The Year in Bankruptcy: 2010

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What should have been the best economic news of 2010 was largely obscured by the deluge of bad news dominating world headlines. The latter included tidings of chronically high unemployment; a continuing malaise in the U.S. housing market; wars in Iraq and Afghanistan; debt crises precipitating the implementation of austerity measures in Britain, Portugal, Italy, Greece, Spain, and Ireland (to name but a few), as well as countless state and local governments in the U.S.; a sharp escalation of food prices worldwide; a deepening U.S. mortgage foreclosure crisis; natural disasters; and the worst environmental disaster in U.S. history.

End of the Great Recession?

Now for the good news. According to the National Bureau of Economic Research, the organization responsible for marking turning points in the U.S. business cycle, the U.S. recession that started in December 2007 ended in June 2009. On January 7, 2010, the Euler Hermes Economic Outlook for Winter 2009/10 similarly reported that the world economy has "staged a technical exit from recession" by piggybacking on the positive performance of the Asian markets.

Pronouncements of the demise of the Great Recession—to the extent that anyone other than economists was paying attention—were greeted with a healthy dose of (well-deserved) skepticism. Abroad, Eurozone countries struggled in 2010 to rein in spending, resulting in the adoption of highly unpopular austerity budgets and yet another round of sovereign bailouts. The United States' balance sheet fared no better. Year-end official debt figures published by the U.S. Treasury show that the federal government accumulated more new debt—$3.22 trillion—during the tenure of the 111th Congress (which expired at the end of 2010) than it did during the first 100 Congresses combined. That equals $10,429.64 in new debt for each of the 308,745,538 people counted in the U.S. by the 2010 Census. At the end of 2010, the total national debt of $13.86 trillion stood at $44,886.57 for every man, woman, and child in America.

In 2010, more U.S. banks failed than in any other year since 1992, the height of the savings-and-loan crisis. Amid near double-digit unemployment, a struggling economy, and a still-devastated real estate market, the U.S. closed the year with 157 bank failures, up from 140 in 2009. Moreover, the Federal Deposit Insurance Corporation's list of "problem" banks—banks whose weaknesses "threaten their continued financial viability"—stood at 860 as of September 30, the highest since 1993.

Average Americans are not only more debt-ridden, but poorer. U.S. Census Bureau data released in September 2010 showed that poverty among the working-age population of the U.S. had risen to the highest level in almost 50 years at the beginning of 2010. Poverty among those aged 18 to 64 rose by 1.3 percentage points to 12.9 percent—the highest level since the early 1960s, prior to then-president Lyndon Johnson's "War on Poverty." The overall poverty rate rose by 1.1 percentage points to 14.3 percent, the highest since 1994.

More than 14.5 million U.S. workers were out of work at the end of 2010, including 6.4 million who have been jobless for six months or longer, according to data reported by the U.S. Department of Labor in January 2011. This equates to an unemployment rate of 9.4 percent. Some estimates put the "underemployment" rate, which counts those looking for jobs as well as those who have given up looking, in addition to people who want full-time employment but settle for part-time, at nearly 17 percent.

The number of Americans filing for personal bankruptcy topped 1.5 million in 2010, as high long-term jobless rates, depressed home prices, and soaring medical bills drove more households to seek court protection. This represents a 9 percent increase from 2009 and is the highest level since the Bankruptcy Code was overhauled in 2005, according to the American Bankruptcy Institute, an association of bankruptcy professionals, and the National Bankruptcy Research Center.

Banks took steps to repossess a record 2.87 million U.S. homes in 2010, as the two-year-old mortgage crisis continued to weigh heavily on the economy. According to RealtyTrac, an online marketplace for foreclosure properties, foreclosures hit 2.23 percent of all housing units in the country, or one out of 45, an increase from 2.21 percent in 2009. More than 1 million homes were actually repossessed in 2010.

According to the National Association of Realtors, fewer people bought previously owned U.S. homes in 2010 than in any year since 1997. Sales fell 4.8 percent to 4.91 million units in 2010, the weakest performance in 13 years. Home prices were depressed by a record number of foreclosures and high unemployment, and many potential buyers held off on purchases in 2010, fearful that prices had not yet bottomed out.

Municipal Distress

The financial plight of towns, cities, counties, and other municipalities in the U.S. remained in sharp focus in 2010. On December 10, the U.S. Congressional Budget Office ("CBO") released an economic and budget issue brief on the fiscal stress that local governments are facing and the options they have, including defaulting on their debt or filing for chapter 9 bankruptcy protection. According to the report, weak economic conditions can lead to fiscal stress—the "gap between projected revenues and expenditures"—for local governments "by reducing their tax revenues, lessening the state aid they receive, increasing the demand for some services and triggering investment losses."

Unlike state governments, the report states, local governments facing "significant fiscal stress may default on their debt or file for bankruptcy," but these options are rarely used. Only 54 out of 18,400 municipal bond issuers defaulted during the period from 1970 to 2009, and only six of the defaulting entities were counties, cities, or towns—the remaining defaulting entities were special districts or government entities. Although investors generally recover most or all of the debt owed, defaults have been rising, with more than $4 billion in defaults in 2010. Furthermore, defaults "may lead a municipality to file for bankruptcy, in part to protect itself from lawsuits." Roughly 600 governmental entities filed for bankruptcy protection over the past 70 years, 203 of which filed between 1988 and the end of 2010.

According to the CBO, filing a chapter 9 bankruptcy may not solve a municipality's problems. The obligation to pay debt service limits a municipality's ability to cut taxes, cover increased costs of existing services, and pay for new services. Additionally, any fiscal advantages of chapter 9 may be reduced due to legal costs incurred during the bankruptcy case. Finally, the CBO noted that "bankruptcy does not necessarily eliminate the political dynamics and state laws that may make recovery difficult" and may "continue to limit the ability of municipalities to address their fiscal problems." Moreover, cutting spending will not affect the heaviest burden that these political subdivisions face. States and cities have nearly $3 trillion in outstanding bonds and more than $3.5 trillion in shortfalls in projected pension obligations. Promised future health benefits alone amount to more than $500 billion.

On a potentially ominous note, for the first time in two years, Switzerland's UBS AG began making markets again in 2010 in derivatives tied to municipal bonds and other securities. These credit-default swaps obligate swap sellers to compensate buyers if a municipal debt issuer misses an interest payment or restructures its debt. In addition, five large derivatives dealers—Bank of America Merrill Lynch; Citigroup, Inc.; Goldman Sachs Group Inc.; JPMorgan Chase & Co.; and Morgan Stanley—met in November 2010 to discuss standardizing agreements for "muni CDSs" in an effort to attract more participants.

Accountability for Transgressions

2010 was the year that recriminations for the financial crisis began in a serious way. The Financial Crisis Inquiry Commission created in 2009 formally convened in January 2010 to begin investigating the root causes of the crisis, and both civil and criminal investigations were opened by state and federal agencies into the conduct of some of the major players involved, including the credit-rating agencies. 2010 was also the year that the most sweeping reforms to the U.S. financial system in decades were enacted, in an effort to prevent any recurrence of the events that led to the crisis.

Silver Linings

All things considered, the financial sound bites and catchwords of 2010, such as "QE2," "ObamaCare," "PIIGS," "flash crash," "robo signers," and "Repo 105 loophole," were relatively innocuous compared to those of the previous two years.

2010 saw some notable and encouraging developments belying predictions that recovery might be thwarted by the specter of a "double-dip" recession. The Troubled Asset Relief Program, implemented in 2008 at the end of the George W. Bush administration to rescue the U.S. financial industry, formally expired in October 2010. Of the $700 billion in bailout funds authorized under the program by Congress, $475 billion in TARP money was actually disbursed. All but the smallest banks repaid their TARP loans in full during or prior to 2010. On October 5, 2010, the TARP bailout, originally expected to cost U.S. taxpayers $356 billion, was estimated to be between $25 billion and $30 billion, significantly less than the burden shouldered by taxpayers in connection with the savings-and-loan crisis of the late 1980s. Even the once written-off American International Group is considered "on track" to repay a significant portion of its $182 billion in bailout money.

At the very end of 2010, the U.S. unemployment rate fell from 9.8 percent to 9.4 percent, its lowest rate since July 2009.

2010 saw the largest overhaul of the overpriced...

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