Don’t Bank on Bankruptcy for Banks

In the next month, the US Treasury Department is expected to decide whether to seek to replace the 2010 Dodd-Frank Act’s regulator-led process for resolving failed mega-banks with a solely court-based mechanism. Such a change would be a mistake of potentially crisis-size proportions.

Yes, creating a more streamlined bankruptcy process can reduce the decibel level of a bank’s failure, and bankruptcy judges are experts at important restructuring tasks. But there are critical factors that cannot be ignored. Restructuring a mega-bank requires pre-planning, familiarity with the bank’s strengths and weaknesses, knowledge of how to time the bankruptcy properly in a volatile economy, and the capacity to coordinate with foreign regulators.

The courts cannot fulfill these tasks alone, especially in the time the proposal under consideration has allotted – a 48-hour weekend. Unable to plan ahead, the courts would enter into the restructuring process unfamiliar with the bank. Moreover, the courts cannot manage the kind of economy-wide crisis that would arise if multiple mega-banks sank simultaneously. And they cannot coordinate with foreign regulators.

Recent Roundtable coverage of this subject includes a round-up of op-eds; a summary of a letter submitted to Congress by financial scholars; a summary of a White House memorandum calling for reconsideration of the OLA; and an analysis of recent legislative efforts to address bankruptcy for banks.

The Roundtable has also published commentary on the treatment of insolvent financial institutions; see Jackson & Massman, “The Resolution of Distressed Financial Conglomerates” and Lubben & Wilmarth, “Too Big and Unable to Fail.”