Academic

Christopher Dodd has announced his latest version of financial reform, and I'd like to focus on his suggestions for "resolution authority," the ability to break up big firm through a quick bankruptcy that is handled by the FDIC, rather than the bankruptcy courts.  The proposed reforms make some sense, but ignore what in my view are the two most important problems of resolution authority:.  The first is a good government problem; namely that the government never, ever exercises its resolution authority as frequently as it perhaps should, so giving more powers doesn't guarantee better results, unless the government is either incentivized to use them, or insulated from political pressure against doing so.  The second is a rights problem, and it is mitigated slightly by the first.  In Europe, the ability of the government to nationalize a big firm at the drop of a hat is pretty terrifying - but here there has been no effort to ensure that the government would not censure owners for the wrong reasons.  The Dodd proposal makes no account of this.

I think those problems are serious ones.  But for now, it is worth thinking about the not insensible proposals included in the Dodd plan as it stands - here's his summary:

• Funeral Plans: Requires large, complex companies to periodically submit plans for their rapid and orderly shutdown should the company go under.  Companies will be hit with higher capital requirements and restrictions on growth and activity, as well as divestment, if they fail to submit acceptable plans.  Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails.  Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.
• Orderly Shutdown: Creates an orderly liquidation mechanism for the FDIC to unwind failing systemically significant financial companies.  Shareholders and unsecured creditors will bear losses and management will be removed.
• Liquidation Procedure: Requires Treasury, FDIC and the Federal Reserve all agree to put a company into the orderly liquidation process.  A panel of 3 bankruptcy judges must convene and agree - within 24 hours - that a company is insolvent.
• Costs to Financial Firms, Not Taxpayers: Charges the largest financial firms $50 billion for an upfront fund, built up over time, that will be used if needed for any liquidation.  Industry, not the taxpayers, will take a hit for liquidating large, interconnected financial companies.  Allows FDIC to borrow from the Treasury only for working capital that it expects to be repaid from the assets of the company being liquidated.  The government will be first in line for repayment.