Giant Bailouts Are Becoming a Misguided U.S. Cure-All
As the economy continues to stagger after the World Trade Center and Pentagon attacks, one painful economic reality has become clear: We are all going to learn more about bankruptcy than most of us ever wanted to know. The nation’s airlines have gotten most of the attention, but hotels, restaurants and other businesses also are headed toward bankruptcy.
Congress has passed a gargantuan rescue package for the airlines--at least $15 billion in cash and loan guarantees--as airline executives announce large layoffs and warn that the entire industry could fail.
The concern for the airlines is warranted, but there is an unfortunate and misguided message in the rush to bail them out. The message is that the U.S. bankruptcy system cannot adequately address the economic fallout from the Sept. 11 atrocities. History tells a very different story.
The U.S. bankruptcy laws were forged in disaster over a century ago, and they are better designed to handle a catastrophe than the laws of any other nation in the world. During the 19th century, a series of devastating depressions caused dozens of railroads--which were even more important to American life than the airlines are today--to default on their obligations. Everyone agreed that the railroads had to be kept in business.
The problem was that no one was quite sure how. Legislation was not an option because of constitutional obstacles that hamstrung both Congress and the states.
The solution was in the courts. In the last half of the 19th century, U.S. judges, together with Wall Street bankers and lawyers, developed an elaborate and uniquely American judicial procedure known as the “equity receivership” for restructuring insolvent railroads.
The same basic approach is still used. When a corporation files for bankruptcy, the U.S. bankruptcy laws attempt to strike a balance between two apparently conflicting objectives.
On the one hand, the laws bring a halt to any effort by creditors to get repaid until the parties can decide how best to deal with the firm’s financial distress. On the other, they do everything possible to enable a debtor to conduct business as usual.
It is this “business as usual” that makes U.S. bankruptcy laws unique. If a firm files for bankruptcy in Germany or Japan, its managers are ousted and a government-appointed official takes charge. The end result is nearly always liquidation of the firm and the end of the business.
In the United States, the debtor’s managers stay at the helm. The assumption underlying the U.S. approach is that many firms that wind up in bankruptcy are good businesses that have been derailed by an unexpected disaster but can and should be restructured. This, of course, is precisely the perspective we need in the aftermath of the tragic Sept. 11 attacks.
In most nations, the government would intervene in a crisis like this by propping up all of the affected industries and keeping firms out of bankruptcy at all costs. Japan has been doing this for years. The beauty of the U.S. system is that it makes governmental intervention unnecessary in all but the most extraordinary of cases.
One can argue that the airlines are such a case, and that a limited bailout is essential. But we should also keep in mind that bailouts are a dangerous strategy for addressing economic distress. They create an expectation that Congress will intervene again if another crisis arises.
Moreover, there is a tendency to try to save every company in an industry, even those that would have failed if the crisis had not occurred. But under U.S. bankruptcy laws, debtors and their creditors make a company-by-company determination whether the business should be preserved or whether it just makes more sense to simply close up shop.
We don’t often think of our bankruptcy laws as one of the things that make the United States great, but, oddly enough, they are. However long it takes for the economy to recover, we can be sure that the unique bankruptcy laws will be an important part of the economic solution.
