Monday, October 13, 2014

BAILOUT FATIGUE Rethinking the Unthinkable: Bankruptcy for Large Financial Institutions

Wow, a Fed prez calls for bankruptcy treatment for large financial institutions in trouble. Great stuff.

James Jones emails:
My day-job consists of being a corporate bankruptcy lawyer.  I just spent last weekend at the National Conference of Bankruptcy Judges in Chicago.  There was an interesting tell from a Fed banker.  See the attached presentation: Rethinking the Unthinkable: Bankruptcy for Large Financial Institutions by Jeffrey M. Lacker, President Federal Reserve Bank of Richmond

Highlights from the paper:

  • The bankruptcy process is an effective tool for reconciling the incentives of creditors and debtors. Yet the government has a long history of handling large complex financial institutions outside the Bankruptcy Code.
  • This has created two mutually reinforcing conditions: Investors feel protected by an implicit commitment of government support, and policymakers feel compelled to provide that support to avoid a disruptive adjustment of expectations.
  • The Orderly Liquidation Authority created by the Dodd-Frank Act retains many of the flaws of ad-hoc pre-crisis practices and does little to improve creditors’ incentives to monitor risk-taking.
  • A better strategy for ending “too big to fail” is the provision in the Dodd-Frank Act requiring large financial firms to prepare “living wills” detailing how they could be resolved under the Bankruptcy Code.
  • Resolution planning is difficult work, but living wills must be credible in order for policymakers to commit to using them rather than relying on government backstops

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