Looting: The Economic Underworld of Bankruptcy for Profit

[WildNovember]

DURING THE 1980s, a number of unusual financial crises occurred. In
Chile, for example, the financial sector collapsed, leaving the government
with responsibility for extensive foreign debts. In the United
States, large numbers of government-insured savings and loans became
insolvent-and the government picked up the tab. In Dallas, Texas, real
estate prices and construction continued to boom even after vacancies
had skyrocketed, and then suffered a dramatic collapse. Also in the
United States, the junk bond market, which fueled the takeover wave,
had a similar boom and bust.

In this paper, we use simple theory and direct evidence to highlight a
common thread that runs through these four episodes. The theory sug-
gests that this common thread may be relevant to other cases in which
countries took on excessive foreign debt, governments had to bail out
insolvent financial institutions, real estate prices increased dramatically
and then fell, or new financial markets experienced a boom and bust. We
describe the evidence, however, only for the cases of financial crisis in
Chile, the thrift crisis in the United States, Dallas real estate and thrifts,
and junk bonds.

Our theoretical analysis shows that an economic underground can
come to life if firms have an incentive to go broke for profit at society's
expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy
for profit will occur if poor accounting, lax regulation, or low penalties
for abuse give owners an incentive to pay themselves more than
their firms are worth and then default on their debt obligations.

http://www.signallake.com/innovation/Looting1993.pdf

[FreakinDJ]

1. Saying what we all know is happening

[xchrom]

2. recommend

[DCKit]

3. Wherever the IMF and World Bank leave their footprints, as well. nt