Why Bail-In? And How!

42 Pages Posted: 10 Apr 2014

See all articles by Joseph H. Sommer

Joseph H. Sommer

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: March 31, 2014

Abstract

All men are created equal, but all liabilities are not. Some liabilities are more equal than others. These “financial liabilities” are products of financial firms. These products shift risk (insurance or derivatives) or provide liquidity (bank deposits, repo). Since these liabilities have an independent value as products, they are worth more than their net present value. The value of a financial firm, then, depends on its liability structure. These special liabilities therefore affect insolvency law. Most financial firms are governed by special insolvency law; those that are not receive special treatment in the Bankruptcy Code. These special laws work well for these special firms. However, they do not work for one subset of financial firms: large financial conglomerates. This article draws three major conclusions. First, no established law can succeed with these firms. Second, the “bail-in” process, which is currently under development, should succeed. Finally, we might want to rethink the meaning of capital for financial firms.

Keywords: bail-in, bank insolvency, Modigliani-Miller, financial liabilities

JEL Classification: G33, G32, K00, G30

Suggested Citation

Sommer, Joseph H., Why Bail-In? And How! (March 31, 2014). Economic Policy Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2422435

Joseph H. Sommer (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-8982 (Phone)
212-720-1756 (Fax)

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