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Systemic Risk and Managerial Incentives in the Dodd-Frank Orderly Liquidation Authority

Journal of Financial Regulation, Forthcoming (2014)

42 Pages Posted: 19 Feb 2013 Last revised: 24 Aug 2014

Joshua Mitts

Columbia Law School; Columbia University - Columbia Business School

Date Written: August 24, 2014

Abstract

Neither the FDIC’s recently announced resolution policy for failed financial institutions nor academic studies on systemic risk address the micro-level managerial incentives resulting from the Dodd-Frank Orderly Liquidation Authority’s incapacity to respond to simultaneous balance-sheet insolvency rather than temporary illiquidity. By holding correlated asset portfolios and serving as counterparties to similarly situated financial institutions, managers can strategically increase the likelihood of a government bailout rather than receivership under the OLA. Three case studies — Lehman Brothers, AIG, and large European banks’ response to the 2011 bail-in proposals — demonstrate the implications of the OLA’s shortcomings and the inadequacy of the FDIC’s approach. In light of these strategic incentives, the FDIC should modify its intervention policy to respond effectively to illiquidity-driven systemic risk and prudential regulators should work to reduce the likelihood of correlated balance-sheet insolvency.

Keywords: FDIC, OLA, Dodd-Frank, systemic risk, insolvency

Suggested Citation

Mitts, Joshua, Systemic Risk and Managerial Incentives in the Dodd-Frank Orderly Liquidation Authority (August 24, 2014). Journal of Financial Regulation, Forthcoming (2014). Available at SSRN: https://ssrn.com/abstract=2220208 or http://dx.doi.org/10.2139/ssrn.2220208

Joshua Mitts (Contact Author)

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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