Prioritization and Mutualization: Clearinghouses and the Redundancy of the Bankruptcy Safe Harbors

10 Brooklyn Journal of Corporate, Financial, and Commercial Law (2015), Forthcoming

25 Pages Posted: 26 May 2015

See all articles by Adam J. Levitin

Adam J. Levitin

Georgetown University Law Center

Date Written: May 26, 2015

Abstract

This Essay argues for the repeal of the bankruptcy safe harbors for financial contracts because they are redundant systemic risk safeguards. Most systemically important types of financial contracts now clear through clearinghouses. Clearinghouses are a superior method to the safe harbors for protecting the liquidity of systemically important money substitutes and do not subordinate bankruptcy policy concerns to systemic risk concerns.

Clearinghouses are a better guaranty against systemic disruption than the safe harbors because they can absorb the losses caused by insolvencies and fire sales due to their deep capital and lack of leverage. Moreover, clearinghouses reduce systemic risk by forcing internalization of systemic externalities on the finance industry through loss mutualization. This reduces the industries incentive to engage in excessively risky transactions. And, in the event that losses overwhelm clearinghouses, they are technically and politically easier to bail out than individual firm when the safe harbors prove inadequate. Accordingly, this Essay argues for the safe harbors to be replaced with a clearing mandate only for those types of highly liquid financial contracts that serve as money substitutes.

Keywords: clearinghouse, bankruptcy safe harbor, automatic stay, avoidance actions, mutualization, prioritization, derivatives, repo, systemic risk, swaps

JEL Classification: G33, K29

Suggested Citation

Levitin, Adam J., Prioritization and Mutualization: Clearinghouses and the Redundancy of the Bankruptcy Safe Harbors (May 26, 2015). 10 Brooklyn Journal of Corporate, Financial, and Commercial Law (2015), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2610469

Adam J. Levitin (Contact Author)

Georgetown University Law Center ( email )

600 New Jersey Avenue, NW
Washington, DC 20001
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
141
Abstract Views
952
Rank
370,936
PlumX Metrics