Law Commons^™

Against Regulatory Displacement: An Institutional Analysis Of Financial Crises, Jonathan C. Lipson

Jonathan C. Lipson

This paper uses “institutional analysis”—the study of the relative capacities of markets, courts, and regulators—to make three claims about financial crises.

First, financial crises are increasingly a problem of “regulatory displacement.” Through the ad hoc rescues of 2008 and the Dodd-Frank reforms of 2010, regulators displace market and judicial processes that ordinarily prevent financial distress from becoming financial crises. Because regulators are vulnerable to capture by large financial services firms, however, they cannot address the pathologies that create crises: market concentration and complexity. Indeed, regulators may inadvertently aggravate these conditions through resolution tactics that consolidate firms, and the volume and …

Epic Fail: An Institutional Analysis Of Financial Distress, Jonathan C. Lipson

Jonathan C. Lipson

This paper presents an institutional analysis of financial distress. “Institutional analysis” compares the effectiveness of large-scale processes, such as markets, courts, and governments, at solving social problems. Although financial distress is one of our most acute problems, there has been virtually no effort to analyze it from an institutional perspective. This paper begins to fill that gap.

Institutional analysis shows that, contrary to conventional wisdom, financial distress is not a problem that courts, such as bankruptcy courts, usually solve by themselves. Instead, it is increasingly a problem that political organs (whether elected or regulatory) both create and purport to resolve. …

Controlling Creditor Opportunism, Jonathan C. Lipson

Jonathan C. Lipson

This paper addresses problems of creditor opportunism. “Distress investors” such as hedge funds, private equity funds, and investment banks are opportunistic when they use debt to obtain control of a financially troubled firm and extract improper gains at the expense of the firm and its other stakeholders. Examples include the mis-use of private information to short-sell a borrower’s securities and creditor self-dealing.

Creditors can act opportunistically because legal doctrines that historically checked such behavior—e.g., “lender liability”—have not kept pace with fundamental changes in the market for control of distressed firms. The recent Dodd-Frank financial reform is not likely to change …

The Shadow Bankruptcy System, Jonathan C. Lipson

Jonathan C. Lipson

This article exposes and explores a puzzle at the heart of the current economic crisis: The surprising under-use, and increasing misuse, of Chapter 11 of the United States Bankruptcy Code, the principal legal system for salvaging troubled businesses.

The answer offered here: The rise of the shadow bankruptcy system. “Shadow bankruptcy” describes the severely under-regulated non-bank financial institutions (e.g., hedge funds, private equity funds and investment banks) that increasingly dominate and manipulate Chapter 11 reorganizations.

Like the “shadow banking” system for which it is named, shadow bankruptcy thrives on and promotes opacity and undisclosed, possibly perverse, incentives. Shadow bankruptcy players …