A few weeks ago, three states â€" Oklahoma, Michigan, and South Carolina â€" joined a challenge to Title II of Dodd-Frank, the new “orderly liquidation authority.â€
The question is, why?
The arguments in the complaint are extraordinarily weak. The states seem to assert some sort of property interest in having their investments dealt with under the bankruptcy code in the event of default. Of course, Congress is free to change the bankruptcy code whenever it wants, so how does that work?
Moreover, nothing in the text of the bankruptcy clause to the Constitution would seem to require Congress to provide a judicial forum for the resolution of financial distress. Indeed, entire categories of debtors â€" like banks and railroads â€" have at times been taken out of the general bankruptcy system and subjected to specialized proceedings, with limited judicial oversight.
None of which is to say that the orderly liquidation authority is prefect policy. B ut economic policy is probably best left outside the Constitutional realm.
As noted earlier this week by Harvey R. Miller and Maurice Horwitz in a Another View column on DealBook, the authority continues to suffer from its limited geographic scope and its unrealistic goals of ending all bailouts and liquidating failed financial firms, while also protecting the financial system from systemic panic.
It is probably not possible to do all of these things at once: in particular, sometimes we need the political courage to say that we need to do a bailout, as distasteful as that is, because we simply can't let Citigroup, Goldman Sachs or any other systemically important financial institution fail. By the time we get to the point of failure, the real alternatives are gone.
The main goal then must be to do the bailout right.
The Federal Deposit Insurance Corporation's new approach to orderly liquidation authority â€" involving a single proceeding for the ho lding company alone â€" is a good step toward acknowledging that the process as drafted is not likely to work. But is it politically naïve?
In particular, its hard to see how an orderly liquidation authority proceeding of the parent company does not become a bailout of the subsidiaries, if those subsidiaries are to be kept out of any sort of insolvency proceeding. And knowing that this will happen, the smart money will come in at the subsidy level, leaving the parent company creditors those whom it is least politically palatable to stiff. Think small, individual investors.
Many of these issues could be at least ameliorated by aggressive enforcement of the rules regarding living wills. The problem is that most people are understandably dubious about aggressive enforcement by regulators â€" it didn't happen before, and why should we expect it to happen now, especially in the face of strong pushback from the banks and their champions in Congress?
Stephen J. Lubben is the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and an expert on bankruptcy.
