The Rotten Foundations of Securitization

I. INTRODUCTION A bankruptcy trustee is supposed to maximize debtor assets for the benefit of unsecured creditors. Often this task is achieved at the expense of the secured creditors. If a bankruptcy trustee can obtain control over collateral, the trustee might be able to use it without paying rent or interest to the lender. According to the U.S. Supreme Court, only oversecured creditors are worthy of postpetition interest.(1) Undersecured creditors are not.(2) To be sure, the lender is entitled to adequate protection for the collateral contributed to debtor rehabilitation,(3) but lenders are skeptical of this right and certainly hostile to the idea that, for the duration of the bankruptcy proceeding, the lender, if undersecured, is unable to earn income on its investment.(4) In the 1980s, disdain of bankruptcy jurisdiction led financial markets to generate a multibillion dollar practice neologized as "securitization."(5) The goal of securitization is for a debtor, called an "originator," to sell accounts, chattel paper, general intangibles, or instruments to a bankruptcy-remote corporation (sometimes called a "special purpose vehicle" or SPV) set up for the sole purpose of buying this property.(6) The SPV raises funds by selling debt or perhaps equity participations in the financial markets.(7) The only obligation of the SPV is the debt or equity obligations the SPV issued to raise funds.(8) The assets are precisely what the SPV has bought from the originator--usually heavily guaranteed by the originator's promise to buy back or replace bad accounts.(9) The form of the transfer from the originator to the SPV--a sale--is supposed to prove that no bankruptcy court can ever claim jurisdiction over the assets again.(10) To be more precise, section 541(a)(1) of the Bankruptcy Code indicates that the bankruptcy estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case."(11) If a debtor were to convey to the SPV a mere lien on accounts(12) or chattel paper,(13) the assets would not have escaped bankruptcy jurisdiction.(14) In such a case, the debtor retains an equity interest in the collateral--enough to justify bankruptcy jurisdiction.(15) But since the debtor sells the accounts, the debtor supposedly retains nothing.(16) This alleged nonrelationship between debtor and thing sold is sometimes said to be the very key to securitization.(17) If the rating agencies were to perceive a mere hypothetical legal risk of bankruptcy jurisdiction, then the transaction would supposedly become more expensive or, it is sometimes alleged, impossible.(18) These are empirical predictions, of course. One is skeptical that mere hypothetical risks should be worth so much in the market. Nevertheless, securitization theorists have assumed that the cost of funds depends on the purely hypothetical question of bankruptcy jurisdiction.(19) The burden of foreclosing any possibility of bankruptcy jurisdiction devolves into some very technical concepts of commercial law. First, lawyers must distinguish between (a) liens upon and (b) sales of intangible personal property.(20) Clearly, the lien is governed by Article 9 of the Uniform Commercial Code (UCC).(21) The commercial world agrees--without careful attention to the text of the Bankruptcy Code--that property encumbered by mere liens is subject fully to bankruptcy jurisdiction. It is assumed that the spirit--if not the language--of the Bankruptcy Code requires the modern secured lender to contribute the use of collateral to the rehabilitation of debtors.(22) It is for this very reason that securitization abandons secured lending and takes up the sale of intangible property as its mode of operation.(23) Second, lawyers must distinguish between the sale of accounts and chattel paper and the sale of other intangible property. Article 9 of the UCC governs the sale of accounts and chattel paper in addition to governing the security interests on all personal property. …