July 30, 2009
Richard Posner Has Some Questions
Posted by David Zaring

Colleen Baker points me to Richard Posner's a list of questions for legal academics, and he thinks we've been remiss about answering them. 

These are not questions that a lawyer can answer, but they are questions that a law professor steeped in macroeconomics and financial economics, or working with a macroeconomist or finance theorist, can contribute materially to answering. But to be able to make this contribution before the train leaves the station--before the workaday legal and poltiical systems grave an answer in stone--will require a change in the outlook, work habits, and even recruitment criteria of academic lawyers.

Well, neither I nor many of our readers are steeped in macroeconomics, but it would be a shame if his questions weren't given a bit of a stab by someone.  Let's see if we can't help the judge out, shall we?  I list his questions, and a few possible responses, including blog posts, though I don't know if the judge - himself a blogger - would entirely approve of the latter.  Perhaps you can chime in with your own thoughts or answers in the comments.

1. Whether, given the economic emergency presented by the collapse of the global banking industry last September, Federal Reserve chairman Ben Bernanke is right in claiming that the Federal Reserve lacked legal authority to save Lehman Brothers, which was at or near the center of the crisis.

I've never understood Bernanke's claim, which I think every observer thinks is disingenuous.  It doesn't take macroeconomic sophistication to recognize that if you can bail out Bear Stearns and AIG, and open the discount window to primary dealers, not to mention create the TALF, you can bail out Lehman.  The claim, by the way, was that the Fed could not be assured that a bailout loan would be secured with sufficient collateral, as required by section 13 of the Federal Reserve Act, which provides for nothing of the kind.  Steve Davidoff and I wrote about it here.

2. Whether a bankruptcy judge should be permitted to cram down the mortgage on a primary residence (that is, reduce the mortgage to the current market value of the mortgage property).

Adam Levitin and Anna Gelpern have done an interesting piece on this, and I'm guessing that bankruptcy scholars are going to flood the zone.  It seems to me that it pits the natural process of bankruptcy - a haircut for creditors - against one of the traditional bankruptcy carve outs - secured creditors get to look to their security.  My own, completely uninformed view: what is the alternative to a cramdown?  If they're bankrupt, they're bankrupt, which means the creditor gets the house at its then market value, or, it seems to me, a cash equivalent.  Anyway, they're also writing about this at Credit Slips.  Randy Picker has blogged about it here.

3. In a bankruptcy, should government bailout loans be given priority over claims of secured creditors?

Again, it's not a strength, but the government has always given itself remarkable priority in bankruptcy, even to the point of modifying private contracts (again, in Depression era jurisprudence).  Why should this be different?  

4. Is there any constitutional limitation on the federal government's abrogating a private contract, for example a contractual obligation to pay bonuses to employee of AIG?

I can't imagine what collaborating with finance theorists would do to solve this question, but the sanctity of contract is not something that is taught as a part of the constitution in law school.  Rather, the government can take any and all property it wants provided it offers due process.  And the government abrogates private contracts all the time, contracts for involuntary servitude being but one example.  Still, it's not as if these questions aren't close, or that the regular abrogation of contracts by the government wouldn't be a bad thing.  I presume answering them would take constitutional theorists back to the Depression era cases, such as Home Building & Loan Ass'n v. Blaisdell, in which the Court upheld the Minnesota Mortgage Moratorium Act, and the Frazier-Lemke cognate federal efforts.  For fun, you could read a US brief summarizing the cases as standing for the principle of modification in a crisis at 1937 WL 63799. My guess is that bankruptcy scholars will also be looking at James Steven Rogers' well-cited 1983 article in the Harvard Law Review on this. 

UPDATE:  Larry Ribstein weighs in here; he notes that I've neglected to mention the, uh, Contracts Clause, which is indeed in the Constitution (but not an incredibly toothy provision).  I don't think he totally disagrees with my analysis at bottom, though.

5. In cases in which the depression prevents a firm from honoring a contract, can it ever appeal to such doctrines of contract law as impossibility and frustration, or to such common contractual provisions as force majeure clauses and material adverse conditions clauses, to be excused from performance without incurring legal liability for nonperformance?

It is an interesting question, isn't it?  The defense usually doesn't work for private parties; should serious economic disasters be treated differently from hurricanes?  I'd like to see an answer to this one myself.  But from a public policy perspective, I doubt we'd want firms to be able to invoke the clause on something where the time of entry and exit are as debated as a recession.  Note this surprising (to me) opinion from an Illinois state court:

Many, if not most, construction contracts are not completed in compliance with the time requirements of the original agreement; and the parties consistently amend the agreement. In such cases difficulty, if not impossibility, of performance may be caused by a myriad of factors: e.g., weather, strikes, illness, death, sudden shortages of materials, recessions and even war. Under such circumstances, the parties, acting in good faith, should be permitted to adjust their agreements without the necessity of new and different detriment and benefit.

Greenberg v Mallick Management, Inc., 527 N.E. 2d 943, 949 (Ill. App. 1988) (citing Restatement (Second) of Contracts § 89).

6. Should bankruptcy law be amended, with respect to the bankruptcy of financial institutions, to bring it closer to the "resolution" procedure by which the Federal Deposit Insurance Corporation winds up the affairs of banks that go broke. Were that done, would resolution still be a superior method of dealing with bankrupt financial institutions (not limited to banks)?

Another good one, because it seems to me that the debate about "resolution authority" involves a lot of government officials saying they need to be able to do something, the need for which hasn't been clear.  Resolution authority was last reformed in FIDICIA, which gave the Fed new powers in addition to the FDIC, and a Fed regional bank president thinks it has authority to break apart banks already.  To me, the Fed's engineering of a sale of Bear Stearns, while unprecedented in size, and involving a non-bank, suggests that it can resolve failed institutions pretty quickly (upheld on judicial review, btw).  But others dither.  So in addition to knowing whether revamped superbankruptices would be a good idea, I'd like to know what problem would be solved with this new authority that cannot already be solved.  New resolution authority is the first financial reform that Congress will give the government, by the way.

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