Orderly Liquidation Authority vs. Financial Institutions Bankruptcy Act

On the Brookings blog, Aaron Klein discusses the Orderly Liquidation Authority that was introduced with the Dodd-Frank Act.

Dodd-Frank extended the FDIC’s authority to resolve failed institutions beyond commercial banks to include the entire bank holding company and all firms designated as Systemically Important Financial Institutions (SIFIs). Thus, if a large, complex financial institution were to fail, the FDIC would have authority to resolve the entire institution, both the commercial bank and the rest of it.

The FDIC needs access to cash to operate these firms while they go through resolution.  Title II of Dodd-Frank created a new fund, the Orderly Liquidation Authority (OLA), to be funded by complex, large institutions and non-bank SIFIs. Unlike the DIF which is pre-funded, OLA is funded only after a failure. The Treasury lends the FDIC money to resolve the institution. If there is a net cost, the FDIC then recoups the money spent by imposing a fee on surviving large, complex financial institutions. In order to invoke the OLA, the FDIC needs the agreement of the Federal Reserve Board of Governors (by a 2/3 majority) and the Treasury Secretary, who is required to consult with the President.

… The FDIC has created a detailed plan on how it would resolve these types of institutions under a scenario called ‘single point of entry’ (SPOE). Under SPOE, the FDIC is appointed as receiver of the top-level holding company, allowing all of its subsidiaries (the commercial bank, investment bank, broker-dealer, insurer, etc.)  to continue operations. The FDIC would then establish a bridge financial company to which the FDIC would transfer the assets and some of the old firms liabilities. The new company would be capitalized by converting a pre-arranged class of debt, which is structured to convert into equity. With equity and limited liabilities, the new firm should be able to access financial markets to fund operations. However, if markets are frozen or otherwise inaccessible, the FDIC could use OLA to lend to the new company.

Klein mentions three criticisms against OLA:

  • It fosters moral hazard.
  • It gives too much discretion to the FDIC.
  • Regular bankruptcy is better. That’s why there is bi-partisan support for “The Financial Institutions Bankruptcy Act of 2017” (“chapter 14”).