Financial Institutions and Bankruptcy

Abstract:     
The first part of this paper sketches the several existing systems for resolving financial distress in financial firms, including the new resolution authority created by the Dodd-Frank bill. By my count, there are at least six systems at work here, not counting state-by-state variations. I then examine the coverage of these systems, and the uncertainty created by the interaction of the same. For example, under current law, a large hedge fund would be “resolved” under chapter 11 of the Bankruptcy Code – unless the newly created systemic risk counsel, a body dominated by people from outside the restructuring community, decides otherwise. This leaves it unclear to the fund’s counterparties which set of rules is incorporated into their contracts with the hedge fund. Undoubtedly both will be priced, with a further discount for the uncertainty. That is unlikely to be the optimal solution, and may increase systemic risk.

Number of Pages in PDF File: 20

Keywords: Dodd-Frank, Resolution Authority, Chapter 11, Lehman, Financial Institutions

Accepted Paper Series