Prime mess would not be solved by any such action, as it represents much more than a problem of less than stellar borrowers. It is mostly a problem of declining housing values in a system where there was precious little equity from the buyers in the first place. Borrowers who could not afford conventional mortgages bought homes, upon which they put little or no money down, and took on mortgages at teaser rates, which are now adjusting to market.

So who are the victims? Not the lenders. They got their fees and their points. And they got paid yet again when they “securitized” their loan holdings and sold them on a market newly created and packaged by other “Financial Engineers.” Not really the borrowers, either, who got houses without having put up any equity, and paid (for awhile) low-interest mortgages instead of rent, for a place to live which they could not otherwise have afforded.

But if the Fed plays the role of the cavalry, or the Government embarks upon yet another bail-out plan (anyone remember the Savings and Loan crisis?), we KNOW who the victims will be: the taxpayers. We will be called upon to save the banks and the hedge funds from the consequences of their “Financial Engineering.”

The “Global Economy” may well be strong, but the U.S. Economy is two-thirds driven by the true American vice: rabid consumerism. Once the credit cards are nearly all maxed out (and accruing interest at, in some cases, over 30%), and the middle class is no longer able to access its non-existent home equity (whether because of declining values or tightening credit standards), consumer spending MUST suffer. The first hints of this are even now coming from profit warnings from Wal-Mart, Home Depot and Macy’s.

I am certainly a believer in the resilience and ultimate success of this Country, and we will somehow grow ourselves out of this mess, too, in the long run. But for the shorter term, all the protestations of Government spin doctors and Wall Street salesmen posing as analysts will not change the simple truth, borrowed and paraphrased from the Clintonian: It’s the Sub-Prime Economy, stupid!

Warren R. Graham
Copyright 2007

A Sub-Prime Economy?

2007-03-08T11:42:00.000-08:00

A Sub-Prime Economy

As a practitioner in the fields of bankruptcy, workout and corporate restructuring, and in a shameless admission of self-interest, I readily admit to being vitally interested in whether the U.S. Economy is due for a downturn. It has often been said that economists have predicted nine of the last five recessions. The notion was also advanced, by the Clinton Administration, not so long ago, that the business cycle, as we have always understood it, was a thing of the past. Is this so?

On the one hand, there have been only two recessions of any real lasting power over the past twenty years. The first was in the early days of the Reagan Administration, when aggressive budget cutting and revenue loss occasioned by the David Stockman “supply side” economic strategy took an enormous bite out of government spending power, forced massive public borrowing, and triggered a recession. The economy soon grew itself out of recession, either through growth or excessive government deficit spending, depending on one’s point of view.

In 1990, another recession ensued, partly as a belated result of the 1987 Stock Market crash. This downturn lasted about two or three years, and the economy expanded once again. After a lengthy period of prosperity, the Clinton Administration declared the business cycle dead, and boasted that the combination of fiscal and monetary policy had permanently rendered it obsolete.

The bursting of the dot-com bubble allegedly triggered a recession in 2001, but it was short-lived enough to be barely noticeable (except, of course, to those who had their entire net worth tied up in it), and was soon replaced by a real estate bubble. By the time the powers that be admitted that there had been a recession, they declared it over, in the same breath. Not even the horror of 9/11 was able to take the speculators off track. In the meantime, hedge funds (truly a misnomer for what, in essence, are private equity funds) were able to generate unprecedented liquidity by “monetizing” all sorts of collateralized obligations…from so-called “sub-prime” mortgages to more conventional asset based lending obligations. This, in truth, was nothing more or less than a replay of the leveraged buyout craze of the 1980’s, in which speculators and corporate raiders took out the value of companies today in the hope that tomorrow’s earnings would be sufficient to replace the withdrawal. And if not, well, that would be someone else’s problem.

The major difference this time around, of course, is that the vast pools of liquidity generated by this mechanism have (after, of course, making some people incredibly wealthy), been largely plowed back into businesses as extremely low cost loans, mezzanine financing and equity. Too much money chasing too few deals has led some of these funds (and, indeed, more traditional lenders, who have to put their shareholders’ investments to work), to put money into marginal businesses, or to finance questionable collateral. Thus far, it has paid off, with the seemingly endless sources of easy money available, and the economy’s enjoying a very long “sweet spot,” of profitability and resource to capital.

The problem will come in one of two ways: either the economy will heat up noticeably, raising the cost of funds to businesses in the form of higher interest rates or reluctance to fund marginal profits, or perhaps losses, or the economy will weaken noticeably, which, though resulting in lower cost of borrowing, will ironically result in tighter lending standards, and increased business failures. You see, profits are infinitely easier to generate if the cost of money is essentially taken out of the equation. In more traditional business environments, debt service is an important component of the profit and loss analysis.

This phenomenon is already beginning to manifest itself in the highly publicized “sub-prime” mortgage crisis. Secondary and tertiary lenders (and in some cases banks and funds lending under the radar screen through the vehicles of these lenders), have been extending mortgages to homeowners whose creditworthiness is suspect, betting on an endlessly rising real estate market, and continued historically low rates. This system worked just fine for a long time, as the position of these lenders was protected by their enhanced collateralization and the ability of borrowers to carry their overleveraged positions through availability of easy money. Now, with the national decline in home values, and upcoming ratcheting up of adjustable rate mortgages, many of these loans will go into default.

What makes this situation particularly dangerous is that the original lenders, for the most part, no longer hold the paper. These mortgages have been “monetized” and place in pools of securities, managed in bulk by faceless, nameless trustees. When the mortgages default, these trustees will be forced to foreclose and will, for the most part, have no discretion to “work out” the loans. This is a potential disaster waiting to happen, especially for the middle class.

The cheerleaders for the economy and the stock market, who contend that the “sub-prime” and home value problems are likely to be contained and not spill over into the economy at large are, I believe, missing a salient point. A full two thirds of the U.S. economy is driven by the only weapon left in our arsenal: our seemingly endless appetite for consumer goods. After all, we scarcely manufacture anything in this country anymore. Ours is almost entirely a service and consumer driven economy. Large numbers of homeowner foreclosures, caused by overleveraging (in many cases, by homeowners seeking to retire high rate credit card debt) cannot fail to have an effect on consumer spending.

In addition, our very weak dollar threatens to make us a secondary power even in consumption. For example, China’s consumption is growing exponentially, with a rapidly growing economy and the largest savings rate in the World (not to mention a billion potential consumers). Chinese holders of stock brokerage accounts have more than tripled in the last two years. And what will we have to export to these folks? Cars? We can’t even sell them here. Technology? Well, many of the intellectual property originates here, but the products are much more cheaply manufactured abroad, as is the service component. Have you called Microsoft tech service recently? Did you get connected to the Silicon Valley or Bombay/Mumbai?

The competition around the World for our historical economic pre-eminence is fierce. If our lead in manufacturing goes (and for the most part, it already has) and our position as the great bastion of international consumerism diminishes, we are threatened with becoming a second rate economic power. And all the easy money in the World will not save us from that.

The business cycle may, indeed, be a thing of the past, but not in the way it has been advertised. This time, we may not recover so easily from the downturn. That downturn may yet be a long time coming, what with the almost conspiratorial partnership of business, financial institutions, the markets and the government to inject oceans of liquidity into a system which depends upon all of our acquiring stuff and spending well beyond our means. But underlying all of that cash, we must have a solid profitable business base. Therein (and only therein) lies our only hope for future economic dominance.

Warren R. Graham
Copyright 2007
Reprinted from: EzineArticles.com
http://ezinearticles.com/?A-Sub-Prime-Economy?&id=480796

Creditors’ Committees under Bankruptcy Reform: More Representative?

2006-07-27T10:22:00.000-07:00

*****NEWEST*****

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), attempted to redress what was perceived to be a failing under prior law. In Chapter 11 Cases (especially larger cases), smaller “trade” creditors and smaller interests were often frozen out of the process and of qualification for Committee membership, by the mere presence of huge bondholder representatives, pension funds, and the like. The intention, under earlier law, was to create a Committee, generally of seven members, consisting of the largest unsecured creditors, with claims generally representative of the types of debt extant in the case. This, of course, proved easier in theory than in practice, as large cases tended to be replete with public debt, managed by institutional holders. The result, often, was that smaller trade creditors, or “mom and pop” businesses were simply not given a seat at the table, and were effectively not afforded the advantages of participation in the reorganization negotiation process.

Under prior law, a conflict developed in the Courts as to whether the bankruptcy court had the power to direct the U.S. Trustee to increase Committee size so as to redress this imbalance of power. It is clear now under BAPCPA that it does, if the creditor seeking membership can satisfy a two-part test: The first part requires that the creditor be a “small business concern,” as that term is defined under the Small Business Act. The definition of that test is beyond the scope of this article, and counsel should be consulted for additional detail. The second requirement, is that the creditor hold a claim or claims which, in the aggregate, “in comparison to the annual gross revenue of that creditor, is disproportionately large.” The term “disproportionately large” is not defined, and will be left to judicial development. The term has been used in certain other bankruptcy contexts, but such use is, in the judgment of this author, of dubious applicability.

It seems obvious, for example, that if 50% of the annual revenues of a “Small Business Concern” is tied up in a bankruptcy case, the provision would apply, but as one goes further down the scale, the cases are likely to reach different results. In any case, in those courts in which the Courts had the power to direct changes in Committee size and composition to provide for adequate representation of types of debt, that discretion does not appear to have been taken away.

In summary, the question of whether “Mom and Pop” have been given a “seat at the table” in large reorganization cases has yet to be tested by the application by the Courts of the new BAPCPA provisions, and only time will tell whether Committees will become “more representative” of types of debt in those situations. Any creditor representative who finds himself or herself in a situation calling for legal analyis in this area is, or course, urged to consult competent counsel.

Warren R. Graham
Copyright 2006

New E-Book: The Top Four Benefits given to Creditors and Landlords under the New Bankruptcy Law

2006-06-29T08:41:00.000-07:00

*****NEWEST DEVELOPMENT*****

Dear Friends:

I am pleased to make available to you my new Four-Part Series, called: The Top Four Benefits given to Creditors and Landlords under the New Bankruptcy Law which is totally complimetary, by simple subscription. This is intended, primarily, as a guide for vendors and landlords who find themselves in business relationships with troubled companies.

I think you will find it informative and helpful, and I welcome, as always, feedback and comment.Many of my contacts will have already received an invitation to subscribe to this series. If you have received it the invitation, please click on it to accept. If you have not received the invitation, please send me an e-mail, and I will see that the invitation goes to you, pronto!Once you have subscribed, you will receive the series, one part every few days. I encourage you to print it and keep it. If you have friends, colleagues, customers, or anyone else whom you think might benefit from this user-friendly, practical guide, please send me their contact info and they will receive the invitation to subscribe in short order.

I also remind you that my previously offered Seven-Part Series, entitled:

The Seven Deadly Si(g)ns: Telltale Indications of a Business in Trouble

is also still available by subscription. Follow the same procedure to receive it. I look forward to your feedback and inquiries.

Warren

Please Subscribe to My New Seven Part Series!

2006-06-01T08:55:00.000-07:00

Friends:

I have authored a Seven-Part Series, called: The Seven Deadly Si(g)ns:
Telltale Indications of a Business in Trouble. It is available by subscription, which is totally complimetary. This is intended, primarily, as a guide for business owners of small to medium family or closely held companies, and those who do business with those entities. I think you will find it informative and helpful, and I welcome, as always, feedback and comment.

Many of my contacts will have already received an invitation to subscribe to this series. If you have received it, please click on the invitation to accept. If you have not received the invitation, please send me an e-mail, and I will see that the invitation goes to you, pronto!

Once you have subscribed, you will receive the series, one part every few days. I encourage you to print it and keep it. If you have friends, colleagues, customers, or anyone else whom you think might benefit from this user-friendly, practical guide, please send me their contact info and they will receive the invitation to subscribe in short order. You may, of course, forward your e-mails to them, but that will require you to follow up as you receive them every few days. You will probably find it easier to encourage them to get on the subscription list.

I hope you find this material useful, and I am anxious to hear your reactions.

Keep in touch!

Warren

I Couldn't Have Said it Better Myself!

2006-06-01T07:42:00.000-07:00

Rather than sound like a broken record, I refer you to a very well written and researched article discussing the disaster that IS Bankruptcy "Reform." It's quite consistent with the points I've been trying to make on these pages for a number of weeks.

Warren

Bankruptcy Reform: A Bust?

2006-05-25T07:24:00.000-07:00

The National Association of Consumer Bankruptcy Attorneys has recently reported on early statistics, which confirm the concerns espoused by opponents of much of the recent Bankruptcy “Reform.” The report provides the first analysis of the over 60,000 consumers who have filed for bankruptcy protection since the enactment of the “Bankruptcy Abuse Prevention and Consumer Protection Act” (“BAPCA”) (editors note: the use of the term ‘Consumer Protection’ in the title of this statute is nothing short of Orwellian) in October of 2005. The full text of this report, entitled: Bankruptcy Reform's Impact: Where Are All the Deadbeats, may be found by following this link.

In its report, the NACB concludes that the changes put in place by Congress are not working as intended. Among other things, the report finds that of the 61,335 consumers seen so far by credit counseling firms nearly all (97%) are unable to repay any debts, and four out of five would-be filers were forced into dire financial straits by circumstances beyond their control, such as the loss of a job, catastrophic medical expenses or the death of a spouse. It is almost certain that, due to the dramatic increase in administrative expenses and new hurtles to recovery of preferential transfers created in the new legislation, unsecured creditors are likely to be receiving less, not more, in bankruptcy dividends and distributions.

And now, in a recent development, the National Association of Consumer Bankruptcy Attorneys, together with the Connecticut Bar Association has brought suit to have portions of the law, relating to debt counseling, declared unconstitutional. This, alas, is what comes of Congress’s having abdicated its legislative function and having given a drafting pen and a free hand to the credit card industry. Unfortunately for that industry, the legislation it wrought is sloppily drafted, and more importantly, will hurt consumers and not help the issuers of credit cards. Nobody is benefited, and, in the opinion of this author, much of this legislation will ultimately be undone.

One does not ordinarily think of Otto von Bismarck (or any German leader, for that matter) as a wit. But his well-known and pithy quote to the effect of: “If you love laws and sausages, you should never see either one made,” seems particularly apropos. One would hope that our future legislators will, if they want to sell their votes, at least do the drafting themselves.

Warren Graham
Copyright 2006

2006-05-18T16:13:00.000-07:00

***YOU SEE??? I TOLD YOU!!!***

Ignore this at your peril

Warren

LATE PAYMENTS ON MORTGAGES RISE
Soaring housing prices and aggressive mortgage lending have saddled home buyers with ever greater levels of debt, and early signs are now emerging that more people are unable to keep up with their monthly mortgage payments, the Wall Street Journal reported today. The increase in late loan payments comes as more buyers have been forced to stretch financially to afford ever costlier houses in recent years, and many homeowners have increased debt by tapping their home's equity. Analysts say that more relaxed lending standards on the part of mortgage lenders also resulted in higher debt loads, which some borrowers are now struggling to repay. With the housing market cooling and interest rates rising, "by the end of the year you could see a substantial increase in delinquency rates" for mortgages, says Thomas Lawler, a former Fannie Mae economist and now a private housing consultant. An analysis by Bear Stearns found that delinquencies on loans originated in 2005 were in most cases far higher than on loans issued in previous years at the same point in their life cycle. Credit Suisse found that borrowers who took out adjustable-rate mortgages (ARMs) in 2005 were three times as likely to be delinquent on their payments after the first year as those who took out ARMs in 2003 and 2004.

Smelling Blood in the Water

2006-05-11T10:42:00.000-07:00

So the statistics are finally starting to emerge, and nobody but the spokespersons for our real estate brokerage industry, our debonair denizens of denial and flagrant fanners of fantasy can gainsay the obvious: the housing market is softening, and it is doing so quickly and rather dramatically. Prices are softening, unsold inventory is rising quickly, and new construction is clearly on the decline. The New York Times pointed all this out in its May 9 Business Section and, as we all know, once the “Old Grey Lady” spots a trend, it’s well underway or, perhaps, very nearly over.

Real estate investors, over the last couple of years, are the equivalent of the late 1990’s high-tech moguls, persuaded beyond any reason that profits were limitless and that the market would, indeed, go up forever. Yes, folks, it’s the tulips again! For those who may not recall 17th Century Holland (all evidence to the contrary notwithstanding, even I can’t remember back that far), irrational and maniacal speculation in tulip bulbs in that era drove the prices up exponentially, until, predictably, the market crashed. I say, “predictably,” even though every time speculative frenzy overtakes society, whether it be a dotcom investment environment “unburdened by earnings” or a frothy real estate market which must go up forever because “they ain’t making any more,” we seem to have to learn the same lesson over and over again.

Is it a lack of intergenerational memory? We certainly don’t have much sense of history, yet most of us know at least something about the Great Depression and Stock Market crashes of the past. Is it mere self-deception, i.e., the determination to think ourselves so clever that we’ve all become real estate moguls? In the late 1990’s, I remember clearly being surrounded at my tennis club by 20-somethings, knee-deep in internet-land, sipping well-aged single-malt scotch, and puffing on expensive cigars, secure and, indeed, smug, in their status as “captains of industry.”

I wonder what happened to those guys?

In truth, it is hard to say why we seem to have to keep learning the same lessons over and over again. This is, perhaps, a question better put to sociologists, and not to lawyers and financial people. But the consequences are, as ever, predictable, to those who see the writing on the wall.

In a previous article, I pointed out that the decline in housing values, coupled with other developments in banking, consumer lending and revisions to the Bankruptcy Code all portended very poorly for the American Middle Class. Depending on what happens in this area in the near future, a similar prognosis may, I am afraid, await the Upper Middle Class who also have a great deal of their wealth tied up in their homes.

Until only a few months ago, clients and colleagues were begging me to find them deals in “distressed” properties. There was, at the time, virtually no such thing, because no sooner had someone gotten wind of a property owner with a financial problem, that the bidding war began, raising “distressed” properties fully to market value (there may well have been no such thing as “market value” either). Now I have the very clear sense that those properties may soon be plentiful. Those who have had the sense to “keep their powder dry” and who have the foresight over the next year or two to begin nibbling at opportunities and the patience to hold the properties they acquire, will, in this writer’s opinion, be well-rewarded. Much as the good leavings of the dotcom meal were feasted upon by so-called “vulture funds,” the sharks may soon be smelling the blood in real estate, and might be slowly, oh, so slowly, beginning to circle.

Warren R. Graham
Copyright 2006

New York Times Article

2006-05-04T12:08:00.000-07:00

Below is an excerpt from a 2002 New York Times Article on the subject of, among other things, retail Chapter 11 Cases, in which I was quoted extensively. I am in the process of preparing an analysis of whether the article's conclusions would change materially under the subtantial revisions to the Federal Bankruptcy Code

MONEY AND BUSINESS/FINANCIAL DESK

Chapter 11? Or Time To Close The Books?

By DANIEL ALTMAN (NYT) 2791 wordsPublished: December 15, 2002

IN the last two years, more than 150 of the nation's large public companies have trooped into bankruptcy court, seeking protection from creditors while they reorganize. The process, under Chapter 11 of the bankruptcy code, has long been praised as one that gives American capitalism an advantage over systems in other wealthy countries, which are more likely to force insolvent companies to liquidate.

But that hardly means that there is no room for improvement.

A growing number of experts, having witnessed the damage to companies involved in drawn-out bankruptcy proceedings, want courts to move the cases along more quickly. Others see their point, but note that companies that have restructured in the nation's fastest-moving courts -- in Delaware and New York -- are the most likely to fail again. And experts in both camps agree that liquidation happens too infrequently.

''We tend to be biased toward saving failing firms,'' said Michelle J. White, an economics professor at the University of California at San Diego. ''The general view is that the United States system tends to overdo it. Often, firms tend to end up failing again after bankruptcy and probably should have been shut down in the first place.''

To thwart the gradual erosion of a company's value during years of legal wrangling, some academics have proposed an entirely new system to deal with insolvent companies. They would use auctions to assess and parcel out quickly the valuable parts of the company.

Yet in the decade since they began publicizing their ideas, Chapter 11 has only grown in use, especially among big, complex companies.

The next year will be telling for the bankruptcy system. When United Airlines filed for protection under Chapter 11 last week, it not only joined the list of the 10 biggest bankruptcies in history but also brought to 7 the number of those now in legal proceedings. How those cases unfold may well influence investors and creditors, hampering the markets' recovery in 2003.
Though only eight years have passed since Congress last revised procedures for corporate bankruptcies, some recent cases suggest that more work on Chapter 11 is in order.

Consider Caldor, the former discount retailer based in Norwalk, Conn., that filed for protection in September 1995 but did not announce that it was going out of business until January 1999.
The company's assets -- including 166 stores -- were worth about $1.2 billion in 1995, versus debts of $883 million, and it ranked fourth in sales among the nation's discount chains. Most analysts expected the company, which did not have a long history of financial problems, to reorganize and survive.

Instead, the chain lost money throughout the late 1990's. By the time it folded, Caldor had sold about half its stores for about $375 million and had received $223 million for its merchandise from liquidators.

What happened to the other $600 million in value?

''Caldor made the decision to liquidate too far down the road to really maximize the value of its assets,'' said Warren R. Graham, who was involved with the case and is co-head of the bankruptcy practice at Duval & Stachenfeld in New York. ''If they had decided Day 1 that they were going to liquidate,'' he said in hindsight, ''they probably would have done pretty well.''
The bankruptcy process allowed Caldor's leaders to keep control of the company, however, and their strategies were not radical enough to keep up with the changing retailing environment. What's more, in the first two years of its bankruptcy, the company paid its lawyers and accountants $15 million. Its executives extracted an extra $8 million to oversee the liquidation and paid its lawyers an additional $10 million.

Mr. Graham said that not even the creditors pushed for immediate liquidation. But it might have allotted Caldor's assets to more competitive companies sooner and saved millions in fees. By the time the liquidation decision was made, the value of Caldor's stores had declined significantly.

BY holding off creditors and protecting assets from sale or seizure, Chapter 11 was intended to give insolvent companies breathing room as they tried to restructure their operations into profitable businesses. Courts oversee their affairs, and companies finance their operations with short-term loans from lenders who move to the head of the line for repayment. Creditors vote on management's plan, and only if they disapprove -- and neither side comes up with an agreeable plan -- does a company liquidate.

But the process has a huge weakness. In the last two decades, several companies -- from airlines like T.W.A. to retailers like Grand Union to building materials giants like USG -- have emerged from bankruptcy only to file again under Chapter 11. That suggests that liquidation or a harsher restructuring might have been merited the first time.

The trouble is, Chapter 11 does not prevent various stakeholders and hired-hand advisers from pursuing their own interests at the expense of the company's value -- and lengthening the whole process.

And the longer a company is in bankruptcy, the more its brand value tends to dissipate. ''When T.W.A. was in bankruptcy, it wasn't the choice airline,'' said Lucian A. Bebchuk, a professor of law and economics at Harvard who has studied the bankruptcy process. Relations with suppliers often suffer, too. ''When companies are in insolvency proceedings, then any business partner would have to deal with it with more precautions,'' he said.

Executives, meanwhile, may no longer have incentives to make good business decisions during a bankruptcy. ''There isn't really any good way to do effective corporate governance in insolvency,'' Mr. Bebchuk said. ''Most of the mechanisms that you hope would do the work outside the insolvency are not there.'' Stocks and stock options, for example, which are traditional mainstays of executive pay, offering incentives to produce profits, become virtually worthless when a company is in bankruptcy. In addition, Mr. Bebchuk said, outsiders can no longer take over the company by buying up its stock -- a powerful way of enforcing investors' will.

The actions of shareholders, who are last in line for payment when a company is bankrupt, often combine with poor management incentives to extend the process, Ms. White said. Shareholders have to agree to any restructuring plan, she said, ''so they often want to drag their feet until, just to get things done, the other groups are willing to give some slice'' of the company to them.
Managers can also have an interest in stretching out the proceedings, said James J. White, a law professor at the University of Michigan (and no relation to Ms. White). They can, and often do, offer several plans for reorganization to try to stave off liquidation and the loss of their high-paying jobs -- even though their actions can be self-defeating.

''Because value is being dissipated,'' Mr. Bebchuk said, ''the ability of the company to be a viable, going concern and compete when it comes out of Chapter 11 might be hurt.''

That destruction of value hurts all creditors; they may have recovered more of their debts, sooner. Eastern Airlines, which filed for protection in 1989, was a case in point. ''They went in front of a judge who viewed bankruptcy as an institution for saving firms, so they were allowed to operate for quite a while,'' Ms. White said. ''The managers had the right to propose reorganization plans. They just kept operating, kept losing money, and there just wasn't anything left. Eventually, they were liquidated.''

Almost two years passed, filled with battles among Eastern's management, employees and creditors, before the airline stopped flying. While Eastern's unsecured creditors lost about $240 million, the company paid out at least $67 million in legal fees. Eastern, once the name of the biggest airline in the noncommunist world by several measures, became a byword for corporate failure of the most grinding and humiliating sort.

Mr. White argues that liquidation should come quickly in many cases. ''It depends on whether the company is in a business that is fatally flawed because of changes in the economy,'' he said, ''versus one that just had a financial problem.''

Airlines have usually fallen into the first category. ''Rarely have airlines that were run well made much money in the last 10 years,'' he said.

An example of the second type was Federated Department Stores, which filed for bankruptcy protection in 1990. Proving that Federated should remain intact was not easy, said Carol A. Sanger, who is now its vice president for corporate affairs. ''It was a matter of providing an awful lot of information to an awful lot of committees in a very short time frame,'' she said. At the beginning of negotiations, she added, liquidation was definitely a possibility. ''Everything was on the table at that point,'' she said.

FEDERATED'S bankruptcy process, however, reached a turning point in bizarre fashion. A judge's decision to allow charitable donations by the company to continue during its insolvency -- a matter of paying out a small but symbolic amount -- acted as the acid test. Federated exited bankruptcy in January 1992. It earned $795 million on $16 billion in sales in 2000, but lost $276 million on $15.7 billion in sales in 2001, as the economy slumped.

But properly categorizing companies at the time of their distress may be difficult, said Randall S. Eisenberg, senior managing director of FTI Consulting and president of the Turnaround Management Association, a trade group. ''Certainly, things occur that weren't anticipated,'' he said, including economic trends, terrorism and changes in technology or competitive pressures. ''I'm not sure that the current process could, by itself, identify them -- nor could any process.''
''Every company is different,'' Mr. Eisenberg said. ''I don't know whether it's fair to say that a company should go through quickly or slowly. The dynamics dictate it.''

Mr. Eisenberg recounted the bankruptcy of a furniture manufacturer he advised several years ago. ''Right after we filed, the industry went into a deep recession,'' he said. ''The judge supported the company's view that it should not rush out of Chapter 11.'' The company reorganized at a moderate pace, left bankruptcy and is still in business.

Speed may have other drawbacks that are more difficult to identify. Delaware and New York courts have traditionally dealt with bankruptcies fastest, according to Ms. White. Yet they may render the process too easy on restructuring companies.

Lynn M. LoPucki, a professor of law at the University of California at Los Angeles, tracked the outcomes of big public companies that emerged from bankruptcy from 1991 to 1996. More than 4 in 10 that exited Chapter 11 in Delaware ended up back in bankruptcy within five years; in New York, the figure was close to 2 in 10. In courts elsewhere, only 4 percent of bankruptcy survivors filed again within five years.

This recidivism has led many experts to argue that there are efficiencies to be gained by tilting the process in favor of liquidation.

Oliver Hart of Harvard and John H. Moore of the London School of Economics, innovators in bankruptcy theory, recognized the single source of these problems of vested interests, speed of resolution and efficient choice of liquidation. Bankruptcy laws around the world, they wrote in 1997 with two colleagues, fail to separate two fundamental decisions: how to best preserve the economic value of a company and how to split up that value among its claimants. When those two conflict, insolvent companies that are economically viable can deteriorate and disappear, and weaker companies can stumble along too long.

The professors offered a new way to resolve bankruptcies, based on a two-tiered auction. As in Chapter 11, it would begin with a court's protecting the company's assets. The court would appoint a receiver to catalog all claims against the company in classes: from the creditors with the strongest rights to the company's assets (the most senior) down to its shareholders (the most junior).

The receiver then asks for offers -- either in cash or in promised shares in the company's future profit -- to buy and restructure all or part of the company. In the meantime, the receiver either operates the company or oversees its existing managers.

After making public the list of claims and any offers for the company, the receiver would issue 100 ''reorganization rights'' to the most senior creditors, based on the relative size of their claims. Next, the more junior creditors and investors, starting with shareholders, could buy the reorganization rights at auction.

The prices for the rights must equal or exceed shares in the more senior classes' claims on the company. The bidding claimants may buy a number of reorganization rights equal to their own share of their class's claims. An owner of 18 percent of one class of debt, for instance, could buy up to 18 reorganization rights at a unit price not lower than one-hundredth of all the more senior creditors' claims.

If the shareholders do not buy all the reorganization rights, then the next most junior class has its chance. A creditor with 7 percent of the next class of debt could buy up to seven reorganization rights, at a price not lower than one-hundredth of all the more senior classes' debts.

The creditors always make their offers to the class directly above them in seniority, whose members are then obliged to buy the rights from the next class up (keeping any leftover cash), to complete the chain of transactions.

Consider a simple example with three classes: senior creditors and junior creditors who are each owed $100 as a class, and shareholders. If shareholders offer to buy 20 reorganization rights, they must pay $2 each for a total of $40, which they give to the junior creditors. The junior creditors must buy rights from the senior creditors, who are obliged to sell them at $1 each -- enough to pay off their debts. The junior creditors receive 40 rights, of which they deliver 20 to shareholders and keep 20 for themselves. They may then buy the remaining 60 rights from the senior creditors at $1 each. The most senior creditors are always paid first, because they hold the reorganization rights initially.

After the auction among the creditors, another auction takes place that allows outside investors to buy reorganization rights. Again, the prices paid must cover the holders' claims. When this auction ends, all the company's stocks, bonds and loans are canceled; only the reorganization rights remain. The final holders of the rights vote on the announced restructuring plans, which may include liquidation, and the company's bankruptcy process has ended.

The whole process should take about four months, the professors estimated. No one can draw it out, and the rights to reorganize the business are sold to the highest bidder.

The auctions-based approach has received much attention in academic circles, yet it has not gained much support among policy makers. ''It's not clear who is the strong, organized body of interests who would support such a reform,'' Mr. Bebchuk said, ''because the benefits would be diffused in a very big way.''

LAWYERS who earn millions in fees under the current system, and managers who can cling to control of their companies, may provide powerful political opposition. ''They are very organized,'' Mr. Bebchuk said, ''and they don't have an interest in reforming the system.''

Nonetheless, he said, the professors' system and later models of its kind could stand up to the naysayers. ''Some people criticize market-based approaches as leading excessively to liquidation, and liquidation has this negative connotation. But it might lead to a more efficient restructuring.''

Copyright 2006 The New York Times Company

Financial "Perfect Storm" Brewing Over America's Middle Class, Says Bankruptcy Expert

2006-05-04T11:21:00.000-07:00

New York, NY (PRWEB) April 30, 2006 --

"A weakening housing market, together with other financial currents in the U.S. Economy, represents the potential final impetus to a ‘Perfect Storm’ brewing over the American Middle Class, and, without luck or prompt legislative action, may lead to disaster, especially for homeowners.” So says Warren R. Graham, a New York Bankruptcy Attorney. The other prevailing currents threatening to collide over the heads of an unsuspecting public, claims Graham, include rising interest rates, limited recourse to bankruptcy relief and the virtual elimination of usury and other restrictions on credit card issuers.

For many millions of Americans, who live “paycheck to paycheck,” the only thing defining their status as Middle Class, and differentiating them from the so-called “Working Class” is their ownership of a home, and the equity accumulated in it. Graham points out that that equity is being eroded by two factors: the first is the threat of declining home values, and the second is the propensity of homeowners, over the last few years, to refinance their homes or take out home equity loans at very low adjustable rates to pay off high interest credit card debt. Now, Graham says, the equity is at risk, because of the softening in the market, the fact that the adjustable rates have risen consistently (and are expected to continue to do so), and the reality that much of it has already been borrowed out to pay off credit card debt, and for other purposes, such as home improvement.

Coupled with the risk of declining home equity, Graham argues, is an enormous, and, to date, largely invisible swinging of the pendulum toward the credit card issuers, and their sponsoring banks. After years of intense lobbying (on both sides of the political aisle) by that constituency, the bankruptcy laws have been extensively rewritten, so as to restrict, severely, access to certain kinds of bankruptcy relief, especially for those who, while certainly not well-off, earn above their respective state’s median income. “Credit card holders, of course, had no lobbyists on retainer,” says Graham.

At the same time, the same financial institutions have found creative ways, by re-domiciling themselves in states hungry for their business, such as South Dakota, to avoid the restrictions of usury laws. So now, observes Graham, it is not unusual for your credit card interest rate, if you are carrying a balance, to rise suddenly from that 5% “teaser rate,” to an unprecedented 32%, in the event of a default. “And worse,” Graham points out, “a ‘default’ doesn’t have to be non-payment. Your cardholder agreement, which you likely have not read, allows periodic review of debt to income ratios, and problems with other creditors as a justification to change rates on almost no notice.”

Add to that the changes in banking procedures, by which banks have restructured their “minimum payment” requirements on cardholders carrying balances, “and that monthly $250 minimum payment has now jumped to $600, or more, multiplied by the number of cards the consumer may be carrying.” The homeowner who wants to do something about this has a much harder time doing so, according to Graham. “His or her house has less equity, because of a softening market, or because it has already been tapped by the homeowner, and the cost of borrowing against it is higher, by virtue of climbing mortgage rates.”

In the meantime, the Middle Class homeowner’s income has not even remotely kept pace with these increased costs, Graham points out. “And this does not even take into account the likely substantial effect of rising gasoline and energy costs.” “And when the homeowner finally reaches the end of his or her tether,” says Graham, “ his or her income level may prevent recourse to bankruptcy. Chapter 7 liquidation may be unavailable altogether, and Chapter 13, in which a percentage of creditor obligations are paid over time, while mortgage debt remains intact, may not be feasible, because the income may simply not support the cost of financing a repayment plan.” Thus, Graham concludes, bankruptcies may be dismissed, and homeowners may have to dispose of their properties, or worse, lose them to creditors in satisfaction of their mounting debts.

According to Graham, “one does not need a crystal ball to see that a potential debacle is looming for the Middle Class homeowner.” Unless pure luck prevents these currents in the economy from coming together, or unless the U.S. Congress revisits its ill-conceived bankruptcy reform (especially that part of it geared to consumer debt) and state banking departments review their willingness to ignore usury prohibitions that date back to biblical times, disaster may await.

“The credit card industry, in the flush days of the late 1990’s started down this path,” says Graham, “and may have overplayed its hand. But without attention and intervention by legislators and regulators, the victim is likely to be the backbone of this Country—the American Middle Class.”

Bankruptcy Backfire! Is Bankruptcy “Reform” Biting the Hand that Fed it?

2006-05-03T12:34:00.000-07:00

by: Warren Graham

As anyone who follows the world of bankruptcy knows, as of October 17, 2005, substantial and, from the point of view of consumers, painful changes were made to the Federal Bankruptcy Laws. At the behest, primarily, of the credit card providers and banks, who had been lobbying for years, new legislation was drafted and approved setting the stage for stricter requirements governing (primarily, though not exclusively) personal bankruptcy. This legislation came at great cost to its proponents, and it was expected that it would lead to fewer defaults and more repayment plans, all of which would redound to the benefit of the banks and credit card issuers.

While it is still too early to say, with any certainty, what the overall effect on defaults will be, it seems that, statistically, Chapter 7 filings are rising again, and the expected relative increase of Chapter 13 repayment plans may not, in fact, be materializing. Fewer debtors than one might expect have been disqualified from Chapter 7 relief by “means testing.”

In addition, at the same time that the new bankruptcy laws were taking effect, credit card issuers and banks were finding creative ways to avoid usury problems by domiciling themselves in creditor-friendly states, such as South Dakota, and default rates for consumers now exceed 30% in some cases. Defaults, for those consumers (virtually all of them, I daresay) who have not read the fine print in their credit card disclosures, may be caused not only by late payments, but by high debt to income ratios observed in periodic reviews by card issuers, and defaults under other credit card agreements. The consolidation of issuers, of course, means that there are only a few issuers out there now. Coupled with this have been changes to “minimum payment” rules, so that where a credit card holder carrying a balance might have been able to carry a $250 per month minimum payment, the combination of 30+% APR’s and higher minimum payment rules may have increased that to $600, or more. Multiply that by the 5 or 6 cards that a consumer might be holding, and, well, one can easily see where this is going. But that same cardholder is now facing higher obstacles to Chapter 7 filings, simply by being, statistically, in the “middle class” and exceeding his or her state’s median income.

What will the result of this be? It’s hard to tell, but one likely scenario is higher defaults with no bankruptcy option. For those cardholders who own a home, with equity, Chapter 13 may not be a viable option because of the sheer amount of debt they are now carrying, relative to their incomes, so the risk of losing their homes may be substantially enhanced. If this happens on a large-scale basis, there will surely be an outcry to “reform” the “reform.” The credit card issuers and banks, having paid dearly for this legislation, may well have overplayed their hand.

Furthermore, those cardholder who can, have, in large numbers, been paying off their balances, outraged as they are by being socked with APR’s exceeding 30%. This has already hurt the bottom line of credit card issuers and their bank affiliates, who make nothing on cardholders who don’t carry a balance. The pot of gold for them is in cardholders carrying balances and paying high rates, and even better, those consumers paying late fees when they get in over their heads, or overlimit fees when, as in many cases, the suddenly increased interest rates take them unexpectedly over their limits. Late fees and overlimit fees are often now in the $40-$50 range.

The result? Less income for the creditors as consumers have wised up. MBNA and Capital One, two huge credit card providers, are seeing their profits sink. Other credit card providers are reporting similar results. Highly dependent on your desire to run up debt, these companies are now seeing their profit margins drop sharply. In a nutshell: high consumer debt equals big profits; low consumer debt levels equals low profits.

During the last five to ten years, beginning in the halcyon days of the late 1990’s when, it seems, everyone was an internet or high tech millionaire on paper, Congress was amenable to bankruptcy reform to address real or perceived abuses. The banks had the will and the cash to finance legislation and, after years of almost getting there, finally crossed over to the “Promised Land” in 2005. By contrast, consumers, many of them unsophisticated, who had been given credit cards with low “teaser” rates, just couldn’t resist the lure of easy credit, big screen TV’s. Predictably, they acted irresponsibly.

But while the lobbyists worked their magic for MBNA and Chase, the consumer had no lobby with which to oppose bankruptcy reform. I’m sure that for the most part, they had no clue as to what was in store for them. Those consumers in the lower economic strata still have no lobby, but they will still be eligible for Chapter 7 relief. The challenge for the banks is that the pain is moving up the ladder to the middle class homeowner. The howling is bound to be heard, and soon.

Warren R. Graham Copyright 2006

Landlords Rejoice! The Bankruptcy Code Loves You

2006-05-02T12:43:00.000-07:00

Landlords Rejoice! The Bankruptcy Code Loves You

"In the wake of the recent and very substantial changes to the nation's bankruptcy laws, the most significant beneficiaries are likely to be commercial landlords." So says Warren R. Graham, a bankruptcy lawyer with 25 years of experience, much of it representing both landlords and tenants in large Chapter 11 reorganizations."Most of the public attention, in the enactment of the new law, has been paid to consumer matters and credit card debt, given that the prime movers for the new legislation were consumer credit issuers," says Graham. "But many changes have been made in the area of business bankruptcies, which are profound, and which have received virtually no reportage."

Much of this did not seem so important since the new law took effect in October, 2005, in the midst of a vibrant economy and explosive real estate market. "But," Graham argues, "with the potential confluence of a weakening economy and softer real estate values, the prospect for commercial lease dispositions in bankruptcy cases is likely to increase dramatically, and soon.

"The new law gives a commercial tenant in bankruptcy 120 days, with a possible one-time 90 additional days, to 'assume' or 'reject' its lease. After that, unless the landlord consents, the lease reverts to the landlord. "Under prior law," said Graham, "landlords could get stuck for many months, or even years, as debtors marketed valuable leases for the benefit of their creditors, often at the expense and risk of the landlords. The uncertainty occasioned by being held 'in legal limbo' created problems for landlords wishing to sell their properties, refinance, or even, in the case of shopping centers, lease adjoining space, because of 'cross-default' and 'use-clause' provisions."

This is a particularly important phenomenon in large retail Chapter 11 cases, in which hundreds, or even thousands of leases may be implicated, and the values realized by their sales often determine the success or failure of the reorganization effort.Graham's own experience, in fact, includes the representation of one shopping center landlord, whose single lease was marketed out of three separate bankruptcies: W.T Grant, Caldor and Ames Department Stores.

According to Graham, the consensus among bankruptcy professionals is that the jury is still very much out on the benefits of the new law for issuers of consumer credit. It has, in fact, been argued that, even as those entities lobbied hard for the changes in the law, the likelihood is that their recoveries will not be materially enhanced by them.

"But there is little doubt," Graham claims, "that landlords will benefit greatly by being able to rely on a swift and certain disposition of their property interests in Chapter 11 Cases. Next year's Christmas season may come earlier for retail landlords than for their retail tenants. And the role of Santa Claus may be played by the United States Congress, with bankruptcy lawyers in the supporting roles of his elves."

Source: The Leading Articles

Copyright 2006

You're Suing ME?! Adding Insult to Injury to Creditors of Bankrupt Debtors

2006-05-01T06:53:00.000-07:00

By Warren Graham

In the course of managing a bankruptcy-centered law practice, one notices that certain themes tend to recur. One of the things that seems, repeatedly and quite understandably, to make the blood of credit managers in bankruptcy cases boil, is the prospect of being sued for a 'preference' while they are already stuck with a bad account receivable. This seems to many vendors to be the ultimate outrage. Having shipped goods, or rendered services on credit, in good faith, and in the expectation of being paid, and then, having already been burned (often for substantial sums) by the bankruptcy filing itself, they may find themselves pursued by a trustee or other estate representative, to give back the smaller amount they received on account of their claim within the 90-day period preceding the bankruptcy filing.

After 25-odd years of minor tinkering with the preference laws as drafted in the Bankruptcy Code, which came into effect in 1979, Congress has, for the first time, and in response to intense lobbying by creditor-based interest groups, made significant, and wide-ranging changes which will, in the view of this author, work a sea change in this area.

First of all, we need to understand what a preferential payment is, and why the bankruptcy laws allow for their recovery, before exploring, in very broad strokes, for purposes of this article, how and why the recent amendments to the Bankruptcy Code have helped 'level the playing field.'
The purpose of making preferential payments recoverable is to promote equality (or, more accurately, "equitable-ness") of distribution among creditors. In other words, the pain should be shared on a reasonably equitable basis by those who are on the receiving end of bad receivables.

To that end, certain payments made by troubled debtors, during the 90-day window preceding the bankruptcy filing are subject to being brought back into the estate for redistribution, on an equitable basis, to the creditor body at large. There are a number of other technical requirements for a payment to be preferential, but these are beyond the scope of this article, and creditors are encouraged to seek appropriate legal counsel as needed.

On the surface, this seems reasonably fair. After all, why should creditors who have a closer relationship with the bankrupt company, or who just scream louder, be paid while the other guy gets left holding the bag. But, alas, here's the dirty little secret of preference claims. For the most part, though not exclusively, they are pursued, by trustees in liquidation cases, in which there will ultimately be little or no recovery for unsecured creditors. So who gets the money recovered in these preference litigations? Why, the trustees, their lawyers and accountants, of course, whose rights to payment come before everyone else. So rather than being a vehicle for equitable redistribution of limited funds of an insolvent debtor, the preference statute has been used as a tool for trustees and their professionals to build an estate as a source of trustee fees, and legal and accounting fees. In most such cases, the creditors end up with nothing at all, except the privilege of paying twice.

On the other hand, the drafters of prior legislation wanted to encourage vendors to continue selling goods to troubled companies so as not to exacerbate an already difficult situation and bring on unnecessary or premature bankruptcies. So various defenses to preference claims were introduced, to exempt certain payments made contemporaneously, or in the ordinary course of business and within invoice terms, from preference attack. These concepts, however, still left the burden on the creditor/defendant to prove these defenses, and they often found that it was easier and cheaper just to 'pay up' or settle the claims, however distasteful it seemed to them
So what has the new bankruptcy law done for these creditors? Well, it has, among other significant changes, substantially tightened up the 'ordinary course' defense, making it substantially easier for creditors to establish them, by creating both a 'subjective' and an 'objective test' (again, the details of this are too technical for the scope of this article).

Perhaps even more importantly, Congress has now exempted smaller payments from the reach of preference attack and changed venue provisions for others, thus requiring trustees or other estate representatives to sue where the preference recipient is located, rather than in the 'home' bankruptcy court. Previously, the daunting prospect of defending on the other side of the country might well induce a creditor to settle a case even of dubious merit because of the expense involved of travel and the hiring of local counsel in a far-off district. Now, in many cases, the economics of this situation have been turned on their heads, and it might well be the trustee who will have to think twice, or three times, about bringing 'nuisance' preference cases when they have to be prosecuted in foreign jurisdictions.

Thus, although this legislation is very new, and largely untested, it seems that creditors in bankruptcy cases will, at least from their viewpoint, be getting a fairer shake, and will less often be having insult added to injury by having to enlarge the size of their already uncollectible receivables.

Warren R. Graham is an attorney with the New York Law Firm of Cohen Tauber Spievack & Wagner LLP. He specializes in the field of Bankruptcy and Creditors' Rights. He is a frequent writer, contributor and commentator on legal, business, political and religious affairs. The views expressed by him in this article are his own, and do not necessarily reflect those of his Firm or its Members. Additional professional information on him may be found at: http://www.ctswlaw.com/templates/page3_attorney.asp?docid=667

E-mail: wgraham@ctswlaw.com

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