Much financial engineering aims to convert the real economy’s activity into derivative products with risk-versus-return profiles that will appeal to particular investors. This has some value, when the result is to spread risk among parties who choose how they wish to participate. For instance, some investors may wish to hold a firm’s equity while others might prefer its debt. Unsurprisingly, though, the engineers find it especially attractive to design products that shift risk onto third parties while keeping returns for themselves. The leveraged-buyout model employed by many “private equity” (PE) firms represents an extreme case, incurring high levels of debt that enable much larger profits when a transaction is successful, while accepting that some bankruptcies will occur along the way. The workers and communities devastated by the bankruptcies do not get to “hedge.”

The United States should create a new, primary obligation to workers that is paid first in the event of a bankruptcy. This could equal, say, six months’ salary for all workers laid off in advance of or during a Chapter 11 reorganization, or for all workers in the event of a Chapter 7 liquidation. A similar claim should be created for local communities, equal to one year’s tax liability in each domestic locality where a business operates. These changes in bankruptcy rules would decrease the value that creditors can recover from a business in bankruptcy while increasing the value available to other affected parties. This would make much riskier the aggressive leverage strategies that accept the chance of bankruptcy as a cost of business and a means to higher returns. It would also give workers and local communities a seat at the table in reorganizations.