More than 100 bankruptcy scholars, including Nobel prize winners and former Federal Reserve governors, are urging Congress not to undo the orderly liquidation authority, the provision of the Dodd-Frank financial reform bill meant to protect the U.S. economy from a bank collapse as bad as Lehman Brothers', or worse.
The group is calling the proposed action currently before the U.S. House of Representatives "a grave mistake."
The letter was written by Jeffrey Gordon of Colombia Law School and Mark Roe of Harvard Law School and signed by Nobel prize winners Oliver Hart and Peter Diamond, former Federal Reserve governors and the so-called father of modern banking theory, Douglas Diamond.
Even a beefed-up bankruptcy law, as is currently being proposed in Congress, cannot on its own handle the collapse of a too-big-to-fail bank or prevent that collapse from causing a worldwide financial crisis, the letter says. A proposal from House Republicans called the CHOICE Act calls for stripping the orderly liquidation authority from regulators in favor of a strengthened bankruptcy law that would put the collapse of important financial institutions in the courts' hands alone.
Rep. Jeb Hensarling, R.-Texas, who chairs the House Financial Services Committee and put forth the CHOICE Act, didn't respond to request for comment on the letter. But proponents of the CHOICE Act have said that it would remove regulations that they say give the biggest banks a competitive advantage. The Congressional Budget Office said that on its face the bill could reduce the deficit by $24.1 billion over a decade by eliminating the orderly liquidation authority and changing the way the Consumer Financial Protection Bureau is funded.
However, the CBO noted that if a big bank actually failed, these estimates would be uncertain, as they don't account for economic losses that would be caused by such a financial crisis.
Or, as the letter-writers put it, removing the orderly liquidation authority "is a reckless gamble with the stability of the U.S. financial system."
The academics don't come out against the replacement portion of the U.S. House of Representatives proposal, which is called the Financial Institution Bankruptcy Act. Increased authority for bankruptcy courts would be beneficial, they say, but stripping regulators of the orderly liquidation authority leaves no safety net if bankruptcy courts aren't able to handle the crisis.
Reasons that a bankruptcy court might not be able to handle the situation include the court's inability to coordinate if multiple financial institutional collapses at once, parties could challenge the bankruptcy court's own authority to decide certain issues, and possibly most significantly, the new rule would give a judge just 48 hours to resolve and stabilize problems related to a likely extraordinarily complex corporate and capital structure, according to the letter.
If a bankruptcy process fails, at that point, "without [orderly liquidation authority], Congress and the financial regulators would be faced once again with the choice between a Lehman Brothers-type event or a bailout," the letter says.
The orderly liquidation authority was granted to the U.S. Federal Deposit Insurance Corp. in 2010 with the passage of Dodd-Frank Wall Street Reform and Consumer Protection Act. The regulation gives the FDIC the authority to step in when systemically important financial institutions, or SIFIs, have become a threat. The authority also requires big banks to plan for their own demise, with living wills. The letter says that this provision gives the FDIC the advantage of advance familiarity with the banks, familiarity that no judge would have.
The CHOICE Act has passed through committee but hasn't been brought to a vote in the full House of Representatives yet.
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