April 27, 2009

Debt To Stock

A while back, I wrote about what seemed to be a clever idea:
One alternative idea I heard on NPR today [September 26, 2008] was a suggestion that a change in the bankruptcy code, perhaps drafted with a very short sunset, would allow debt in qualified financial institutions to be transformed into equity. Creditors of these failing institutions would become stockholders of them instead. I'm not sure if that would be a good idea or not. It would take some pressure off of the failing bank, for a while, by relieving it of its debts and allowing it to start to accumulate capital to retire other debt. The value of the institution's stock would fall dramatically when this happened, of course, but perhaps the company could be de-listed while its debt (or a portion of it) is transmuted into equity. A week or so later, it could be re-listed on the exchanges, when it would obviously trade for far less than it had before, having been both diluted and de-valued. But, its debt-asset ratio would be considerably more favorable and its abilty to recover from making bad loans would be enhanced.
It's an interesting idea, radical and bold and therefore well beyond the ability of the current government to handle. I'm still not sure what to think of it. It would be a big help with the secondary-debt market side of things, which would probably keep several banks afloat that would otherwise have failed. And, it would produce new blocs of shareholders who would impose new directorates and therefore new governance rules for the banks, so over time it would have the effect of helping shore up another one of the fundamental causes of the current situation -- banks making too many risky loans.
The proposal then was contemplating banks, but the idea is now being applied to GM. As part of its desparate dance to avoid bankruptcy, GM has announced that Pontiac is about to be dissolved, and 21,000 jobs lost, and that GM will seek the government's permission and assistance in converting $27 billion (that's with a "B") in bond debt to common stock. Same idea that I wrote about back in September.

Currently, there are six kinds of bankruptcies -- liquidations (Chapter 7), municipal reorganizations (Chapter 9), generalized reorganizations (Chapter 11), debt adjustments for family farmers or family fishermen (Chapter 12), restructuring of debts for individuals with regular income (Chapter 13), and cross-border cases (Chapter 15). To do this, Congress would have to either add a new Chapter to the Code, or amend Chapter 11 to make debt-to-stock conversion a possibility. Indeed, 11 U.S.C. § 1123(a)(5)(J) appears to contemplate debt-to-stock conversions (among other kinds of transactions), approved on a case-by-case basis by judges supervising Chapter 11 proceedings.

What bothers me is that this is being done outside the context of a Chapter 11 proceeding, which would enable, and indeed require, that the company's whole situation be looked at. Certainly, a Chapter 11 proceeding would hurt the company in the short run. But really, right now, how many of you think a warranty issued by G.M. is going to be worth the paper it's printed on? The point of a Chapter 11 is to work those kinds of problems out so the company can emerge stronger and able to continue doing business into the future. What we're seeing now is the slow conversion of what was once the world's best-capitalized business into a corporate Terry Schiavo. Continued life support is to the advantage of no one.

G.M.: Restructure or liquidate. It's come to that choice. But either way, quit wasting the government's time and money.

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