Every year, Tsinghua, which partners with Temple’s China LLM program, puts on an international conference on corporate or commercial law. This year’s theme: Corporate Restructuring. Speakers from around the world (but mostly Asia) gathered to talk about everything from bringing the ineffable elegance of the reverse triangular merger to China to the scourge of needless transactional complexity.

Organized by Tsinghua Professors Wang Baoshu and Zhu Ciyuan, speakers included Helmut Kohl (University of Frankfurt); Professor Chih-Cheng (Spencer) Wang (National Chung Cheng University (Taiwan)); Professor Len-Yu Liu (Chengchi University, [...]]]> Okay, just about everything in the title is false, except that I have been at Tsinghua University, in Beijing, to present a talk entitled “Enron Rerun: The Credit Crisis in Three “Easy” Pieces.” [ Download file]

Every year, Tsinghua, which partners with Temple’s China LLM program, puts on an international conference on corporate or commercial law. This year’s theme: Corporate Restructuring. Speakers from around the world (but mostly Asia) gathered to talk about everything from bringing the ineffable elegance of the reverse triangular merger to China to the scourge of needless transactional complexity.

Organized by Tsinghua Professors Wang Baoshu and Zhu Ciyuan, speakers included Helmut Kohl (University of Frankfurt); Professor Chih-Cheng (Spencer) Wang (National Chung Cheng University (Taiwan)); Professor Len-Yu Liu (Chengchi University, Taiwan; Professor Alain Couret (Sorbonne); Jennifer Hill (Sydney University); Daniel Ohl (Orleans); Nicholas Howson (Michigan) and Daniel Kleinberger (William Mitchell).

Kleinberger’s paper was especially interesting to me, as it was on the problems inherent in what he considers needless transactional complexity. His examples of this complexity involved things like dual entity citizenship and the phenomenon in LLC law of permiting “series” to subsist as distinct legal entities (at least for certain purposes) within a larger LLC. He could, of course, just as easily have talked about the role that arguably needless complexity played in the current credit crisis.

Fortunately for me, he didn’t, so I had something to talk about.

My talk was pretty much what it sounded like. Today’s crisis can be seen as Enron writ large, as both have been dominated by (1) needlessly complex trsactions, (2) regulatory and investor complacency; and (3) unchecked conflicts of interest. The affirmative claim—and this is the hard part—is that complexity played a material role in facilitating the complacency and complexity that produced both debacles. The talk as presented doesn’t get into this question in detail (I had only 10 minutes). But the basic point is that we’ve used complex contracts and entity structures to facilitate (or mask) all sorts of bad behavior, for a variety of reasons.

If I get a real paper out of this, it will have to address some of the following problems:

(1) What do I mean by “complexity”? Contracts with lots of words? Deals with lots of contracts? Lots of choices (options) embedded in the deals? Lots of entities?

(2) Assume for the moment it is possible to define complexity: What’s so bad about it? Don’t parties willingly choose it? And doesn’t complexity really just represent the advance of legal technology? Concerns about complexity might be equivalent to concerns about the development of the microcircuit.

(3) Even if I am correct that complexity was a screen to mask self-dealing, what exactly would we do about it? Even if you could distinguish a (bad) complex transaction from a (good) simple transaction, what would you do to alter it? What is the regulatory response to complexity?

(4) If it is a problem, won’t excess complexity cure itself? We know that this is not the first time in history that transactions and structures were comparatively complex. The trusts that grew up around the railroads and the rapid development and aggregation of assets and rights throughout the late 19th and early 20th century reflected tremendous complexity. The ultimate response was, in part, a drastic reduction in deal activity generally (the Depression). This produced much simpler transactions. Won’t the market for legal technology correct itself here, as it (arguably) did in the past?

(5) If complexity is a problem, what besides disclosure is the solution? If disclosure is the cure, isn’t it really just more of the disease? After all, there is no claim (at least not yet) that MBS/CDO issuers were concealing the real risks of loss. From what we know, the securities disclosures were likely to have been adequate. The deals may have been too complex to fully understand (or investors over-relied on ratings, etc). But would more information have made them less complex? Arguably not.

In any case, I’d welcome comments on this.

Cuomo’s leverage (so to speak) arises from, among other things, laws forbidding fraudulent conveyances and similar transactions. Fraudulent conveyance law is a complex, if vital, corner of debtor-creditor law. It essentially says that a company cannot convey property for less than “reasonably equivalent value” if it is “insolvent,” undercapitalized, or the like. If you’re in financial trouble, the saying goes, “you must be just before you are generous.”

Among other things, this means that if a company like AIG was paying bonuses (or redeeming stock) while it was in fact [...]]]> New York Attorney General Andrew Cuomo has been making headlines because he has strong-armed AIG into trying to recover “outrageous” bonuses and other perks while its financial condition was not so great.

Cuomo’s leverage (so to speak) arises from, among other things, laws forbidding fraudulent conveyances and similar transactions. Fraudulent conveyance law is a complex, if vital, corner of debtor-creditor law. It essentially says that a company cannot convey property for less than “reasonably equivalent value” if it is “insolvent,” undercapitalized, or the like. If you’re in financial trouble, the saying goes, “you must be just before you are generous.”

Among other things, this means that if a company like AIG was paying bonuses (or redeeming stock) while it was in fact in distress, those who received AIG’s cash—like Joe Cassano, who was paid millions for running AIG’s brilliant credit default swap shop–should have to pay it back unless they gave AIG “reasonably equivalent value.” Gifts are axiomatically not supported by any (much less reasonably equivalent) value.

But if AIG is Cuomo’s only target, he’s thinking WAY TOO SMALL. Today’s New York Times reports the following “grim milestone: All of the combined profits that major banks earned in recent years have vanished:”

In the case of the nine-largest commercial banks — Citigroup, Merrill Lynch, Bank of America, Morgan Stanley, JPMorgan Chase, Goldman Sachs, Wells Fargo, Washington Mutual and Wachovia — profits from early 2004 until the middle of 2007 were a combined $305 billion. But since July 2007, those banks have marked down their valuations on loans and other assets by just over that amount

.

What does this mean? Well, it may mean that all those profits they declared weren’t exactly, uhm, profits. Which may mean that they actually weren’t so healthy financially after all. Which may mean that all those bonuses and crazy severance packages—remember when we thought Stan O’Neal’s $57 million looked reasonable?—should, in theory, be as vulnerable as Joe Cassano’s $1 million/month “consulting” fee at AIG.

I know, I know. The accounting and bankruptcy wonks will start shouting that proving insolvency is a fool’s errand. And in any case, there will be serious defenses that the recipients of these companies’ largesse can assert (their brilliant performance was “reasonably equivalent value”, Cuomo lacks standing, etc).

Perhaps. But the real point is, as I observed here earlier, if we care about recovering some of the ill-gotten gains from the mortgage crisis, we need to reconceptualize the whole program. We can’t just give money to the banks and hope (against hope) that they will start lending. We might want to figure where the money went, and how to get some of it back.

“As president of the United States,” Mr. McCain said, “I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished value of those homes and let people make those, be able to make those payments and stay in their homes. Is it expensive? Yes.”

How? He didn’t say. But he’d have to overcome a mountain of contractual and legal obstacles in the “toxic” securities (bonds) that these defaulted mortgages were supposed to back (pay for).

Georgetown Law Professor Adam Levitin has done a good job of explaining [...]]]> In last night’s debate, John McCain proposed that Treasury purchase defaulted mortgages, thereby providing relief to distressed homeowners.

“As president of the United States,” Mr. McCain said, “I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished value of those homes and let people make those, be able to make those payments and stay in their homes. Is it expensive? Yes.”

How? He didn’t say. But he’d have to overcome a mountain of contractual and legal obstacles in the “toxic” securities (bonds) that these defaulted mortgages were supposed to back (pay for).

Georgetown Law Professor Adam Levitin has done a good job of explaining why simply purchasing the bonds themselves will provide little relief to homeowners: Unless the government purchases a controlling amount and number of bonds–meaning lots of bonds–it will lack the voting power, among other things, to cause any changes to the underlying mortgages.

It is possible the government could do this already under the Paulson bailout plan. in theory, it could also purchase individual mortgages from the trusts that currently hold them (which, in turn, issued the mortgage-backed securities that are said to be “toxic”).

But I am not sure the trustees of the trusts that now own these mortgages have, or want, the power to pick and choose which mortgages to sell to the government. Nor is it clear that the servicing companies that really manage the mortgages have the power–or the incentive–to facilitate these sales. There is some evidence that it is easier (and perhaps more lucrative) for them to foreclose than renegotiate the mortgage.

The real solution, as many bankruptcy hands have been arguing for years, is amending the Bankruptcy Code to permit bankruptcy judges to modify existing mortgages, bringing them in line with the fair value of the underlying property.

Until recently, banking and financial interest groups (and most Republicans) vehemently opposed this as a bailout of profligate borrowers. Banks would stop lending if Congress made this change, and all commerce as we know it would come to an end.

Now that the banks stand to receive in excess of $1 trillion in federal largesse (and commerce as we know it is coming to an end, anyway), I am not sure where they are on this. I have been informed that the Commercial Law League–not exactly a lobbying organization for profligate borrowers–has come out in support of these changes.

In the meantime, I look forward to learning how the Maverick plans to rewrite millions of pages of bond indentures.

But the prize for crazy claims about the credit crisis must go to former Dallas Fed President Bob McTeer, whose Monday post on the New York Times’ Economix blog claims that: (i) Wall Street banks were the real victims of the crisis; (ii) the real villains were minorities; and (iii) the only thing needed to fix the crisis is to change accounting rules.

I kid you not.

Let’s consider each in turn.

1. Banks are Victims

“[A]ll the focus on C.E.O. salary caps,” he writes “implied [...]]]> The credit crisis has provided ample opportunities for foolishness. Certainly California Republican Darrell Issa’s claim that the House bill would have been a “coffin on top of Reagan’s coffin” was an oddly necrophilic bunkmate to President Bush’s penetrating insight that “this sucker’s going down.”

But the prize for crazy claims about the credit crisis must go to former Dallas Fed President Bob McTeer, whose Monday post on the New York Times’ Economix blog claims that: (i) Wall Street banks were the real victims of the crisis; (ii) the real villains were minorities; and (iii) the only thing needed to fix the crisis is to change accounting rules.

I kid you not.

Let’s consider each in turn.

1. Banks are Victims

“[A]ll the focus on C.E.O. salary caps,” he writes “implied that the holders of illiquid mortgage-backed securities were the villains in this drama rather than the victims. They didn’t package the securities, or sell them; they bought them as an investment.”

Excuse me? I didn’t get that.

Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs, Citibank and many others now in or near trouble did not package or sell these securities? Perhaps the league tables were just lies?

The reality, of course, is that investment banks were both issuers and purchasers. That was the point: To keep the paper moving as fast as possible, hoping that once the music stopped, there would still be a seat. No one realized (or admitted) that this game of musical chairs was being played on the deck of the Titanic.

2. It’s Minorities’ Fault

The real villains, McTeer would have us believe, are minority borrowers. This was because “the government had encouraged the purchase of mortgage-backed securities by giving banks C.R.A. (Community Reinvestment Act) credit for securities that contained mortgages made in ZIP codes.” While he concedes that this lending may not have played a “decisive” role, the implication is clear: It was lending to people who look like, you know, Barack Obama, who are really to blame here.

This is truly outrageous. There is not a shred of evidence that CRA-based lending had anything to do with the credit crisis. The CRA is an extremely weak piece of banking legislation that in theory requires banks to lend in their “communities,” which has usually (albeit mistakenly) been taken to mean “minority” communities. Excess liquidity doubtless resulted in mortgage lending to all sorts of bad risks, including minorities. But it wasn’t the CRA that caused this.

And, while it is true that a disparate amount of subprime lending was to African Americans, it wasn’t by banks. It was by non-bank originators like Countrywide.

You would expect a former Fed branch president to know this.

3. The Magic Cure: New Accounting!

To the extent the credit crisis is not the fault of minority borrowers, McTeer appears to believe it was caused by “mark to market” accounting rules that forced holders of toxic securities to write these assets down if they couldn’t offload them quickly. This is not really McTeer’s insight. Many, including William Isaac, who was the F.D.I.C. chair during the S&L crisis, believe this was a critical part of the problem, since it forces lenders to declare something valueless simply because it is illiquid, which really doesn’t make much sense.

I am not an accountant, so offer no opinion on whether this is true. But what McTeer doesn’t bother to tell us is what should now replace it? “Marking-to-model?” That got us into this problem in the first place, because it enabled sponsors—you know, McTeer’s victims—to claim unrealistical valuations and amortization rates for the securities they issued. Should we go back to that? How would that revive the market for these securities? If you add zeroes to the balance sheet, will the credit market miraculously revive?

4. Who IS this Guy?

McTeer is not only a former President of the Dallas Fed. He has a PhD in economics from the University of Georgia, is a former of Chancellor of Texas A&M, and self-published poet. He is a zealous free marketeer, whose insights include this: “The market system features consumer sovereignty, meaning that the consumer is king. We decide what will be produced by casting dollar votes for the things we want and by not spending on the things we don’t want.”

That may well be true–in a world where people have dollars that are worth something. So far as I can tell, his version of the free market has gone a long way to making sure that we have fewer dollars, and those we have are weaker.

He is also a management guru who’s maxims include this mind-bender: “Too long” and “too short” appear to mean the same thing. Go figure.”

Perhaps he’s right. Only a man who thinks opposites are identical could believe investment banks are victims and minority borrowers villains.