With President Donald Trump's barrage of executive actions since taking office, it would be easy to overlook a memo indicating he wants to scrap a system set up after the 2008 financial crisis for handling failures of large banks.
And indeed, Trump's April 21 directive to Treasury Secretary Steve Mnuchin on the topic, issued late last month, received little news coverage.
It's nonetheless reverberating in financial circles in New York and London because of its potential effect on a painstaking international effort to rein in the risk that large companies pose to the economy if they fail, a possibility highlighted when the collapse of investment bank Lehman Brothers in September 2008 froze global credit markets.
Trump's memo orders Mnuchin to review the effects of a Dodd-Frank reform law provision creating Orderly Liquidation Authority, the power to wind down a collapsing financial institution deemed likely to threaten financial stability -- and to refrain from using it as far as possible. Of particular concern, the president wrote, is whether the system improperly shifts costs to taxpayers, might cause excessive risk-taking and conflicts with Trump's goal of curbing unnecessary regulation.
The liquidation authority has been criticized by Republicans who say it gives regulators too much discretion to pick winners and losers among junior and senior creditors, depending on their political stripes. They also contend that the system enshrines too-big-to-fail by allowing for taxpayer-funded backdoor bailouts of large creditors of a failing big bank.
It's likely that Trump's mandate will put a warm spotlight on deregulatory legislation GOP lawmakers are spearheading on Capitol Hill -- called the Financial Choice Act -- that includes a section seeking to replace liquidation authority with a revised Chapter 11 system.
The proposed structure includes prohibiting derivatives traders from terminating their swaps contracts immediately at the beginning of an insolvency proceeding, thus ensuring that a historic "run on derivatives," like the one that occurred after Lehman's bankruptcy, doesn't recur.
Democrats, former top bank officials, and overseas regulators point out that the current system already addresses termination of derivatives deals and argue it's the only one that could stem a growing panic because it would initially employ taxpayer funds to dismantle a failing big bank.
That's what the GOP sees as a bailout since the funds could be used to make payouts, for example, to systemically important creditors, presumably other big banks and financial institutions on the verge of failure.
Taxpayer dollars, based on the statute, would later be recouped through a sale of assets and a fee on banks with more than $50 billion in assets, such as JPMorgan Chase (JPM - Get Report) , Citigroup (C - Get Report) , Bank of America (BAC - Get Report) and Goldman Sachs (GS - Get Report) .
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"It's not a bailout," said Michael Barr, who served as assistant Treasury secretary for financial institutions in the Obama administration. "The recoupment is automatic. The Federal Deposit Insurance Corp. gets paid back either from a sale of assets of the firm or an assessment on the industry."
Democrats and many academics say they are supportive of the congressional bankruptcy reform effort -- but only if it is a complement to the Obama liquidation system.
A pivotal difference between the two approaches is that with orderly liquidation authority, regulators have the power to shut down a failing megabank while the bankruptcy code leaves that decision to the company, said Columbia Law School Professor John Coffee.
"It would be shut down when the bank totally runs out of money," Coffee said. "Lehman was shut down on the last day, and it was flat broke and could not continue to operate."
Without liquidation authority, the U.S. faces the risk of bigger losses "because there will be a longer period of insolvency," he explained. The financial system would lose access to vital liquidity, a more common cause of large bank failures than insolvency, he said.
Another consideration is that Wall Street financiers, as well as U.K. and U.S. regulators, agree that international cooperation is critical. Rough two-thirds of the foreign assets for the top eight U.S. banks are in the U.K., which means collaboration between them is vital.
Foreign regulators would probably lose confidence in how the U.S. handles banking crises if liquidation authority is eliminated, Andrew Bailey, head of the U.K. Financial Conduct Authority, recently suggested to the Financial Times.
"Frankly, if we were left with a bankruptcy code-only solution there, it would be worrying," Bailey said. "If that got disrupted badly, and I hope it won't, I really hope it won't, that would be the element that I think would be problematic internationally."
Barr, the former Treasury official who's now a law professor at the University of Michigan, suggests that agreements between the U.S. and U.K. regulators, including the FCA, would "blow up" if that occurs.
"The U.K., FDIC, and Bank of England have an agreement that says, 'This is how a global financial institution based in both countries should be resolved,'" Barr said. "The [Republican] Financial Choice Act would undo that agreement. It would eliminate the ability to conduct international coordination and dramatically increase systemic risk."
Former International Monetary Fund chief economist Simon Johnson, now a professor at the MIT Sloan School of Management, argues that the change the GOP is considering could lead to a Lehman-like scenario.
"There would be a big scramble in different jurisdictions to grab collateral and protect certain creditors in their jurisdiction because they don't know what is going to happen," Johnson said.
While the Trump memorandum's Treasury study -- a first step -- won't be completed until October, there are signs that legislative efforts could speed up quickly in a way that avoids Democratic opposition.
An obscure budget reconciliation process, created by the Congressional Budget Act of 1974, could be used, allowing Republicans -- who have 52 Senate seats -- to approve the legislation with only 51 votes. In such a case, backers wouldn't need a filibuster-proof 60 votes and some Democratic support to obtain approval.
The measure could presumably qualify for the budget tactic because of the liquidation authority's estimated potential cost to taxpayers.
Alternatively, a bipartisan approach to repealing it could work as well. "This may be one of the few issues that could pick up enough votes to pass Congress on the far left, and the far right are not fans of the megabanks," Cowen Washington Research Group analyst Jaret Seiberg said in a May 1 report.
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