BankThink

Treasury gets it right: Bankruptcy code, Dodd-Frank can work together

I commend the Treasury Department for correctly answering the big question of how to structure a failure resolution regime for large, complex financial firms.

Treasury’s new report rejects the mistaken answer that has been circulating among congressional Republicans and some think tanks: that it is a choice between an enhanced bankruptcy code or the Dodd-Frank Act.

Treasury came to the correct conclusion: enhanced bankruptcy and Dodd-Frank.

Rep. Barney Frank, D-Mass., and Sen. Chris Dodd, D-Conn., in 2010
Representative Barney Frank, a Democrat from Massachusetts and House Financial Services Committee chairman, left, speaks at a news conference with Senator Christopher "Chris" Dodd, a Democrat from Connecticut and Senate Banking Committee chairman, at the White House in Washington, D.C., U.S., on Wednesday, March 24, 2010. Dodd said President Barack Obama wants to move quickly on financial-reform legislation with the goal of getting a strong bill to sign this year. Photographer: Andrew Harrer/Bloomberg *** Local Caption *** Christopher Dodd; Barney Frank
Andrew Harrer/Bloomberg

This is a big deal. It should finally put to bed calls to repeal Dodd-Frank’s “orderly liquidation authority” and provide an impetus for Congress to enact a responsible enhancement to make the bankruptcy code work better for financial institutions — what Treasury has termed Chapter 14 bankruptcy.

The report is a rare twofer, moving one good idea forward and knocking one bad idea backward.

When President Trump laid out his core principles for regulating the financial system in his Feburary executive order, many defenders of Dodd-Frank, including myself, were nervous. While the text of the order was broadly consistent with the substance of much of Dodd-Frank, Trump’s campaign rhetoric and the rhetoric of leading Congressional Republicans was not. The Treasury Department set out to write a series of reports to flesh out the executive order’s details — which is where the devils usually lie in financial regulation.

The report on OLA was especially concerning for two key reasons. First, leading congressional Republicans such as House Financial Services Committee Chairman Jeb Hensarling, R-Texas, and Sen. Pat Toomey, R-Pa., have advocated repealing OLA. Second, unlike most of Dodd-Frank, repealing OLA would technically count as a budgetary savings under congressional accounting. This means that legislation to repeal OLA could be enacted under a reconciliation bill, which would be immune to filibuster in the Senate.

"This is fundamentally consistent with Dodd-Frank’s core goals of using the bankruptcy system as a first alternative — as embodied in the so-called 'living wills' required under Title I of the law — and of having Title II only as a break-the-glass last resort."

To those who closely follow OLA and Dodd-Frank’s failure resolution regime, Title II of the law, it was evident that the law would never actually cost taxpayers a dime. The structure of Title II made great strides to force losses on bank ownership and pre-designated unsecured debt holders. And even in the unlikely event that taxpayers would be on the hook, any losses to taxpayers would be recouped by an automatic industry wide-assessment.

Despite this, congressional budget rules impose arbitrary time-horizons and create a fictitious cost to taxpayers. Against this backdrop, coupled with the toxic politics of “too big to fail,” there was a real threat that OLA and Title II could be repealed — and that this report would be the beginning of a full assault.

Instead, Treasury conducted a fact-based analysis that led them back to the same conclusion that 93 U.S. Senators reached when the issue was debated on the Senate floor in 2010.

As the department concludes: “Since the bankruptcy of a large, complex financial company may not be feasible in some circumstances, Treasury also recommends retaining OLA as an emergency tool for use under extraordinary circumstances.”

This is fundamentally consistent with Dodd-Frank’s core goals of using the bankruptcy system as a first alternative — as embodied in the so-called “living wills" required under Title I of the law — and of having Title II only as a break-the-glass last resort.

That is one reason that when OLA was first put forward, it had strong bipartisan consensus. None other than Senator Richard Shelby, R-Ala., helped draft the provision, which 93 Senators then supported. The idea behind OLA and Title II is simple: Give the Federal Deposit Insurance Corp. the authority and tools necessary to wind down failing mega-banks and investment banks. The FDIC has successfully closed failing commercial banks for generations, and they should be able to figure out how to handle investment banks and merged commercial and investment banks.

The FDIC rose to the challenge, creating a new regime called “single point of entry” that theoretically solves these problems. SPOE is still a theory because it has not been tested, either by the failure of a single systemically important institution or by the failure of many institutions. Yet there is broad consensus that it will work.

There is also broad consensus that it would be better still if the FDIC never had to invoke it. This is because letting non-commercial banks fail through the traditional bankruptcy system is preferable, if it can be done in a viable manner that does not threaten the stability of the financial system.

Treasury’s report contains a myriad of suggested changes to OLA and to the FDIC’s plans. Some of these are improvements, such as the proposal to more quickly trigger industry-wide recoupment in the event of taxpayer losses.

Others are problematic. One of the biggest errors would be to expand the grounds for failing bank executives and owners to legally challenge FDIC action. Do not underestimate the gall of financial executives whose firms fail and require governmental support: Even AIG’s former executives sued the federal government for its action, which saved AIG from certain bankruptcy. People should not be given enhanced standing to sue the fire department for breaking down their door to put out a fire — especially a fire they sometimes set themselves.

The Bipartisan Policy Center conducted an in-depth analysis of the same issues in 2013 and concluded, “OLA was not designed to replace the Bankruptcy Code for reorganizing or liquidating SIFIs. Instead, it was designed as a supplement to the Bankruptcy Code. The Bankruptcy Code remains the preferred law to govern the insolvency or other failure of most financial institutions, other than insured depository institutions and insurance companies.”

The Treasury Department reached a similar conclusion and rightfully suggested a series of additions to the bankruptcy code to do just that (aka Chapter 14).

But congressional action on Chapter 14 has been delayed by the argument that it should be coupled with repealing Dodd-Frank’s Title II. Given congressional scoring gimmicks and heightened political rhetoric around Dodd-Frank, it seemed unlikely that progress would be made on enhancing bankruptcy (which goes through the Judiciary Committees of Congress) as long as it was linked to repeal of Title II. The Treasury Department’s report should end that.

This moves the ball forward in both directions: It provides additional stability and certainty around the existence and implementation of Dodd-Frank’s OLA and the Title II regime and it unlocks a major political roadblock to enhanced bankruptcy reform. Job well done.

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