Abstract

http://ssrn.com/abstract=1522205
 
 

Citations (1)



 
 

Footnotes (227)



 


 



Why Banks are Not Allowed in Bankruptcy


Richard M. Hynes


University of Virginia School of Law

Steven D. Walt


University of Virginia School of Law

December 11, 2009

Virginia Law and Economics Research Paper No. 2010-03

Abstract:     
Unlike most other countries, the United States uses different procedures to resolve insolvent banks and non-bank firms. When non-bank firms file for bankruptcy, the Bankruptcy Code divides control among the various claimants and a judge supervises the resolution process. By contrast, the FDIC acts as the receiver for an insolvent bank and has almost complete control. Other claimants can sue the FDIC, but they cannot obtain injunctive relief, and their damages are limited to the amount that they would have received in liquidation. The FDIC has acted as the receiver of insolvent banks since the Great Depression, and the concentration of power in the FDIC is traditionally justified by two arguments: i) the need for a timely disposition of the bank’s assets to maintain the liquidity of deposits and encourage faith in the banking system, and ii) the FDIC’s role as the largest creditor gives it an incentive to maximize the recovery from the assets. We revisit these arguments in light of the dramatic changes that have occurred in banking and ask whether they still (or ever did) justify FDIC control. We suggest that the first argument fails because it conflates the need for a timely satisfaction of the claims of insured depositors by the FDIC with the need to quickly dispose of the failed bank’s assets. As stated, the second argument does not justify FDIC control as one must generally ask whether the largest creditor will take actions that are harmful to the other claimants on the failed firm’s assets. However, if modified the second argument is much more persuasive. A detailed survey of the capital structure of failed banks reveals that the FDIC is usually the only major creditor and that the value of the FDIC’s claim nearly always exceeds the value of a failed bank’s assets. The FDIC is therefore the residual claimant and has the incentive to make the right decisions in disposing of the bank’s assets. We question whether this principal can justify recent proposals to extend FDIC control over the resolution of large bank holding companies. We further note that this principle limits the circumstances in which the FDIC should retain control over the resolution of the banks themselves. Four limits are considered: i) capital structure is endogenous - the absence of claims junior to the FDIC may reflect the lack of voice given to these claimants in a bank resolution process, ii) agency costs internal to the FDIC may prevent the FDIC from maximizing the recovery from the failed bank’s assets, iii) the FDIC may not be the residual claimant of extremely large banks with complex liability structures, and iv) debt conversion schemes which allow for automatic financial restructuring of a failed bank may render bank resolution procedures less necessary. The Article argues that these limits do not justify removing the FDIC from control in resolving most bank failures.

Number of Pages in PDF File: 71

Keywords: Bankruptcy, Banking, Bank Resolution, Bank Insolvency

JEL Classification: G21, G33, K29

working papers series





Download This Paper

Date posted: December 14, 2009 ; Last revised: March 12, 2010

Suggested Citation

Hynes, Richard M. and Walt, Steven D., Why Banks are Not Allowed in Bankruptcy (December 11, 2009). Virginia Law and Economics Research Paper No. 2010-03. Available at SSRN: http://ssrn.com/abstract=1522205 or http://dx.doi.org/10.2139/ssrn.1522205

Contact Information

Richard M. Hynes (Contact Author)
University of Virginia School of Law ( email )
580 Massie Road
Charlottesville, VA 22903
United States
434-924-3743 (Phone)

Steven D. Walt
University of Virginia School of Law ( email )
580 Massie Road
Charlottesville, VA 22903
United States
804-924-7930 (Phone)
804-924-7536 (Fax)

Feedback to SSRN


Paper statistics
Abstract Views: 1,390
Downloads: 351
Download Rank: 48,011
Citations:  1
Footnotes:  227

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo5 in 0.297 seconds