John B. Taylor, the George P. Shultz Senior Fellow in Economics at the Hoover Institution, testified before the House Financial Services Subcommittee on Oversight and Investigations that the Orderly Liquidation Act (OLA) in Title II of the Dodd-Frank Act has not reduced the likelihood of bailouts of large financial firms. Taylor’s blog and Wall Street Journal commentary with Kenneth E. Scott, senior research fellow at Hoover, explain that the OLA requires more discretion by the FDIC, thus leaving policy makers with less clarity about the reorganization process and more likely to ignore it in the heat of a crisis.
Taylor and Scott’s view is that, “a straightforward reform of the bankruptcy code will facilitate the orderly bankruptcy of large failing financial institutions and thereby deal with the bailout problem. The reform should be enacted now, whether or not further actions are taken on big banks.”
They suggest a better way than the OLA involves adding a chapter 14 to the federal bankruptcy code specifically for large financial institutions (all financial groups with assets of more than $100 billion). A specialized panel of judges and court-appointed special masters with financial expertise would oversee the proceedings, which would include all the parents’ subsidiaries, including insurance and brokerage firms. (Under Dodd-Frank, insurance and brokerage services must be handled separately—which adds complexity—banks and other subsidiaries are under FDIC jurisdiction.)
“The managements of the five largest financial firms in the United States control the investment of over $8 trillion. A credible bankruptcy procedure designed specifically for these and other large financial firms would substantially reduce the occasions to use the Dodd-Frank resolution machinery and thus the concerns about its effects. It would make creditors' exposure much better defined and predictable and thereby reduce the likelihood of bailouts and the perverse, unfair subsidy they create.”
Click here for further information on their Chapter 14 proposal.