Too big to fail?

Israel has potential for economic security with new anti-concentration law, a result of the IDB scandal; what the US and Israel can learn from each other on corporate bankruptcy.

By YONAH JEREMY BOB
DAVID HAHN (fifth from left) and renowned US attorney Harvey Miller (sixth from left) stand with top US jurists and academics in Tel Aviv. (photo credit: YONAH JEREMY BOB)
DAVID HAHN (fifth from left) and renowned US attorney Harvey Miller (sixth from left) stand with top US jurists and academics in Tel Aviv.
(photo credit: YONAH JEREMY BOB)
Recent months brought the near-implosion and eventual change of control of Israeli corporate heavyweight IDB, as well as a December 2013 law fundamentally limiting the extent of Israeli corporate expansion.
IDB’s creditors agreed to allow it to continue to operate while legally insolvent in order to maximize their returns. This was an uncharacteristically American-style move where, at least relative to Israel, debtor’s rights and permitting corporate reorganizations are favored.
A recent Tel Aviv conference hosted some of the all-star US corporate bankruptcy lawyers and judges, including Harvey Miller, who for decades has dominated many of that country’s top cases, such as Lehman Brothers (by far, the largest ever), General Motors and some of the mammoth airlines.
The attendees debated the commonalities and differences between the Israeli and US corporate bankruptcy systems.
David Hahn, the Justice Ministry’s head trustee and a leading policymaker and implementer, asked Miller and other panelists whether Israel might be a bit too different from other countries in the bankruptcy realm, and whether it could borrow other countries’ ideas on the issue.
As partial proof of Israel’s uniqueness, he noted that corporate law here combines different systems’ ideas, such as US-style compensation of corporate directors, but UK-style corporate structure (meaning less-widely disbursed ownership.) He also said that Israelis often see themselves as “protracted negotiators and emotional negotiators” who are “not so rational.”
He balanced out that point by saying that maybe this was not a “real claim,” that it was “just made to preserve the current order” by particular interest groups.
Somewhat addressing his own question, Hahn added that Israel might have “special characteristics” and “might need to be careful with applying US or UK lessons,” but still “need to learn from everyone else.”
Miller, in Israel for the first time, did not address the critique of Israeli uniqueness head on, but did say that with all the positives he ascribes to US bankruptcy, with its greater emphasis on reorganization (and from which, he said, countries around the world had incorporated some aspects), he does not view the US system as rational at its core.
He playfully baited leading academic Barry Adler, also on the panel, who defended economists’ use of rationality to explain corporate bankruptcy.
He said he did not believe rationality dictated many major developments in corporate bankruptcy.
“I don’t put any truth in economists. If you put all the economists in the world and lay them down, you would get a crooked line,” he said.
In fact, much bankruptcy legislation in the US had been driven by “populism” far more than rationality, he claimed.
Miller added that other than Congress’s introduction of the 1978 Bankruptcy Code, which he put forth as a hallmark of proper balance among the debtor, secured creditors (creditors who can foreclose on assets to satisfy what they are owed) and unsecured creditors (with no assets to foreclose on), most legislation had been retrogressive.
He complained that each time a large financial institution was hit “with a ruling by a bankruptcy court judge that it did not like,” it and its allies lobbied Congress to create a patchwork of exceptions to strengthen their position.
He contrasted the influence of such financial institutions, usually secured creditors, with the non-existence of any lobby for institutional debtors or unsecured creditors.
However much he believes that the US system is better than others, since it provides a greater possibility for debtor corporations to salvage value by reorganizing as a going concern, Miller said that the lobbying imbalance had sometimes distorted the system.
Overall, the conference was more focused on what Israel could learn from the US. But ironically, with Israel’s ground-breaking anti-concentration law, at least one writer, Steven Davidoff of The New York Times, asked in an article last month whether the US could learn from Israel’s approach to the corporate bankruptcy question of “too big too fail.”
SNL Financial reported last month that America’s five largest banks control 44 percent of the industry’s total assets, compared to 1990, when the five largest banks controlled only 9.67%.
Israel’s new anti-concentration law eliminates the possibility of a four-pyramid-level company like IDB, where someone like former IDB chairman Nochi Dankner could control vast swaths of the economy while owning only, say, 50% of 50% of 50% of corporate holding companies at each level – meaning he had complete control of everything although his actual ownership share might have been in the single digits.
Under the new law, corporations cannot have more than two levels of a pyramid structure, limiting corporations from expanding by using the artificial pyramid structure while lacking sufficient revenue, and forcing some of the current pyramids to break apart in the coming years.
The idea is to eliminate corporations that are too big to fail and which, when in financial distress, can by themselves harm the wider economy.
The US undertook a number of initiatives to prevent a recurrence of the 2008 financial crisis, in which Washington felt compelled to step in to bail out juggernauts like Bear Sterns and AIG, worrying that their complete liquidation would inflict too much harm on the greater economy. But Miller expressed skepticism that congressional legislation like the Dodd-Frank Act ended the problem of “too-big-tofail” in the US, saying this was “nonsense.”
He pointed to JP Morgan Chase, calling it too big to fail both in terms of its domestic holdings and the “overseas impact” that its failure could have in light of its global holdings.
He asked rhetorically: “Do you really think the US government would just stand there and not do anything” if JP Morgan was failing? “If anything,” he said to his own query, “some large institutions are even bigger now than in 2008.”
Miller did not fully specify his criticism of Dodd-Frank, but one thing the legislation did not do, and which Israel’s anti-concentration law did, was essentially to place limits on corporations’ maximum size.
New lessons may have been learned from the IDB debacle and from the US experience, and new economic security may have been reassured through the new anti-concentration law. But after all the debate, if Miller’s irrationality principle is right, the same complex corporate bankruptcy questions challenging US and Israeli policymakers are unlikely to go away soon.