Bankruptcy Litigation Does Not Generate New Wealth

Litigation is the fantasy fix for those brawling in a shrinking pool of wealth.

As municipal bankruptcies become the New Normal, it's worth noting that litigation does not generate more wealth to distribute, it simply burns existing wealth, leaving less to distribute. Yes, this is stating the obvious, but what's obvious is precisely what's ignored when fantasy attempts to trump reality.

Shrinking tax bases, fewer tax-generating jobs, an expanding (tax-free) informal economy: this is the New Normal for many communities. Every single pension and benefit entitlement promised to someone was based on projections of endlessly rising tax revenues skimmed from an endlessly expanding tax base of businesses and workers.

No public pension plan or benefit package can survive a shrinking tax base and the bursting of asset bubbles. Those locales with rising tax revenues are once again drawing straight-line projections into the future: the new real estate bubble pushing property taxes higher will expand forever, the revenues from stock options will rise forever as the next Facebook is surely just around the corner, and hot sectors such as tourism will continue expanding forever, too.

Every public pension plan's viability is based on the endless expansion of asset bubbles in stocks, bonds and real estate. The bond bubble has been expanding for 30 years, and the recent hiccup hasn't triggered any real worry because The Federal Reserve has promised low interest rates forever. Stocks have been bubbling higher for over four years, and buying every dip has been very profitable. Real estate has soared since early 2012, and pundits are elbowing their way to the podium to declare that the housing market is once again healthy.

Asset bubbles are not evidence of health, they are evidence of boom-bust cycles.The measures that have been undertaken to inflate the current asset bubbles in these three asset classes are extraordinary, and each measure has unintended consequences that have yet to play out.

Every constituency in every municipal bankruptcy believes they're the most deserving, and they believe that litigation will reveal the obvious truth of their claim.

The idea that their claim is no better than any other constituencies' claim is anathema, and of course there are teams of attorneys on hand to support their belief at $300 to $500 per hour (if not more).

Case law in Chapter 9 (local government bankruptcies) is rather thin, as very few municipalities have gone through Chapter 9 proceedings in recent decades. There will be plenty to argue over in terms of legal precedent and other issues. Judges will be careful, knowing that their rulings will likely become precedent for future cases.

Consider for a moment the costs of multiple teams of attorneys billing hundreds of hours of time on cases that could stretch on for years. Millions of dollars will be spent on claims that are already visibly fruitless, as the pool of money available to be divvied up amongst the claimants will be shrinking as legal fees soar and those who might have once considered doing business in the bankrupt city/county decide to pass until the bankruptcy bonfire burns itself out.

We already know the demands of all the claimants: raise taxes on whomever and whatever still generates a taxable income in the bankrupt city/county. Do the claimants think about the incentives and disincentives their demands create? Of course not; they are focused on their sense of entitlement and "what's owed to me."

So anyone with any prospect of earning more income elsewhere decamps from the bankrupt city/county to elsewhere. This further shrinks the tax base and bleeds the most productive (or potentially productive) enterprises and people from the city, leaving less income and vitality for those who choose to remain in the bankrupt community.

Higher taxes and fewer services creates a self-reinforcing feedback loop where those who leave first are better off than those who leave second, and so on.

The only viable long-term strategy for claimants is to focus on doing whatever it takes to help the city/county start generating new wealth. But this is far more difficult than hoping to win some court ruling, and it also requires sacrificing the dearly held belief that fantasy entitlements should be made real by somebody, somewhere.

Which brings us to the ultimate make-us-whole fantasy, the Federal bailout of every bankrupt city, county and state in the nation. Every constituency in every insolvent city, county and state is of course first in line in terms of being deserving of "what's owed to me."

Unfortunately for those counting on the Grand Federal Bailout, the queue at the Federal bailout window is already long: $100+ billion bailout of FHA, which issued hundreds of billions of dollars of mortgages to unqualified buyers; $100+ billion in uncollectible student loans owned or guaranteed by Federal agencies, and of course the $1+ trillion annual deficits needed just to fill the massive feeding troughs of the Status Quo.

Should the "impossible" happen and boom is once again followed by bust (Gasp! Tell me once again that this time it's different!) and pension funds suffer 30% to 40% losses in their bond, stock and real estate portfolios, the fantasy Federal Bailout would require trillions of dollars of freshly borrowed money, on top of the $7 trillion the Federal government has borrowed in the past 4+ years and the $5 trillion it needs to borrow just to fill the Federal feeding troughs for the next four years.

Every craven, donation-desperate politico in Washington knows that borrowing trillions more on top of the current borrowing of trillions raises the risk of the whole corrupt contraption imploding. So politicos will squeeze out a few alligator tears and declare "I feel your pain" while quietly burying every bailout scheme in committee.

Litigation is the fantasy fix for those brawling in a shrinking pool of wealth. But it's already predictable that any ruling that gives one constituency a resounding victory over other claimants will be overturned; after years of appeal, a deal that could have been reached on Day One of the bankruptcy--i.e. everyone gets less than they set as their absolute minimum--will be imposed.

In the meantime, the pool of wealth that can be siphoned by the claimants shrinks daily, and claimants expecting victory will find the pool has completely dried up by the time they "win." For precedent, please study Jarndyce vs. Jarndyce.

If you think this is "impossible," consider that $755 million has already been spent without any resolution on dividing up the Nortel Networks estate. 

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

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