Tag Archives: Resolution

Single-Point-Of-Entry, Orderly Liquidation Authority and Chapter 14

In the thirteenth, fourteenth, fifteenth and sixteenth chapters of “Across the Great Divide: New Perspectives on the Financial Crisis,” Randall Guynn, Kenneth Scott, David Skeel and Michael Helfer discuss legal strategies to resolve financial institutions, including single-point-of-entry, orderly liquidation authority under the Dodd-Frank act, or proposals for a new chapter in the bankruptcy code.

Proposed in 2012 by the FDIC, the single-point-of-entry strategy has widely been acknowledged as useful, both in the US and internationally (for example in Switzerland by FINMA). Guynn writes:

The key to solving the TBTF problem without taxpayer-funded bailouts is a high-speed recapitalization of the failed financial group that imposes losses on shareholders and other stakeholders but avoids unnecessary value destruction and preserves the group’s going-concern value. …

The SPOE strategy can be implemented under the existing Bankruptcy Code, although a new Chapter 14 could increase the likelihood of its success, particularly if it were coupled with a secured liquidity facility from the government that would be able to provide such liquidity under the most severe economic conditions.

“Financial Market Infrastructure”

In the eleventh chapter of “Across the Great Divide: New Perspectives on the Financial Crisis,” Darrell Duffie argues that central clearing parties administering tri-party repurchase agreements cannot be resolved under current bankruptcy law, including recent provisions under the Dodd-Frank act. He argues that

a financial institution should not operate key financial market infrastructure backed by the same capital that supports much more discretionary forms of risk-taking, such as speculative trading or general lending.

“How Is the System Safer? What More Is Needed?”

In the ninth chapter of “Across the Great Divide: New Perspectives on the Financial Crisis,” Martin Baily and Douglas Elliott argue that significant progress has been made in safeguarding financial stability:

  • Due to higher bank capital requirements, the FDIC can intervene before equity is wiped out.
  • Liquidity requirements work in the same direction and render fire sales less likely.
  • Easier resolution of distressed financial institutions helps to shield taxpayers when a bank fails.
  • Better macro prudential oversight helps to manage systemic risks.

The authors discuss these dimensions in much detail.

Conference on “Law and Economics” with Focus Session on “Bank Resolution” at the Study Center Gerzensee

Joint with CEPR, the Study Center Gerzensee organised a conference on law and economics. The program can be viewed here and papers can be downloaded from CEPR’s website. The focus session on bank resolution featured contributions by

  • Patrick Bolton and Jeffrey Gordon (paper)
  • Martin Hellwig (paper, slides)
  • Mathias Dewatripont (slides)
  • Gerard Hertig
  • Wolf-Georg Ringe (paper)
  • Paul Tucker (paper)

In his talk, Jeff Gordon explained how Dodd-Frank extends the FDIC’s resolution technology from the 1930s to “non-banks” that engage in banking business. Dodd-Frank establishes an “Orderly Liquidation Authority” and in title II a “Single Point of Entry” by putting a holding company (topco) into receivership. The objective is to minimise disruption costs for large institutions, to preserve the going-concern value of the company and to avoid collateral damage. Single point of entry also helps resolve cross-border issues. No comparable institutional framework is available in the EU. In the crisis, US authorities implemented ad-hoc alternatives to bankruptcy: Mergers (which require the approval of shareholders and therefore make it hard to wipe out the target’s shareholders) worked for Bear Stearns (JPMorgan Chase, Maiden Lane, Fed) but not for Lehman Brothers (Barclays, Fed) because the UK authorities refused to waive Barclays shareholder approval, fearing fiscal implications. Recapitalisation with third party funds (Fed) in the case of AIG also required shareholder approval and protected creditors and counter-party claims.

Patrick Bolton cautioned that the rules for the topco are still not clear and discussed alternatives to Dodd-Frank in the bankruptcy code. He emphasised the role of qualified financial contracts and debtor-in-possession interventions.

Martin Hellwig argued that the government rescue of Hypo Real Estate reflected the political will to help influential creditors rather than systemic importance. He questioned the viability of single-point-of-entry arrangements in cross-border resolution, pointing to lack of trust among national regulators. He questioned whether internationally active banks can ever be resolved in an efficient manner and asked whether, in that light, they are socially valuable.

Mathias Dewatripont warned that excessive emphasis on bail-in arrangements can undermine financial stability, for example by having the expectation of a small haircut applied to senior debt tranches trigger a run on all senior debt. To avoid such an outcome, he favoured a clearly identified seniority structure with a significant balance-sheet share of “bail-inable” liabilities. He questioned the usefulness of higher capital requirements, arguing that “prompt corrective action” is politically infeasible unless the equity ratio has fallen below a very low value, 2 percent say.

Wolf-Georg Ringe favoured holding-company structures with sufficient “bail-inable” debt.

Paul Tucker discussed potential problems with the holding-company/single-point-of-entry strategy, related to centralised operations (IT). He raised the issue of accountability and the potential lack thereof if companies are resolved by regulators rather than judges, and he wondered whether national regulators can commit to collaborate across borders if need be. He favoured “bail-inable” debt over equity because the former gives incentives to monitor without the incentive to speculate on the upside.

Gerard Hertig warned that regulatory incentives lead to bank mergers rather than resolution, in particular because authorities tend to be more lenient in crisis times. He argued that because of deposit insurance, resolution worked well in Japan until recently.

Patrick Bolton argued that cocos are badly designed as their triggers are too low and they refer to accounting equity. Instead, he favoured reverse convertible bonds that can be converted by the issuer.

Oliver Hart argued that resolution has the advantage over cocos that the management gets replaced.

Many panelists voiced scepticism towards narrow banking proposals. They feared that control over the money supply might turn into control over credit, referring to the discussion in the US during the 1930s.