The House of Representatives late Monday voted to approve a bipartisan bill amending the bankruptcy code for large financial institutions as part of an ongoing response to the 2008 collapse of Lehman Brothers.
The House approved the measure by voice vote, which means that the names or numbers of senators voting on either side are not recorded. It follows approval – also by voice vote-- of a "substantially similar" measure by the House Judiciary Committee in September.
The bill H.R. 5421, titled the Financial Institution Bankruptcy Act of 2014 or FIBA, seeks to ensure that a failing big bank can employ the traditional bankruptcy process in a way that doesn't cause collateral damage to the global financial markets.
"FIBA removes potential obstacles to an efficient bankruptcy of a financial institution," said Rep. Bob Goodlatte, R-Va., the chief of the House Judiciary Committee, in a statement. "This legislation enhances the bankruptcy code and its ability to resolve financial firms for the benefit of stability in the U.S. and global economies and does so with minimal financial burdens or cost."
The bill, which is supported by Wall Street, is intended to drive failing banks to employ bankruptcy instead of an alternative system set up by the post-crisis Dodd-Frank Act known as the Orderly Liquidation Authority. The OLA allows regulators to infuse a failing bank and its creditors with taxpayer funds initially to stem a panic emerging from a collapsing big bank.
Critics say the OLA is an opaque process that gives regulators and politicians too much discretion to pick winners and losers among junior and senior creditors when a failing institution is dismantled. In addition, they worry that taxpayer funds spent through the OLA process would never be recouped even though there is a provision in the law requiring those costs to later to be covered by a fee assessed on big banks.
Alternatively, the bankruptcy bill seeks to produce an expedited bankruptcy process at the same time that it maintains creditor priority as well as transparency in the process.
The goal of speeding up Chapter 11 is to avoid the kind of lengthy six-plus year bankruptcy process that took place when Lehman Brothers filed for Chapter 11 in September 2008 and helped drive the financial crisis. To speed up the process, the House bill would give a bankruptcy court judge 48 hours to decide whether derivatives contracts should be transferred to the bridge bank, a move that backers argue would help stem a future financial crisis.
Prospects for approval in the Senate are unclear, though the recent shift in control of the chamber into Republican hands could be encouraging news for supporters of big bank bankruptcy reform efforts on Capitol Hill. Sens. John Cornyn, R-Texas and Pat Toomey, R-Pa., last year introduced legislation known as the "Taxpayer Protection and Responsible Resolution Act, which shares many of the characteristics of the House measure but also calls for repeal of the OLA.
For example, both House and Senate bills mandate that specialized expert bankruptcy judges from different circuits be designated in the case of a big bank failure, to ensure that the judicial system can move quickly and thoughtfully in the event of a large financial institution failure. However, the Senate bill would need to have its effort to repeal the OLA removed in order to be approved by the Obama administration. The OLA system, as an alternative to bankruptcy, is a key component of the Obama administration's post-crisis reform effort and any move to repeal it would likely receive a veto from the White House.
The House bill is substantially similar to the provision that was approved by the House Judiciary Committee in September but it does make several "technical" changes involving a failing bank's capital structure, according to a panel spokeswoman. Another spokeswoman said the measure does not provide access to the Federal Reserve's so-called taxpayer-backed lender-of-last-resort authority, which is also known as access to the central bank's discount window.
Thomas Jackson, president emeritus of the University of Rochester, said that the bill would never have received sufficient votes in the House of Representatives to pass if it had included access to the Fed liquidity facility. However, he added that without access to Fed lending, the bill is less likely to be used as an alternative to the OLA by an administration that believes liquidity is a problem at a failing big bank.
Jackson added that the bill's approval is an encouraging sign for eventual approval of bankruptcy reform for big banks. However, he acknowledged that the complementary Senate measure would never be approved by the Obama administration if it contained the OLA repeal measure. "Even with Republicans in control of the House and the Senate, a bill that says repeal OLA isn't going to go anywhere because the president is going to veto it," he said. "Therefore why not pass a bill that accomplishes 90% of what repeal folks want which makes bankruptcy effective enough."
The measure's approval comes after eighteen global banks, including five U.S. institutions, took a step in October that many regulatory observers say will assist the resolution of a large failing international bank through bankruptcy.
The banks, including Citigroup Inc. (C) and Bank of America Corp. (BAC) , agreed to sign a new global resolution stay protocol that would prohibit swap counterparties from immediately terminating their derivatives agreements in the event of a big bank failure. The move is intended to give regulators time to decide whether derivatives contracts should be transferred to a bridge bank set up when a big institution files for bankruptcy.
Right now banks' derivatives counterparties can automatically net out or terminate their swaps contracts immediately at the beginning of an insolvency process. The move of swaps counterparties to cancel their contracts when Lehman Brothers filed for Chapter 11 helped drive a "run on derivatives," accelerating the financial crisis.
The banks' recent action complements a provision in Monday's bankruptcy bill that would prohibit derivatives counterparties from netting out their swaps contracts for 48 hours after an insolvency process is commenced. The OLA and European Union Bank Recovery and Resolution Directive, also have stay protocols. However, the international agreement seeks to impose a similar stay on cross-border trades, where a particular national bankruptcy regime does not apply.