Epstein on Bankruptcy and Bailouts

Richard Epstein was interviewed by Peter Robinson of Uncommon Knowledge with Peter Robinson on a wide range of subjects involving law and economics. The interview is divided into five segments; a transcript is also provided. I will be quoting from the third segment in which Robinson asks Epstein about the impact of government bailouts of firms outside of bankruptcy courts.

Peter: During the final months of the Bush administration...the fed and treasury cooperated in overseeing a fire sale of Bear Stearns, the effective nationalization of Freddie Mac, Fannie May and AIG and in bailing out GM and Chrysler President George W. Bush on January 12th, 2009, "I readily can see that I chucked aside some of my free-market principles." Did Bush and his administration do right?

Richard: Not really. Let me sort of indicate what I think first the proper approach is structurally and then how to treat it...the first and kind of difficult situation was the Bear Stearns situation in 2008. And I had actually looked at the terms of that transaction and it looked like a pretty standard bankruptcy situation in which the priority rules apply so that the debtors got money before the shareholders got money and when all the shareholders at Bear Stearns claimed that they had been given a haircut that was a good not necessarily a bad sum.

Peter: You're saying that Bernanke and then Treasury Secretary Paulson handled it reasonably well? They achieve a close facsimile of actually bankruptcy?

Richard: But the steak was that they did it and it would have been much better to have a bankruptcy clause do this.

Peter: The original sin in all this was letting Bear Stearns go not letting Lieman [assumed spelling][the correct spelling is Lehman] go down later it was letting Bear -- it was saving Bear in the first place?

Richard: Well it was saving Bear through political means through the treasury...bankruptcy has is two forms it has liquidation and it has reorganization...If a concern has going concern value that is it continues to work in a sensible way...you'll keep it alive in the reorganization thing, sell off useful units and rationalize the rest of the structure and it'll be free of political complications and the shareholders may come out with a little and they may come out with a lot. The reason why I give them pretty good marks is that when they try to do this through the Treasury Department in the Federal Reserve they were trying to do what a bankruptcy judge did and they were left relatively free of political interference. The danger is when you start getting to Lieman [Lehman] and everybody else and now you're keeping it out of bankruptcy if it's in the political arena you're gonna save some, you're not gonna save others, you're gonna get a lot lobbying to see what you get to save and why. In addition to that you're not gonna be able to keep it off of congress' desk so if you go back and you look in the October transformation the first of the bills which was designed to deal with the AIG problem and so forth was about 3 pages it was a kind of standard bail-out bill. The republicans vetoed it because it was a giveaway, they had a point right? By the time you got it past a week later that bill was 150 pages and my favorite portion of the bail-out program is the Paul Wellstone [assumed spelling] mental health and addiction provisions which were designed to establish parody in health care markets in the treatment that's afforded to mental illness and addiction treatment with physical injuries, somehow or other that had to be part of the bail-out right? And so at this particular point you're having regulatory chaos come into place because everybody says oh you want my vote on this bail-out you got to do my favorite things and measures that could never pass while standing alone get passed when bundled up with everything else...

Peter: You know what -- can I just -- one of the common threads here in your comments about the Bush administration and the Obama administration is that they don't know enough about bankruptcy law, they don't understand -- it sounds to me as though they're permitting themselves to be spooked like an ordinary layman to think that bankruptcy equals...death and destruction...it's a relatively orderly process, we have legal, this law is well known, there are bankruptcy judges who know how to do it, right?

Richard: Yeah what we do is we take it away from experts and give it to a collection of congressional individuals who are charitably called clowns, I mean it really makes no sense whatsoever to do it in this particular fashion. And as I look this over time and time again I'm always struck about how it is when you bring things to congress it becomes politicized and politicized decisions become destructive decisions.