Overstating "White Privilege"

The phrase "white privilege" has become a standard buzzword among social justice warriors in the United States and creeps from time to time into more mainstream fora, such as the (poorly argued) debate between Bill O'Reilly and Jon Stewart on The Daily Show last October. 

In the New York Times a couple weeks ago, I read a Michiko Kakutani review of a new book by Ta-Nehisi Coates, a writer at The Atlantic whose column I used to read occasionally.   The review summarizes Coates' book as "a searing meditation [sic (I have no idea how a meditation can  "sear" anything)] on what it means to be black in America today. It takes the form of a letter from Mr. Coates to his 14-year-old son, Samori, and speaks of the perils of living in a country where unarmed black men and boys ...  are dying at the hands of police officers, an America where just last month nine black worshipers were shot and killed in a Charleston, S.C., church by a young white man with apparent links to white supremacist groups online."

Other MSM participants and, of course, the left wing echo chamber have dwelt on Coates' book at length too.  Like Kakutani's review, David Brooks of the Times calls it a "searing contribution to ... education for white people" before excerpting several hateful passages (example: "‘White America’ is a syndicate arrayed to protect its exclusive power to dominate and control our bodies." Or the passage in which he calls the first responders who died in the 9/11 attacks "menaces of nature")(Parenthetically, I can actually understand someone black feeling that way in the flash of a given moment, but I can't understand anyone retaining that feeling and publishing it after any sort of minimal reflection on the facts of 9/11). 

Kakutani's review excerpts a brief passage in which Coates makes  typical assertions about the benefit of being white in America, which even the review - in the Times! - characterizes as "cliched".  Notwithstanding that judgment, I want to go beyond epithets into a deeper analysis of the illogic and inaccuracies in assertions like Coates' about "white privilege", as I did earlier this year in reaction to a fallacious editorial by Nicholas Kristof about modern bias experiments.  Here is the excerpt from Kakutani's review:

"Mr. Coates contrasts [the] world of the streets with the 'other world' of suburbia, 'organized around pot roasts, blueberry pies, fireworks, ice cream sundaes, immaculate bathrooms, and small toy trucks that were loosed in wooded backyards with streams and glens.' He associates this clichéd suburban idyll with ... an exclusionary white dream rooted in a history of subjugation and privilege.  [White people] he contends, 'have forgotten the scale of theft that enriched them in slavery; the terror that allowed them, for a century, to pilfer the vote; the segregationist policy that gave them their suburbs.'"

It's obvious to any reader that white people in suburbs have no monopoly on pot roasts, blueberry pies, fireworks, ice cream sundaes, clean bathrooms or small toy trucks.  So, obviously overstated, but that is not my paramount concern, since any reader can make that judgment for herself or himself.  More significant are the examples of "subjugation and privilege": slavery; vote deprivation; and segregation.  What I want to unpack here is the confusion between "subjugation" and "privilege", which the author, and evidently the reviewer, seem to think of as two sides of the same coin.

I think that is fallacious; that is, probably because discussion of racial bias tends to proceed in terms of  dualities:  white/black; slave/free, etc., which, unquantified, sound equal, reciprocal, zero-sum, the frame obscures a simple quantitative fact, that the percentage of blacks in America at relevant times to the discussion has been consistently 10 - 11%, so small that blacks could indeed be "subjugated" by what Coates identifies, without that subjugation playing a substantial role in causing the status of very many white people today.  Put another way, as I shall illustrate below, there have been so many more white people in America than black at all relevant times, that the current economic status of white people is largely independent of the causes of the current economic status of black people.  Therefore, the concept of "white privilege" is grossly overstated; it would be more accurate to speak about "disparate impact" of policies on black people than to falsely inflate the benefit of "white privilege".  

An easy demonstration of this is the "segregationist policies that gave [white people] the suburbs" according to Coates.  In the period of most rapid suburban expansion, 1950 - 1970, there were three censuses and, in each of them, whites never made up less than 88% of the population:

Year	White	Black	Ratio
1970	177.7	22.6	7.9:1
1960	158.4	18.9	8.4:1
1950	134.9	15	9:1
Net Population Growth	31.8%	50.7%	1.6:1

source:  Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1970 (Bicentennial Edition, Part I), Series A73-81; all numbers in millions and rounded to first decimal

Before I delve more deeply into the demographic profile of suburban presence in this period, I will offer a simple example of what these overall demographics mean for "white privilege".

Imagine that every neighborhood in the nation at these points in time had been a microcosm of the national demographics, perfectly mirroring the nation's demographics, with no racial disparity whatsoever.  If, for example, there was a suburban development built in 1950 with 50 homes, the ownership of those homes would have been allocated 45 to whites and 5 to blacks.  By 1970, ownership would have shifted 44:6 (7.9/8.9 * 50). 

If we contrast that with the worst-case segregation scenario, with all the suburbs being populated in the year of highest black population and yet complete exclusion of the black minority, we see that 6 blacks would have been excluded, and 6 whites would have benefited disproportionately.  But, 88% of whites would have been there anyway! 

This is the simple point that needs to be understood about "white privilege".  The vast majority of whites would have been in suburbia under any scenario from the worst case to the most utopian, enjoying all the benefits of the "cliched suburban idyll" Coates depicts.  They would have seen the same home appreciation; paid the same mortgage and property taxes; the vast majority of their kids would have gone to the same public school funded by those taxes, gotten the same grades, and gone to the same colleges; they would have shopped in the same places, joined the same country club, had much the same social interactions, etc. Whatever specific example of the "white privilege" argument one wants to offer, the odds are very high that, as to any given white person, the identified benefit has not been received at the expense of a black person.  Some white people will have benefited disproportionately but, by definition, even in the worst case I've just posited, they cannot amount to more that the black minority's on-average 11% share of the total population -- and  when one  delves into the demographics of residence during the period of suburban expansion more closely, it's really even smaller than that, more like 3% of white people in the relevant period, 

When you get into the demographics of suburban expansion, you may be surprised to find that  the black population in every category classifiable as suburban grew slightly faster than the similarly classifiable white population in this time;

Year	White Urban Fringe	Black Urban Fringe	White Rural Nonfarm	Black Rural Nonfarm	White Other Urban	Black Other Urban
1970	51.4	2.54	41.3	3.8	27.8	2.7
1950	19.9	0.95	28.5	2.5	24.8	2.3
Growth	158%	167%	44%	52%	12%	17%

source:   same document, Series A73-90; all numbers in millions

However, given that the total black population grew 60% faster than the total white population in those decades, as the first table showed, these slight differences cover less than half of the black population growth (3.3 million out of 7.6 million) in those decades.  The real change in black population location was that black rural families moved disproportionately into the central cities, as documented in, among other things, "The Warmth of Other Suns", a 2010 history of that migration by Isabel Wilkerson that won the Pulitzer Prize (such a rural - > urban migration is, by the way, not an uncommon demographic movement in nations worldwide, regardless of race; it happened in the Industrial Revolution in England; it has been the source of urbanization in China and India, for example; it goes on today in Brazil and it is a substantial part of the Hispanic migration into the US as well).

Year	White Rural Farm	Black Rural Farm	White Central Cities	Black Central Cities
1970	7.8	0.45	49.5	13.1
1950	19.7	3.16	42	6.1
Growth	- 60%	- 86%	18%	115%

source: same as above

If I recompute the suburban population of 1970 to mirror the total national population of that year, the racial distribution would look like this (all numbers in millions):

White non-farm, non-central-city (unadjusted)	White non-farm, non-central-city (adjusted)	Change	Black non-farm, non-central-city (unadjusted)	Black non-farm, non-central-city (adjusted)	Change
120.1	114.6	-5.5	9.0	14.5	5.5

So, roughly 5.5 million whites would have been replaced in the suburbs (loosely defined  --I know that this national level of analysis is an over-generalization but it is the level Coates argues at, so I think it is where the response should be couched) by blacks, out of a total white suburban population of 120.1 million, or roughly 5%.   That same small shift in the white population would, however, have increased the black suburban population by roughly 60%.  Measured against the total population of each race in 1970, if you want to measure the total impact on each race, the numbers are 3.1% and 24%.  So that was -- roughly speaking, given the 50,000 foot level of national census data -- the racial disparity in housing:  96.9% of whites and 76% of blacks would have landed in the same categories in a racially unaltered allocation of housing. The point, I hope, is well taken: there is virtually no "white privilege" in housing (or much of anything else) because whites are such a large portion of the population, and thus they are inherently a large portion of all of the outcomes of the population.  It's in fact a ludicrously inaccurate form of stereotyping, as much a stereotype as claiming that all black men are criminals.  Yet, even if white privilege is in fact negligible, the black population can experience a disparate negative impact from exclusion.  For this reason, it would be more intelligent to speak in terms of "disparate impact" on blacks than in terms of the insubstantial "white privilege".

The same proposition holds true when one looks at income and affluence, instead of housing dispersion.  It is of course the case that, on all statistical fronts, black income is lower than white income.  For example, the Census Bureau calculates the following median incomes for the several main demographic categories in the US in 2012 as follows (h/t Business Insider):

"Among the race groups, Asian households had the highest median income in 2012 ($68,636). The median income for non-Hispanic White households was $57,009, and it was $33,321 for Black households. For Hispanic households the median income was $39,005,"

It seems clear that the same principle holds true, that, owing to the much larger proportion of white earners in the earning population, substantially all white people would be in approximately the same position, if black earners were distributed in perfect proportions throughout the overall income distribution instead of being over-represented in the lower half of that distribution and under-represented in the upper half of it.  For example, I selected this quote from the Wikipedia page "Affluence in the United States" (which, at least as of this date, has a very progressive perspective):

"in 2005, 81.8% of all 114 million households were White (including White Hispanics), 12.2% were African American, 10.9% were Hispanic and 3.7% were Asian American. While White households are always near the national median due to Whites being the by far most prevalent racial demographic, the percentages of minority households with incomes exceeding $100,000 strayed considerably from their percentage of the overall population. Asian Americans, who represent the smallest surveyed racial demographic in the overall population, were found to be the prevalent minority among six figure income households. Among the nearly twenty million households with six figure incomes, 86.9% were White, 5.9% were Asian American, 5.6% were Hispanic^; and 5.5% were African American.  Among the general individual population with earnings, 82.1% were White, 12.7% were Hispanic, 11.0% were African American and 4.6% were Asian American.^"

Note that the percentages add up to > 100% because of double counting of "white hispanics".  Still the order of magnitude of the white/black ratio is such that the double counting doesn't meaningfully alter the main point.  Even if all "white hispanics" are subtracted from the "white" population, the excess percentage of white earners "among the nearly twenty million households with six figure incomes" is 17% ((.869 - .056) / (.821 - .127)), meaning that 5 of every 6 whites in that top earning bracket would be there if its constituents were a perfect mirror of the demographics of all earners.  That would be the most one could say about "white privilege" in the modern income distribution (although one might, I think, fairly question, in an analysis of an asserted birth-based privilege within the polity of the United States, whether new immigrants, who (a) were born outside the US and (b) came here voluntarily, should be weighted; that they dwell in a white majority polity and compete against a white majority workforce and have to sell to majority white consumers are not accidents of birth, but the results of their conscious choices. (In fact, one might fairly call it a "privilege" for a person to be able to live and work in a wealthier polity than the one he or she was born into). Having been born outside the polity, they are not on an apples-to-apples basis with the vast majority of the population set being scrutinized; were they to be subtracted, the white proportion of the population set would skew higher and the percentage of "excess" white membership in the top earning bracket  would shrink materially). 

A subsidiary point I want to draw out circles back to my comment at the outset that the Jon Stewart / Bill O'Reilly "debate" over "white privilege" was poorly argued.   As I think I've shown, in a nation that is mostly white, most of the successful people will likely be white, even in a perfectly racially distributed set of outcomes.  So any white person, if challenged to defend his success against contentions of white privilege, can quite rationally and legitimately respond by saying, "no, I am confident I would have been in this position even in a world of perfectly racially distributed outcomes."  Obviously some small number of white people would be wrong in making that statement, but they would be a small minority.  So that is one relevant point O'Reilly should logically have said in response. 

But there is actually a stronger point that the most successful people like O'Reilly and Stewart can make. When a white person,  like each of those men, succeeds in generating a very high income, he has outcompeted, not just the people of color in his demographic cohort, but the whites in it as well.  If he's in the top 99%, or 99.9%, he's outperformed at least 98% of the other holders of "white privilege".  So mere "whiteness" can't explain very much of his income, or median white income would be up at his level.  A "white privilege" attack on the most successful seems to me to be remarkably sophomoric and truly superficial, even though they are the most visible targets of such attacks.  .

Rather, where the effects of "white privilege" would be highest would be the lower one goes in the income distribution. Think of this in terms of displacement.  In the very top percentile, let's say, for argument's sake, 1/6 of the whites are there by virtue of "white privilege".  If you extract them from the top percentile, they have still outcompeted all the whites below them.  They don't drop to the bottom, they just drop to the next level of measurement, the 98th percentile; meanwhile, the people of color from the 98th percentile and lower would hypothetically move up to the 99th to replace them.  But this process repeats at each percentile, and when it does, the proportion of whites that have to be moved down grows.  When you examine the 98th percentile, because you've just moved whites in from the 99th percentile, while moving people of color out, it has become even more lopsidedly white, and therefore, the "1/6 of all whites" in that cohort is an even larger raw number than in the 99th percentile, so to make it perfectly racially representative, even more whites within it have to move down to the 97th percentile, from which even more people of color get moved up again, and the process snowballs all the way down the income rankings. 

What this confirms is that, at the very top of the income distribution, the whiteness of anyone in that cohort is least meaningful in terms of its contribution to his or her income, compared to other positions in the income distribution.  Which is really why I thought the O'Reilly / Stewart "debate" missed the point and was poorly argued. 

But, conversely, the lower one goes in the income rankings, the more likely it becomes that at least some of the disparity between a white person's income and that of blacks below them in the rankings can be attributed to the status of being white, because that white person has outperformed less white people than those above him in the rankings.  

 

Maybe this explains in part why "limousine liberals" and other white elites have been historically more progressive on race, while opposition has tended to be strongest at the working class level, that intuitively, the former perceive - I would argue largely correctly - race to have been essentially irrelevant to their success and therefore they are not really sacrificing any of their status to support minority progress, while the latter may intuitively sense their status is more at risk.  Certainly the numbers bear this out.

Coates's passage itemizes other wrongs as well - slavery and voting discrimination in particular. I am not going to write a tome on racial issues and civil rights, but I would analyze them with the same theme, that the black population may suffer a disparate impact from any given policy, but the outcomes of the white population may not be meaningfully affected by that policy, and "white privilege" is a terribly inaccurate frame for the debate.  This is pretty obvious regarding voting, where a 10-11% share of the electorate is not going to, in and of itself, win any elections, especially were it to be dispersed proportionally among all neighborhoods (in fact, I wonder whether the Obama Administration's recently announced plan to push for more racially distributed housing patterns might ironically wind up diluting black representation in legislatures over a few decades).  Claims of black vote suppression in the 21st century strike me as a strategic overstatement made for political purposes; the Democratic party has a huge incentive to maximize black voter presence and decades of electoral results indicate they have been by and large successful, so I doubt there remain significant impediments to black votes mattering.  In the 2 most recent Presidential elections, black turnout percentage has surpassed white turnout percentage, which doesn't plausibly reconcile with a claim of black voter suppression; maybe the candidate matters at the margin (Gore, Kerry, ...  Obama).

Slavery has been covered extensively and I have little to add: all the slaves and slave owners and children thereof and 99%+ of the grandchildren are dead; the vast majority of the white population did not own slaves and were so poor they derived negligible benefit from slavery; there were white slaves and indentured servants throughout the 17th century and substantial albeit non-slave-level discrimination against certain white ethnic groups in the 18th and 19th centuries (in my mother's hometown, when her Irish ancestors arrived, the town experienced "German flight"); slavery was endemic in Caribbean nations, yet black immigrants from those nations often outperform African-Americans in the modern US economy; the Union Army that freed the slaves at staggering human cost to themselves and their families was almost entirely white; the vast majority of the current population had no ancestors who profited, even indirectly, from American slavery, and even among those people who do have such a connection, it represents a small fraction of their ancestry and personal heritage, so it's myopic and distorting to focus on that to the exclusion of the rest of their identity.  

Most of the wealth created in the era of slavery, directly or indirectly, has been destroyed and dissipated, not just by the Civil War but by the several financial crises and panics since then, as well as the creative destruction of capitalism at work, not just here but abroad.  Most of the wealth existing today in the US comes from services provided, goods manufactured and inventions invented in the post-Jim-Crow era, sure, maybe you can find in some institution, like a bank or university, that has been around for two hundred plus years, some record of making money from the slave trade hundreds of years ago, but that has to be measured against all the money it made from other sources in its history to gauge the impact of slavery on the status of that institution today. And a truly full accounting of value transfers between whites and blacks would need to add in the billions of dollars of transfers, through progressive taxation and welfare state mechanisms like Medicaid and food stamps, from the predominantly white upper class to the lowest classes, in which blacks are disproportionately represented, and the value of the urban infrastructure that "white flight" left behind when the suburban exodus occurred -- the water pipes and reservoirs, electric power plants and wires, sewers, paved roads, and so on -- that the new black arrivals did not have to create from scratch.

I can imagine a number of rejoinders to this argument.  Most of them would, I think, from having read hundreds of arguments along these lines, be totally ad hominem and therefore of no intellectual merit; the rejoinders to Brooks's column that popped up when I googled to find the column, for example, all fall into this camp.  A number would consist of rage and epithets and personal insults and claims to possess a higher truth by dint of birth that are again of no intellectual merit. 

Some would sophomorically make the "if Bill Gates were black, he wouldn't have become the  richest person in America" argument, which is (a) fallacious (ecological fallacy), because a statistical analysis, by definition, does not purport to be true of each and every member of the population studied (if it were, you wouldn't need a statistical analysis; and in fact you couldn't do one, as there would be only one statistic); (b) intellectually dishonest, because it materially changes the data set being studied, and (c) even if the sentence in quotes were true, the odds are very high that the person who replaces him as "the richest person in America" would be as white as he is, given the proportion of whites in the population. 

Some would nitpick (e.g.,, blacks are systematically undercounted in censuses - even so, but not to the extent that the white / black proportions would change materially, and I know from ancestral research that whites have been  repeatedly undercounted as well -- among my 8 great-grandparents, for instance, I can come up with 4 omissions off the top of my head from the censuses of 1910, 1920 and 1930, which is a 16.6% undercounting). 

Some would point out, intelligently, that the census data is insufficiently granular to capture the full extent of housing segregation -- there are suburbs and then there are suburbs, and even within suburbs. there was educational segregation (which in my opinion was the largest factor), and everywhere there were job opportunity barriers, often erected by labor unions and politicians responding to their demands (Google "Davis Bacon Act racist" and learn about its racist origins, for instance; why aren't there reparations lawsuits against unions for damages?)  True, I agree with all those points.  In fact, I would say the root of black economic underperformance lies in the fact that they arrived in urban economies, not only with just rural skills (technical and social), but also, unfortunately, at just the time when the economy was changing over to one that required much more sophisticated skills than even the white working class possessed so their gap was larger and has never closed.   But I must also point out that Coates has couched his argument in a simplistic black-urban / white-suburban duality and I am merely responding apples-to-apples.  Were he to write a more nuanced essay, it would be of greater intellectual merit, but likely not garner him the same publicity, so he sort of picked his poison and I decline to be judged by a higher standard than he set for himself.  I also note that Coates sharply criticizes education as an answer to black economic status, and is himself a dropout, so again, I am just responding to the man's particular argument, and I think in respect of education he is seriously wrong.  As well, education funding has been mainly locally raised and therefore, if a white community has higher education spending, they're not taking the excess out of black people's wallets, in some kind of "theft", to use Coates's word; they're funding it themselves by taxing their own white selves.  The progressive argument in this sector is really the opposite of what Coates is arguing, not that whites are taking from blacks, but that white income should be taken and spent in majority-minority school districts by replacing the local property tax method of funding with statewide tax and transfer mechanisms.   

Some would miss the point of this post and assert that this post whitewashes the harm done to black people from various laws, which in fact this post recognizes at multiple points; the point of the post is that contemporary white outcomes are almost entirely independent of contemporary black status and of policies and actions that harmed black people in the past.  Yes, there was segregation, discrimination and racism, and all of that was harmful and wrong, but the demographics are such that the vast majority of white outcomes would have been the same or very close to the same, even if there had been none.  That is just a quantitative fact when one population constitutes 88-90% of the total.

The "white privilege" rubric is just a tactical attempt to advance "social justice"  by de-legitimizing the success any given white person may have had, and thereby legitimizing the transfer from that person of some of his or her economic gains to minority populations, because, even though the most successful white people are the ones whose success is least attributable to race, they, as Willie Sutton once explained about robbing banks, are where the money is.  But it is an intellectually false dogma and deserves to be rebutted by anyone in the "reality-based community" where I've always prided myself on dwelling.

Hillary Clinton's Proposal to Combat "Short Term Capitalism" by Raising Capital Gains Tax Rates is Crazy Stupid.

I am stunned at the stupidity of Hillary Clinton's policy proposal to combat purported "short-term capitalism".  I say this as someone who contributed to her campaign in 2008 and wishes she, not Barack Obama, had been elected President that year.  And my objection does not go to whether the goal is a good one, which I have views on, but will set to one side for now.  Rather, my objection is, if you wanted to correct "short-term capitalism", increasing the capital gains tax  based on duration of holdings is so obviously ineffective, I call into question whether anyone with any grasp of stock market dynamics was involved in formulating the proposal.

1.           The Little Guy is Not The Problem.   Investors who pay long-term capital gains taxes are not responsible for most stock trades.   The vast bulk of trading is done by either (a) tax-exempt institutional investors, like pension funds, mutual funds, hedge funds, charitable and university endowments, etc.  or (b) financial institutions which, while taxable, change their portfolio daily and already have their profits and losses taxed as ordinary income, so will not be affected by changes in capital gains rates.  Just a small fraction of volume comes from people who pay long-term capital gains taxes.  I don't even know if there are any stocks in the S&P 500 as to which non-management, non-institutional holders hold a majority of the outstanding shares.

2.           Compensation Formulas Drive Short-Term Focus.  Even when an asset manager is subject to long-term capital gains taxes on his or her individual holdings or share of the fund s/he manages, any tax incentive to hold a position is likely to be offset by the terms of pre-tax compensation, which are generally a function of (a) assets under management (AUM) and (b) performance (alpha).  As well, being able to show the other investors in the fund a record of above-market performance enables the manager to retain or attract more funds or reduce any concessions given in pricing initially.  Just to give a simple example, imagine a $1B fund whose manager owns a rather large 10% of the capital in the fund; assume it is unleveraged, to simplify things; and has the standard "2% of AUM & 20% of profit" fee structure.  If the manager produces a 20% gain, even if his or her own share of that gain is taxed at 50%, costing $10 million, that tax hike is dwarfed by the incremental income received for generating the gain (2% of the additional $200MM under management is $4MM, while 20% of the $200 million profit is $40 MM, so the manager is up $44 million).  Even after you deduct taxes on that income, say at the same 50% rate, the manager is still way richer for having focused on short-term performance.

3.           Losses?   Short-term trading  is not limited to selling quickly just to book a capital gain that gets taxed.  Every month, there are stocks that plunge right after an earnings report or change in guidance.  And a good number of the persons selling are taking a net loss on a position they built up in anticipation of a previously favorable trend continuing into the future (a/k/a the long term). Think of the people who bought fracking companies just a year ago because U.S. energy independence was a solid long-term trend.  A capital gains tax hike has absolutely no effect on those trades because they produce no gains, only losses.  It may even encourage them, because the losses they produce can be used to offset short-term gains in other positions.  Or, the flip side of the same coin, since the tax code limits the deductibility of net capital losses, the existence of a capital loss in one's portfolio can actually cause one to sell another position that carries a matching gain, so as to soak up the tax benefit of the loss.

4.           M&A?  To illustrate this, here is an anecdote: I bought shares in a biotech company earlier this year.  Its drugs in trials had amazing long-term prospects if the trials proved successful, and I had no monetization event in mind when I bought in.   Two months later, a larger company apparently agreed with my assessment and swooped in and struck an all-cash deal to acquire the company at about a 50% premium to my purchase price.   There was nothing short-term in any buyer's mind, mine or the acquiror's.  Yet the Clinton proposal would characterize my gain as if it were part of a supposedly evil short-term investing philosophy.

I would analogize Clinton's proposal to a school that has a small population of bullies and announces that, to combat their bullying, they will raise tuition.  Or a proposal to curb gasoline usage by raising the luxury tax on purchasing sports cars.  The mismatch between (1) the actors and actions that precipitate the supposed problem and (2) those who pay the increased tax is so great, it verges on the absurd. 

If you wanted to curb short-term trading, among the many better devices would be an excise tax on the aggregate number of trades of less than the desired duration, or on the aggregate dollar amount of such trades or on portfolio turnover above a certain level, possibly graduated the further the taxpayer went from the desired norm.   That would pick up the institutional holders who do most of the trading, regardless of their exemption from income taxes, and it would also capture short-term trades to cut losses.  It would also exempt sales in M&A situations, because those aren't considered trades generally in brokerage reports.  In other words, it would avoid all of the idiotic pitfalls of the Clinton proposal.

That said, there is a whole roster of macro-level objections to the proposition that "short-term  capitalism" should be curbed at all, either because it's a net-positive, or net-neutral, or just not net-very-bad and there are more significant things to devote political capital to,  all of which I will leave for another day or voice to develop further.

Redemption Option Premium, Part II: Chapter 11 Valuation Dates are not "Arbitrary".

Last fall when the ABI commission on Bankruptcy Reform came out, I wrote a post about its proposal that out-of-the-money junior classes be thrown a bone in chapter 11 plans by instituting a "redemption option premium" ("ROP") that would require bankruptcy judges in a cramdown context to value a hypothetical three-year call option on the reorganized debtor at a price that would pay off all claims senior to that class in full.  As the commission's principal justification for the proposed mechanism was that it would be a superior alternative to what it portrayed as time-consuming and costly cramdown valuation litigation, I expressed the view that it was not nearly as efficient as portrayed because (a) it did not preclude anyone else in the case from precipitating the kind of litigation we have now, and (b) it was itself so complex that it would, in practice, require the same evidentiary inputs, and be as contestable, as the cramdown practice we have now. You can't value the ROP until you have valued the company, so you don't skip any valuation litigation.

Nor did I find, when doing some calculations of a hypothetical chapter 11 debtor, that it was generating a large amount (in fact, looking back, I should have noted that the premium value would often be less than the professional fees debating it might run up) so that the gain was hardly worth the candle.

The ROP proposal is tied, implicitly at least, to a companion proposal for eliminating the "minimum of one accepting impaired class" requirement for confirmation in 1129(a)(10), because letting voting control the confirmation outcome could, in a case with a simple capital structure, bar use of the ROP to ensure confirmation. I gave an example from my own restructuring experience of a situation where 1129(a)(10) was the key to efficiently reaching a consensual out of court restructuring of a luxury retailer, so I think its removal would be a negative development.

The June 2015 ABI Journal carried an article by two very respected restructuring professionals, Don Bernstein of Davis Polk and Jim Millstein of his eponymous financial advisory firm "explaining", but really advocating, the ROP mechanism. It emphasizes a different justification for the reform, which is evident from the first subheading:  "Focus:  The Timing of Valuations in Reorganization Cases". That focus identifies two motivations for the proposal:

1) debtors are spending less time in bankruptcy, due supposedly to secured creditors dictating the length of time the debtor languishes in chapter 11,  and thus supposedly being valued lower than they would be in "the fullness of time". They report that, "in 2013, debtors exited chapter 11 proceedings in fewer than 200 days, compared to close to 1,000 days in 1989."

They do not, notably, compare recoveries of junior classes between 1989 and 2013, which would seem to be necessary to prove their claim that reducing time in bankruptcy has resulted in reducing value to junior classes.  In other words, they assert that phenomenon A causes effect B, but only cite evidence of the pheneomenon, not of the purported effect or of a causal relationship.

As I explained in a series of 2013 posts, that causal proposition is not provable based on the data published to date.  One would have to go back to court files languishing in warehouses and not online, and do a bottoms-up reconstruction of recoveries in 1989 to generate a database from which the proposition could be examined.  Further, the choice of "1989" as a beginning point is suspicious, because it predates the first collapse of the high yield market and thus a 1989 dataset would consist of companies with balance sheets, capital structures and leverage ratios very different from those that wind up in bankruptcy today, whose increased leverage might explain any decline in recoveries that might be observed.  As well, chapter 11 debtors today -- as the Commission acknowledges elsewhere  -- have a much greater mix of intangible assets and overseas operations than those of the "1989" era making it even more questionable whether one could prove the asserted negative effect of getting through chapter 11 faster.

Without demonstrable evidence of a negative effect, what's wrong with efficiency?  In any other field of human endeavor, like package delivery, learning to read or medical diagnoses, getting an equivalent  result in less time would be considered progress.  Among restructuring professionals, many of whom of course get paid by the hour, it seems to be a bug instead of a feature to get things done faster.  Notably, the commission did not propose any fee reforms as companions to its bankruptcy-lengthening proposals.

If you will forgive the lack of creativity of a sports analogy, it's like arguing that, when a football team scores a touchdown quickly, it is usually scored by a wide receiver catching a long pass, but if you march slowly down the field, running backs score a higher proportion of touchdowns, and so, out of fairness to running backs, we need to slow offenses down, to achieve the "balance" that the inventors of football intended when they created both the pass and the run.  That is not something any one (other than running backs and their agents) is crying out for;  rather, the overarching goal of the game is to generate entertainment for the public by attempting to score touchdowns.  And the same is true in the reorganization context:  there is an overarching public policy goal to reorganize businesses so as to minimize disruptions to the broader economy.  If the team working on the reorganization succeeds in doing that fast, that just means they got across the goal line fast -- which is what they should be doing.

2)  The other proffered justification in the focus of the article is that the the valuation date in bankruptcy is an "arbitrary fortuity":  "Creating an entitlement to  redemption option value is intended to remove the fortuity of an arbitrary valuation date ...."    That is just overheated rhetoric.  "Arbitrary" means randomness, lacking in any order, evidence, reason or justification.  (Sometimes "arbitrary" is equated with "unfair" but that is not a wholly accurate understanding:  many dispute-resolution mechanisms, such as a coin flip, drawing straws or a lottery all have arbitrary results, but they may be entirely fair, if the parties involved have all agreed to be bound by the result, usually because they couldn't devise a process that would deliver an unbiased result in timely fashion in a more reasoned manner.  Conversely, a biased decision-making process -- e.g., Judge Y is highly likely to rule in favor of the party represented by lawyer X -- is ordered and predictable and thus not "arbitrary", but hardly fair or consistent with how judges are supposed to decide things.)

The valuation date in a bankruptcy is not random or lacking in order, reason, evidence or justification.  If you don't get misled by the false precision of the word "date" and understand the authors to refer more generically to the "timing" of valuation, that is pretty predictable.  In any given case, given an understanding of the debtors's liquidity and capital structure, the confidence the creditors have in management and its financial advisors, the debtors' overall industry environment including M&A activity, overall financial market conditions, the prospect for major avoidance, sub con, etc.litigation, and after a round of substantive discussions with the major parties in interest, an experienced restructuring professional will be able to predict with a fair degree of confidence what scenarios in the case are plausible and how long it's going to take for them to be sorted out. In some situations, all the major players have this understanding when the petition is filed. The scenarios are often obvious:  negative cash flow, no confidence in management, etc.  Or: complex capital structure, few distressed opportunities, lots of avoidance type litigation, all serving to keep the case running for years.

There is nothing "arbitrary" about when valuation occurs in bankruptcy cases.  I doubt either author would tell a client, who asked them to forecast when a given chapter 11 might reasonably be expected to be resolved, that "it's pretty arbitrary".  There are a number of economic variables, and a number of drivers in the legal process itself, but that is not arbitrariness, it is just complexity, which exists in all business valuation contexts. All of the economic variables flow from decisions the owners and managers took at some point or another in the life of the business or were known at the time to be risks of those decisions or being in that business; all that has happened is the variables interacted in a manner that the investors and managers failed to assess properly.

But that is no different from what every risk-taking investor faces every day.  It's no different than, say, buying the stock or a bond of a biotech company with a drug in Phase 3 trials, or a semiconductor company with a patent dispute or an auto company whose union contracts are up for re-negotiation, or American Express the month before Costco drops their favored status, or an E&P or copper miner in a world where commodity prices fluctuate.  There is nothing arbitrary about the date you find out the results of the trial or the result of the patent case; there is nothing arbitrary about Costco dropping Amex, or Saudi Arabia pumping more oil, or China stopping its copper purchases.  It's just a risk you bought into and didn't gauge correctly.

As I wrote in multiple posts about cramdowns last year, given how well-developed the capital markets of the 21st century are, it is an antiquated, anthromorphic or black-box fallacy to worry about "fairness" to junior classes of investors.  The vast majority are pools of capital allocated by institutions with widely diversified portfolios.  The given hedge fund or mutual fund that shows up as a "creditor" or "equity security holder" is really a pool of capital drawn from a much larger global universe of savings that is invested in literally dozens of other asset classes and millions of other individual securities and instruments managed by thousands of intermediaries. They have diversification to protect against the risk of an individual position being wiped out.

Therefore, it is unproductive and inefficient in the modern era to spend much time and money fighting about valuation of a single business to generate a small little recovery to one single investment among those millions.  It is much, much more efficient for policy makers in this context to establish clear rules, like the absolute priority rule, and then let markets do the valuation for the courts.  It may be more boring and less lucrative, but clearly that is the optimal policy for the economy as a whole. Let's keep making business reorganizations more efficient instead of letting outmoded concerns lead to novel and complex entitlements that are inefficient to compute.

"Lost in Translation" Article Published on Till and Momentive

My posts from 2014 on Till v SCS Credit Corp and Momentive Performance Materials have been consolidated and prettied up into appropriate form for a law journal by virtue of the yeomanlike diligence and assistance of Katie M. McDonough, an associate at my old firm. The Fordham Journal of Corporate and Financial Law has just published the resulting piece, which is entitled "Lost in Translation: Till v SCS Credit Corp and the Mistaken Transfer of a Consumer Bankruptcy Formula to Chapter 11 Reorganizations." It can be found at 20 Fordham J. Corp. & Fin. Law 893 (2015) on Westlaw and Lexis and eventually in other online databases like Heinonline and SSRD.  There is no ungated link, afaik.

In brief, the article criticizes bankruptcy judges and creditors' lawyers for failing to notice the significant statutory distinction between chapter 11 cramdown and chapter 13 cramdown, i.e., the presence of the judicially defined "fair and equitable" standard in chapter 11 vs. the absence of that standard in chapter 13. The article shows how the "fair and equitable" standard has been consistently interpreted by the Supreme Court to require creditors protected thereby to receive 100% recoveries in real economic terms, and how the Court has repeatedly recognized that market forces are the best measure of the "fair and equitable" standard.

The article also goes behind the opinions in Till to recount how, in the briefs and oral argument, the prevailing parties, the Solicitor General and every Justice all disavowed any comparison between chapter 11 jurisprudence and the consumer debt repayment context, and focused instead entirely on practical factors that were unique to the consumer bankruptcy context.  What kind of model of Supreme Court decision-making does one have that results in the Court overruling a century of its own precedent, not only without saying so, or mentioning the precedent in the opinion, but without taking any briefing or argument on the question and consistently saying it wasn't even pertinent to the case before them?  That is the question judges should be asking debtors' lawyers who try to import Till to chapter 11.  Until a debtor's lawyer comes up with something more persuasive than "ipse dixit", the proposition that Till created a new rule for chapter 11 cramdown is ridiculous on its face.

The article argues that recognition of these two inexplicably overlooked yet highly relevant facts will enable future courts to fulfill the intention of Congress in both chapters of the Bankruptcy Code, respecting the Till decision as a pragmatic solution to issues presented uniquely in cases brought under chapter 13, which has no "fair and equitable" constraint, while restoring the "fair and equitable" scrutiny of nonconsensual reorganizations required by the plain language of chapter 11. 

Many thanks to Katie for not only wielding the laboring oar in transforming the posts into an article, for doing ALL the footnoting, for handling the law review submission process with which I was completely unfamiliar, but especially for suggesting the article be written in the first place. 

Tsipras wins Exclusivity Extension Over Creditors' Objections - Still Needs DIP Loan

Back on January 4, in my first post of the year, I wrote:

"If the ultra-left Syriza party wins control of Greece's government this month, I expect Greece will default, for three reasons.  One, the core reason for Syriza's existence is to repudiate the terms imposed by the "Troika" (EC, ECB, and IMF) as part of the 2011 bailout and restructuring, so it doesn't really have a politically viable alternative to default, although I expect there will be an elaborate show of offers and counteroffers between its leadership and the Troika before a default occurs.  Two, even after the massive haircut inflicted on private creditors back in 2011, Greece was left with an unserviceable debt load, so it was inevitable it would get to the point of defaulting eventually, and there is a lot to be said on both sides to get it over with sooner rather than later, as opposed to the surplus-generating nations in the EU throwing good money after bad.  Last, those nations have to be worried about emboldening copycat repudiations by ultra-left parties in larger nations, especially Podemos in Spain, where there will be national elections in December, so it makes sense to let Greece make an example of itself that, one hopes, causes Spanish voters to avoid following in its shoes.

"The counter-scenarios are that either (1) the bureaucrats in the Troika are not politically strong enough to take an action that effectively throws a member out of the EU, in part because they are bureaucrats to begin with and in part because France, Portugal, Italy and possibly Spain may want to see Greece treated liberally so they themselves can receive similar treatment.  In this view, the Troika will ultimately cave and kick the can down the road a ways ....   The second counter-scenario is that, once Syriza comes to power, they will, like many before them,  soften their rhetoric, face up to reality and settle for some easy loan terms if the Troika pushes back hard enough and a deal will get done.  These are very possible, but at the end of the day, I think that, much like the Kirchners in Argentina, Tsipras will choose to play to the crowd with a populist repudiation."

And that is essentially what has happened year-to-date.  A lot of posturing to try to position the other side of the table as the one responsible for the fault.  But ultimately, as Tip O'Neill once put it, "All politics is local".  

I was apparently in the minority with this prediction.  I haven't understood why so many pundits did not see how this would play out.  Tsipras and Syriza have played out the textbook Left - Populist political strategy, dating back to Hitler and recurring through Latin American history from Castro and others right up to the present with the Kirchners and Chavez/ Maduro, and perhaps other episodes elsewhere about which I am not as well-read, which consists of the 5 following steps:

1)  Take one indebted nation in economic crisis;

2)  Demonize its foreign lenders / investors, and often the business and financial elite of your own country;

3)  Wrap yourself in the most ancient traditions of your nation, positing the economic negotiation as an existential, good vs evil struggle;

4)  Promise consumption subsidies and welfare payments to the poorer half of the electorate, and heavy nationalization of the economy, to win their vote;

5) Take power and repudiate the debt.

It wasn't an  insight gained from my career in debt restructuring, but just a knowledge of politics and history.  Perhaps those who held a more optimistic view were just talking their book, like Wilbur Ross, or just too steeped in financial market norms to see what was coming.  But, notwithstanding Syriza's ethnic slur of equating modern Germany to WW2 Germany, it's been Tsipras who has tracked Hitler's rise to power, not Merkel. Germany in this drama is more analogous to the creditor nations of the US and France, and Greece more like the debtor Germany in the 1930's, a fact Macron, the French Economy Minister, has apparently recognized.  I don't imply Tsipras will be invading anybody or sending anyone to the gas chambers.  I just mean his political strategy and rhetoric track those Hitler employed when he campaigned in the early 1930s, and other Left-Populists have used since.  If you want another, more American example, think of Huey Long, or on the right wing, George Wallace standing in the doorway of the University of Alabama administration building, positioning himself as the man fighting for local traditions against external forces whom he demagogues. All politics is local.

That said, I thought it might be useful to draw on my restructuring experience to point out how many similarities there are between what has gone on between Greece and its creditors and a contentious, "free-fall" corporate debt restructuring  here in the US, because it's apparent a lot of the media covering this are not able to get a handle on what is going on.  That's why I stuffed the title of this post with chapter 11 buzzwords.  And from this I will draw out one important point: notwithstanding the talk in recent years about the need for a "sovereign bankruptcy regime", the Greek episode reveals why that won't be an adequate solution; remember, all politics is local

Greece right now is like an administratively insolvent chapter 11 debtor who is unable to pay, not only its pre-petition debt (here, pre-Syriza debt), but its day-to-day operating expenses. It has been depleting its cash and engaging in emergency liquidity conservation measures, such as raiding accounts dedicated to other purposes and just not paying vendors, and now even those have been exhausted.  

The creditors have been unhappy with the debtor's business plan, which fails to generate any cash flow for debt service, and after months of negotiations, have lost confidence in management.  They hoped that the management would be replaced, but management instead sought an exclusivity extension.  The creditors objected, stating that the existing management was incompetent, as proven by the fact that revenue has gone down precipitously since management took over, and yet management refuses to take steps to bring costs in line with the reduced revenue. Similarly, management has declined to sell assets (i.e., privatize) to generate cash to fund operating losses. Nevertheless, the judge hearing the exclusivity extension, (i.e., Greek people) had a pro-debtor bias and granted the management the sought-after extension.  As we know, such orders are non-appealable.  

Having won this procedural victory, management still confronts the same substantive problem:  no money.  It is an iron law of life on this planet.  You cannot indefinitely consume more than you produce, unless you steal from someone else.  If you borrow in one year to fund consumption, thereafter you must include the resulting debt service in your expenses, and you either have to reduce consumption, reduce investment, liquidate assets (like privatizing ports or pumping out your oil reserves) or produce more than the year before.  If a nation borrows to fund investment, and invests wisely, it may be able to generate additional returns that service the debt.  But borrowing to fund consumption is by definition unsustainable over the long-term. Which is why Greece is where it is.

So the debtor needs a DIP loan.  To do that, it has to produce, yet again, a business plan and cash flow projections.  First, it has to show it will change its way of doing business to begin to generate positive cash flow. These are called "structural reforms" in sovereign debt parlance.  Second, it has to project the cash flow that will result from those changes, using assumptions the creditors find reasonable.  Third, it has to show how much of that cash flow it will allocate to service the DIP loan and as much of the pre-petition debt as is feasible.  For example, the creditors want to reduce the amount of cash flow that is being siphoned off to maintain the status quo of unproductive sectors of the economy, like nonworking people who are still able to work.  

Will Syriza do this? It is strictly a matter of political will. The most hopeful scenario is that, with this big electoral victory, Tsipras now has the political capital to cut the final deal.  The creditors can give him some more concessions, particularly writing down the debt which is unsustainable anyway, and in return he can accept more of their reforms, and they go on harmoniously, each side saying they got something more than when negotiations broke off.  In this context, the resignation of Varoufakis, the embarrassment he appointed as Finance Minister, is a hopeful sign. And all politics is local - now that his local status is solidified, Tsipras can face up to the reality of the larger problem.

I just don't know if Tsipras is that rational.  So far, he seems to be as mercurial as any national leader in history, one day purporting to make concessions and the next rhetorically destroying the environment for reasonable negotiations.  It's like he studies Richard Nixon's strategy in negotiating with Ho Chi Minh. 

The other concern is that, to the extent the rest of the EU in any way is seen to ratify Tsipras's strategy and tactics, that strategy will be re-enacted in the other low-productivity EU nations -- like Spain, particularly, where Podemos has already won many local elections recently and is consistently #1 or #2 in the polls for their November elections for national office.  But Italy and Portugal and even Ireland won't be far behind.  Once the norm of debt repayment breaks down, there isn't any logical stopping point.   So the creditors have to weigh the prospect of a rolling wave of debt repudiation cresting higher and higher if they work things out with an ultra-left Greece. 

If the negotiations of a consensual, going - concern reorganization doesn't work out, then we will see the sovereign equivalent of a chapter 7. The banking system and the government coffers will literally run out of euros in the next few days. Not just banks, but stores, businesses, government offices, will all shut their doors, as happens in a 7.  Yes, some parts of the country will continue to operate but massive amounts of GDP will cease to occur.  I don't think they can create a new currency fast enough to avoid this problem.  

And behind all this,there is the threat of further military incursions by Russia into places like the Baltic nations, which calls for as united a Europe as can be achieved.   

Angela Merkel has to be the George Washington, Abraham Lincoln and Alexander Hamilton of Europe, all at once, and all this month. She has her work cut out for her.