Re: Bankruptcy

["David S. Shemano" <dshemano@xxxxxxxxxxx>]

Jim Devine writes:

>> weren't the bankers consciously taking a risk by lending to Enron? if they're
>> automatically bailed out, doesn't that encourage moral hazard, i.e., a willingness to
>> lend to similar miscreants?

You are being loose in your language.  Who is arguing that they should be "bailed out?" The risk the bankers took was that they would not get repaid.    They simply want the value of Enron to be maximized so their repayment is maximized.  It is a fundamental premise of the bankruptcy world that the "going concern" value of the corporation exceeds its "liquidation" value.  Therefore, if Enron is permitted to stay in business, there is more value available to repay the debts owed to the banks and all other creditors.

To the extent that the bankers knew about and facilitated the wrongdoing, they are being sued and their claims may be "equitably subordinated" under the Bankruptcy Code.  I am sure they are arguing that they had no idea of the wrongdoing, etc.

To minimize the risk of nonpayment, some of the banks insisted upon collateral.  The argument has been made that secured lending does increase moral hazard by reducing oversight.  However, collecting a debt through the collateral is expensive, frustrating and risky, and the existence of collateral, in my experience, rarely justifies or creates a care-free attitude to the loan.  What secured lending does do is make lending available to higher credit risks, which is a different issue.

David Shemano