The Truth About Secured Financing
The debate over the social value of secured credit (and the appropriate priority for secured claims in bankruptcy) is entering its nineteenth year. Yet the continuing publication of succeeding generations of papers exploring the topic have yielded precious little in the way of an emerging scholarly consensus about the nature and function of secured credit. In this paper, I build upon the existing scholarship and seek to answer three questions. First, what are the right (and the wrong) questions to ask if we are to advance our understanding of secured credit and its appropriate priority. Second, what do we know (and do not know) about the answers to these questions? Third, what normative stance is justified in a world of uncertainty in which many of the key questions will likely not be answered for some time (if ever)? I conclude that the best theoretical explanation for secured credit that survives observation centers on the unique advantages of leverage over the debtor provided by the foreclosure options given to secured creditors in Article 9. The leverage of secured credit is used to solve several different contracting problems for certain classes of debtors and creditors. These solutions carry both social and private benefits as well as offsetting costs. The social benefits derived from the ability of security-created leverage to control vexing problems of overinvestment and underinvestment that are ubiquitous in financial contracting. The private benefits derive from the use of leverage to improve repayment probabilities vis-a-vis other creditors. Unhappily, the costs of security are high, and thus, security is observed in the world only where the social benefits and private benefits work in combination. This combination of social and private benefits means that the answer to the question whether secured credit does (or does not) promote social welfare is both currently unknown and unknowable. In a world of uncertainty, therefore, I argue that the intellectual burden of proof should turn on an analysis of the political economy of both the Article 9 and bankruptcy law making process.