In US bankruptcy law, an automatic “stay” prevents creditors from collecting debts from a debtor who has declared bankruptcy. The idea is to give the debtor breathing space from creditors and to allow the debtor time to reorganise and reschedule its debts.
But the stay doesn’t apply to all creditors. In 1978, reforms to the US bankruptcy code exempted certain types of financial contract (commodity contracts and margin payments) from the automatic stay, with the objective of ensuring the smooth running of the financial system and avoiding systemic distress in the futures markets.
These so-called “safe harbour” provisions have been extended in scope by lobbyists and now cover a range of financial contracts, including secured loans, repurchase and forward contracts, says Steven Schwarcz, professor of law and business at Duke University and my guest on the latest episode of the New Money Review podcast.
The broadening of safe harbour carries risks of its own, not just for the integrity of bankruptcy law but for the financial system as a whole, says Schwarcz.
“The guts of bankruptcy law are being torn out,” Schwarcz says in the podcast.
“I believe there is a very high risk that these exemptions will exacerbate systemic risk. They undermine the ability of viable companies to reorganise,” he says.
Listen to the podcast for more.
Schwarcz’s recent paper on the flaws in the US bankruptcy code is available here.
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