At a Federal Reserve conference last week, I was once again contemplating orderly liquidation authority and how it has changed under the Federal Deposit Insurance Corporation’s “single point of entry†proposal, which would put the holding company of a failing financial giant into into receivership, but its operating subsidiaries would still operate.
Much optimism was expressed at the conference that orderly liquidation authority now or soon will work wonderfully. Less optimism was expressed about Chapter 11 as a tool to resolve financial institutions, which starts of my list of things I’m still wondering about:
First, what about the fact that the bankruptcy code is supposed to be the first line of defense? Indeed, under Dodd-Frank all-the-too-big-to-fail entities are busy preparing resolution plans (otherwise known as living wills) that outline how they would be fair in a bankruptcy case. But little has been done to address a bankruptcy code that was seen as unable to handle American International Group in 2008.
Second, those living wills are supposed to present a credible resolution plan under the bankruptcy code. I have heard from lots of law firms that bankruptcy partners have been heavily involved in the process. But what about the regulatory side? Best I know, the F.D.I.C. does not have a lot of in-house Chapter 11 experience. How are they determining that these plans represent a realistic bankruptcy approach?
Third, can the F.D.I.C. replace the Fed of old when lending under Dodd-Frank, or is its role more like that of a traditional debtor-in-possession lender? Too often industry types want to have it both ways. If the F.D.I.C. is simply a D.I.P. lender, then it can only lend based on the current value of the failed institution’s assets.
If it acts like the Fed, then it could lend against “real†or post-crisis value. But that second approach, however practical, starts to look awfully like a bailout. No other distressed borrower gets to tell its lender “trust us, these assets are worth more than it currently appears.â€
Fourth, are all of the operating subsidiaries going to be saved under single point of entry, or just the “good†ones? If the latter, how is that going to be decided? And doesn’t any effect on the operating subsidiaries undermine the key benefits of a single-point-of-entry approach?
As I understand it, the proposal overcomes the obvious problems with orderly liquidation authority - it’s crazy complicated to apply to the whole firm, and limited geographically to the United States when no real systemically important financial institution is so limited - by only addressing the holding company. Once we deviate from that model, the risk of a more generalized panic comes to the fore.
But how precisely would A.I.G. have been handled under single point of entry? Could any parent company every realistically prop such a black hole of a subsidiary?
I could go on but I’ll save my additional points for a future time. Question No. 1 alone seems to represent a big issue, and thus far most of the work has been done only by the Hoover Institute people, who obviously bring their own agenda to the project.
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.
