Academic

David Skeel's New Financial Deal (in an earlier post, I told you that his broad perspective on what is the first scholarly book out about Dodd-Frank may be thought of as Jacksonian/Tory), is, in large part, a story of the advantages of bankruptcy over resolution authority ? the two alternative ways of dealing with insolvent banks.  Dodd-Frank, of course, chose to double down on resolution authority, and Skeel thinks that bankruptcy is the better way to handle bank restructurings. But the paradigm organizes the narrative:

• Dodd-Frank is formed by what he calls the Lehman myth - the myth that the Lehman bankruptcy was catastrophic.  Skeel subscribes to John Taylor's event study that correlates the collapse of the capital markets with uncertainty about the TARP, rather than uncertainty caused by Lehman?s collapse.  I'm not sure I am entirely convinced with Taylor's analysis, though it is interesting that Lehman's bankruptcy jolted the markets but didn't tank them.  It is also of course the case that if Bear Stearns had been allowed to fail, the failure of Lehman might have gone very differently.  And Bear Sterns probably could have failed without sinking the financial sector. 
• What Skeel thinks bankruptcy does and the preferred alternative taken by DF does not can be reduced to three of the four chief reasons he sees for having an insolvency regime: 
  • Bankruptcy imposes haircuts on creditors, especially unsecured ones, while resolution - at least if the government cannot resist the urge to bail out creditors at one hundred cents on the dollar - does not distribute losses among creditors.  Haircuts would lead to market discipline for debtor banks, as the creditors will monitor the bank?s solvency. 
  • Resolution puts the decision to fail a bank in the hands of the regulator rather than through the more market-driven bankruptcy process. 
  • DF limits the kinds of useful restructuring that the FDIC can impose on resolved banks, but bankruptcy permits creative restructuring.  That may be better for the financial institution and the financial sector as a whole.
  • The fourth thing that bankruptcy and resolution are supposed to do, viz. insure systemic stability by providing for orderly windups, Skeel says is provided by DF, but at the cost of doing a bad job for the other three.
• If I had to critique the trust-in-bankruptcy paradigm, I might point to the automobile bankruptcies. They do not appear to have been bad but nor were they a panacea (Skeel says that these were miscarriages of bankruptcy, with too much government interference in the process).  Skeel has more belief in the technical expertise of bankruptcy judges than I do, too.  It could be that we want particularly dangerous bankruptcies - and the financial sector is always a risk for contagion - to be handled by particularly expert bankruptcy specialists.  That's what resolution authority and the FDIC is supposed to provide. 
• Two nice things that Skeel does in the book is to identify two objectives to think about with DF.  He says the statute?s
  • "first objective is to limit risk before the fact ? before an institution or a market collapses. []  The second objective is to limit the destruction caused in the event that is systemically important institution does indeed fail, despite everyone's best efforts to prevent that from happening."

• If those are the goals of DF, Skeel is concerned that rather less salubrious themes have also emerged from the legislation:
  • "The two themes that emerge, repeatedly and unmistakably, from the 2,000 pages of legislation are (1) government partnership with the largest financial institutions and (2) ad hock intervention by regulators rather than a more predictable, rules-based response to crisis."