When I put to an FDIC spokesman the question of whether FDIC chairman Sheila Bair's idea of limiting the claims of secured creditors of financial firms to no more than 80% of their secured credits was intended to apply to just newly issued debt or to apply retroactively to existing secured creditors, he got back to me with the response: "The chairman simply raised the issue as a possible approach. No details were provided."
If retroactivity is intended, it would seem to violate the concept of the rule of law as announced and predictable and non-retroactive as described by Richard Epstein in this talk, in which Professor Epstein also warns that the treatment of the Chrysler bondholders was a threat to the systems of property rights and credit. When the Founders wrote the Contracts Clause of the Constitution, they restricted the states from doing this sort of thing, though the restriction hasn't been applied to the federal government and it hasn't even been particularly well enforced against the states, as the owners of New York apartments with rent-controlled or rent-stabilized tenants can attest. Alas, too, the ex post facto clause of the Constitution has been read to apply only to criminal and penal law. When the federal government dealt in this fashion with the Chrysler secured creditors, a law professor, Todd Zywicki, warned presciently that it wouldn't end with the auto industry: "lenders face the potential of future government confiscation."
Since the Constitution left the matter vague in respect to the federal government, a reader suggests clarifying just what Ms. Bair is up to by requiring her, if she intends to forge ahead with the idea of retroactively squeezing the bank bondholders, to pass a Constitutional amendment. It could read: "Congress may pass an ex post facto law impairing the obligation of contracts, even though for good reason the original text of this Constitution originally prohibited the states from doing that." At least it would have the virtue of clarifying what Ms. Bair is up to.
All this may seem somewhat legalistic or obscure, particularly if you weren't a big Chrysler bondholder or aren't a secured creditor of a financial institution. But when you take a step back and think about it, the underlying principles are pretty fundamental to a functioning free and just society. If the government can step in at any moment and unilaterally change the rules that had been previously agreed upon between a lender and a borrower, that changes a lot. The existence of that risk would be likely to make potential lenders behave differently. Ms. Bair's comments haven't gotten much attention (After our initial post on the topic at 12:16 a.m. on October 5, Felix Salmon of Reuters posted on the topic at 4 p.m. on October 6, declaring that he liked the idea notwithstanding that few people had picked up on it). Maybe nothing will come of the proposal. But it is potentially a big deal.
