BPC and Hoover Institution on Ending TBTF
Bipartisan Policy Center
Hoover Institution
“Ending Too Big to Fail: Reform and Implementation”
Friday, January 22, 2016
Key Topics & Takeaways
- Chapter 14 Bankruptcy: Thomas Jackson stressed that focused amendments to the Bankruptcy Code, in the form of a new Chapter 14, are the necessary solution to resolvability through bankruptcy. He said it would require specific loss-absorbing capacities known in advance, specific statutory authorization for rapid transfers of assets, and stays and overrides to enable this transfer to happen.
- TBTF: Paul Tucker described the disagreement over whether too big to fail has been solved as no more than an “intra-DC struggle,” and suggested that officials have to “get out and explain what they’ve done” to the American people.
- TLAC: FDIC Vice Chairman Thomas Hoenig, who was in the audience, said his concern with TLAC is that it forces institutions into a single model that will force them to change their business models and increase leverage. He commented that strong equity is the best way to deal with contagion.
Speakers
- Thomas Jackson, President Emeritus, University of Rochester
- Paul Tucker, Chair, Systemic Risk Council
- Wilson Ervin, Vice Chairman, Credit Suisse
- Randall Guynn, Head of Financial Institutions Group, Davis Polk & Wardwell LLP
- Emily Kapur, Hoover Institution
- William Kroener III, Senior Council, Sullivan & Cromwell LLP
Opening Remarks
Thomas Jackson, President Emeritus, University of Rochester
Jackson said four conditions need to be met for bankruptcy law to play the best possible role in resolution: 1) it should minimize losses and place them on pre-determined parties; 2) it should minimize systemic consequences; 3) it should not result in a bailout; and 4) it should be predictable in its conformance to the rule of law. He added that any resolution system must also involve loss-bearing capacity known in advance.
The current bankruptcy law, Jackson opined, “comes up short” and Chapter 11 will struggle with financial institutions because the transfer of assets and subsidiaries to a new bridge company must be done with great speed to restore market confidence without contagion. He worried that a judge may not feel comfortable with the rapid transfer of assets within a 48-hour period, which makes resolution plans under bankruptcy impossible and leads to Title II’s Orderly Liquidation Authority (OLA) becoming the default resolution mechanism.
Jackson stressed that focused amendments to the Bankruptcy Code, in the form of a new Chapter 14, are the necessary solution. He said it would require specific loss-absorbing capacities known in advance, specific statutory authorization for rapid transfers of assets, and stays and overrides to enable this transfer to happen.
Emily Kapur, Hoover Institution
Kapur outlined her chapter in the Hoover Institution’s new book, Making Failure Feasible: How Bankruptcy Reform Can End Too Big To Fail, which theorizes what would have happened to Lehman Brothers under the proposed Chapter 14 bankruptcy. She explained that firms must file for bankruptcy before a run begins, and that in the event that a firm is unwilling to do so, the Federal Reserve could initiate a case and trigger an automatic stay. Kapur said that while the time frame will be short, firms will have already worked with the Fed to develop resolution plans under Chapter 14, so no one would be “caught by surprise.” The transfer of assets to a new holding company, she went on, would create a well-capitalized firm that gives investors no reason to run.
Kapur stated that under certain reasonable assumptions, a Chapter 14 case would have been able to return Lehman Brothers to solvency, with creditors taking on far fewer losses. She stressed, however, that Chapter 14 could only work with international cooperation and planning.
William Kroener III, Senior Council, Sullivan & Cromwell LLP
Kroener stated that while Title I of the Dodd-Frank Act requires institutions to develop living wills to show how they can be resolved under the Bankruptcy Code, there have been challenges because of the current Code’s unsuitability for financial intermediaries. He said the Chapter 14 proposal addresses difficulties with timing and makes it easier to write credible living wills, which would in turn make it less necessary to default to OLA for resolution.
Questions
Asked whether the Federal Reserve is capable of making the right decision between a bailout and bankruptcy for a failing firm, Jackson answered that Title II of Dodd-Frank “pretty severely limits” the ability of financial institutions to be bailed out. Kroener added that the availability of Chapter 14 would leave less of a need to resort to OLA.
Asked whether Title II should be repealed altogether, as has been discussed by some in Congress, Jackson replied that a more focused bill that only establishes Chapter 14 without repealing Title II is more likely to be passed. He also reiterated that concerns with Title II should be allayed with Chapter 14 making it less likely to be used.
Panel Discussion
Preparedness to Handle Firm Failure
Asked how prepared regulators are to deal with a failing firm today as compared to before the financial crisis, Randall Guynn, Head of Financial Institutions Group, Davis Polk & Wardwell LLP, noted that there was “no real contingency planning” prior to the crisis and regulators did not have the legal tools to deal with a failing institution. However, he explained, it is very different today with living wills and the development of the single point of entry (SPOE) strategy. He expressed his belief that a failing firm could be resolved under the current Bankruptcy Code.
Guynn also added that firms are more resilient, with far greater liquidity and capital on bank balance sheets. Guynn even commented that there is enough liquidity on balance sheets today that lender of last resort powers may not be needed, and he said this calls into question whether there has been too much focus on liquidity, which in turn hurts lending.
Paul Tucker, Chair, Systemic Risk Council, commented that there is no reason why a major firm’s failure should lead to taxpayer support today, but this “doesn’t mean it would be calm.” He said the only challenge is how you choose which creditors should take losses, but that the structure of subordinated debt does not leave this in question. Tucker added that the U.S. “should be pleased as a nation” that it has already established the power to handle a failure, and that whether it should be done in court or by an administrator is a “second order question.”
Wilson Ervin, Vice Chairman, Credit Suisse, agreed with Tucker’s assessment that the U.S. has “already cracked this problem” and added that the markets know it.
The panel was next asked why there is disagreement that the problem of too big to fail (TBTF) has been solved. Tucker described the disagreement as no more than an “intra-DC struggle,” and suggested that American officials have to “get out and explain what they’ve done” to the American people. Ervin said the industry has been stuck with a bad label in “TBTF,” which focused people’s attention on the size of firms rather than their inherent resolvability.
TLAC
Asked whether the Financial Stability Board (FSB) “got it right” with its total loss absorbing capacity (TLAC) standard, Ervin answered that while there are some issues, the TLAC proposal is “well-scaled” and would have been enough for any of the banks to be recapitalized during the crisis.
An audience member followed up by asked who would hold TLAC debt. Tucker said the real question is who should not hold these bonds, and he listed other banks and dealers. Ervin commented that while it is important to be careful about who can hold the debt, it will require “big markets” and he said it should not face higher standards than equity.
It was noted that Vice Chairman Thomas Hoenig of the Federal Deposit Insurance Corporation (FDIC) has criticized TLAC, warning that it gives a strong incentive to increase leverage and reach for yield to service the debt and that there should be more focus on equity rather than TLAC. Jackson retorted that debt has an advantage over equity in that it also serves as a “monitoring function” for creditors and leaves them with a strong incentive to watch over what a firm’s management is doing.
Tucker said he is not comfortable with the exercise of discretion by the Fed or FDIC in deciding the required level of TLAC, “given the scale of lobbying.” He suggested that requiring as much TLAC as equity would be a “pretty simple thing to explain.”
Hoenig, who was in the audience, commented that if Tucker is concerned with regulator discretion, then he has a problem with the living will process as a whole. He added that his concern with TLAC is that it forces institutions into a single model that will force them to change their business models and increase leverage. He reiterated that strong equity is the best way to deal with contagion.
Living Wills
Guynn said the living will process is “still a little opaque” in terms of how the plans are graded, and commented that the fact that all institutions failed the test in the past implies problems with the process, not just the firms.
Tucker stated that “no one thinks” any major firm will be put through bankruptcy with the current state of the Bankruptcy Code, and if this is the case then it is a “terrible tragedy to waste all this effort on living wills.” He stressed the importance of discussing the Chapter 14 proposal.
For more information on this event, please click here.
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Bipartisan Policy Center
Hoover Institution
“Ending Too Big to Fail: Reform and Implementation”
Friday, January 22, 2016
Key Topics & Takeaways
- Chapter 14 Bankruptcy: Thomas Jackson stressed that focused amendments to the Bankruptcy Code, in the form of a new Chapter 14, are the necessary solution to resolvability through bankruptcy. He said it would require specific loss-absorbing capacities known in advance, specific statutory authorization for rapid transfers of assets, and stays and overrides to enable this transfer to happen.
- TBTF: Paul Tucker described the disagreement over whether too big to fail has been solved as no more than an “intra-DC struggle,” and suggested that officials have to “get out and explain what they’ve done” to the American people.
- TLAC: FDIC Vice Chairman Thomas Hoenig, who was in the audience, said his concern with TLAC is that it forces institutions into a single model that will force them to change their business models and increase leverage. He commented that strong equity is the best way to deal with contagion.
Speakers
- Thomas Jackson, President Emeritus, University of Rochester
- Paul Tucker, Chair, Systemic Risk Council
- Wilson Ervin, Vice Chairman, Credit Suisse
- Randall Guynn, Head of Financial Institutions Group, Davis Polk & Wardwell LLP
- Emily Kapur, Hoover Institution
- William Kroener III, Senior Council, Sullivan & Cromwell LLP
Opening Remarks
Thomas Jackson, President Emeritus, University of Rochester
Jackson said four conditions need to be met for bankruptcy law to play the best possible role in resolution: 1) it should minimize losses and place them on pre-determined parties; 2) it should minimize systemic consequences; 3) it should not result in a bailout; and 4) it should be predictable in its conformance to the rule of law. He added that any resolution system must also involve loss-bearing capacity known in advance.
The current bankruptcy law, Jackson opined, “comes up short” and Chapter 11 will struggle with financial institutions because the transfer of assets and subsidiaries to a new bridge company must be done with great speed to restore market confidence without contagion. He worried that a judge may not feel comfortable with the rapid transfer of assets within a 48-hour period, which makes resolution plans under bankruptcy impossible and leads to Title II’s Orderly Liquidation Authority (OLA) becoming the default resolution mechanism.
Jackson stressed that focused amendments to the Bankruptcy Code, in the form of a new Chapter 14, are the necessary solution. He said it would require specific loss-absorbing capacities known in advance, specific statutory authorization for rapid transfers of assets, and stays and overrides to enable this transfer to happen.
Emily Kapur, Hoover Institution
Kapur outlined her chapter in the Hoover Institution’s new book, Making Failure Feasible: How Bankruptcy Reform Can End Too Big To Fail, which theorizes what would have happened to Lehman Brothers under the proposed Chapter 14 bankruptcy. She explained that firms must file for bankruptcy before a run begins, and that in the event that a firm is unwilling to do so, the Federal Reserve could initiate a case and trigger an automatic stay. Kapur said that while the time frame will be short, firms will have already worked with the Fed to develop resolution plans under Chapter 14, so no one would be “caught by surprise.” The transfer of assets to a new holding company, she went on, would create a well-capitalized firm that gives investors no reason to run.
Kapur stated that under certain reasonable assumptions, a Chapter 14 case would have been able to return Lehman Brothers to solvency, with creditors taking on far fewer losses. She stressed, however, that Chapter 14 could only work with international cooperation and planning.
William Kroener III, Senior Council, Sullivan & Cromwell LLP
Kroener stated that while Title I of the Dodd-Frank Act requires institutions to develop living wills to show how they can be resolved under the Bankruptcy Code, there have been challenges because of the current Code’s unsuitability for financial intermediaries. He said the Chapter 14 proposal addresses difficulties with timing and makes it easier to write credible living wills, which would in turn make it less necessary to default to OLA for resolution.
Questions
Asked whether the Federal Reserve is capable of making the right decision between a bailout and bankruptcy for a failing firm, Jackson answered that Title II of Dodd-Frank “pretty severely limits” the ability of financial institutions to be bailed out. Kroener added that the availability of Chapter 14 would leave less of a need to resort to OLA.
Asked whether Title II should be repealed altogether, as has been discussed by some in Congress, Jackson replied that a more focused bill that only establishes Chapter 14 without repealing Title II is more likely to be passed. He also reiterated that concerns with Title II should be allayed with Chapter 14 making it less likely to be used.
Panel Discussion
Preparedness to Handle Firm Failure
Asked how prepared regulators are to deal with a failing firm today as compared to before the financial crisis, Randall Guynn, Head of Financial Institutions Group, Davis Polk & Wardwell LLP, noted that there was “no real contingency planning” prior to the crisis and regulators did not have the legal tools to deal with a failing institution. However, he explained, it is very different today with living wills and the development of the single point of entry (SPOE) strategy. He expressed his belief that a failing firm could be resolved under the current Bankruptcy Code.
Guynn also added that firms are more resilient, with far greater liquidity and capital on bank balance sheets. Guynn even commented that there is enough liquidity on balance sheets today that lender of last resort powers may not be needed, and he said this calls into question whether there has been too much focus on liquidity, which in turn hurts lending.
Paul Tucker, Chair, Systemic Risk Council, commented that there is no reason why a major firm’s failure should lead to taxpayer support today, but this “doesn’t mean it would be calm.” He said the only challenge is how you choose which creditors should take losses, but that the structure of subordinated debt does not leave this in question. Tucker added that the U.S. “should be pleased as a nation” that it has already established the power to handle a failure, and that whether it should be done in court or by an administrator is a “second order question.”
Wilson Ervin, Vice Chairman, Credit Suisse, agreed with Tucker’s assessment that the U.S. has “already cracked this problem” and added that the markets know it.
The panel was next asked why there is disagreement that the problem of too big to fail (TBTF) has been solved. Tucker described the disagreement as no more than an “intra-DC struggle,” and suggested that American officials have to “get out and explain what they’ve done” to the American people. Ervin said the industry has been stuck with a bad label in “TBTF,” which focused people’s attention on the size of firms rather than their inherent resolvability.
TLAC
Asked whether the Financial Stability Board (FSB) “got it right” with its total loss absorbing capacity (TLAC) standard, Ervin answered that while there are some issues, the TLAC proposal is “well-scaled” and would have been enough for any of the banks to be recapitalized during the crisis.
An audience member followed up by asked who would hold TLAC debt. Tucker said the real question is who should not hold these bonds, and he listed other banks and dealers. Ervin commented that while it is important to be careful about who can hold the debt, it will require “big markets” and he said it should not face higher standards than equity.
It was noted that Vice Chairman Thomas Hoenig of the Federal Deposit Insurance Corporation (FDIC) has criticized TLAC, warning that it gives a strong incentive to increase leverage and reach for yield to service the debt and that there should be more focus on equity rather than TLAC. Jackson retorted that debt has an advantage over equity in that it also serves as a “monitoring function” for creditors and leaves them with a strong incentive to watch over what a firm’s management is doing.
Tucker said he is not comfortable with the exercise of discretion by the Fed or FDIC in deciding the required level of TLAC, “given the scale of lobbying.” He suggested that requiring as much TLAC as equity would be a “pretty simple thing to explain.”
Hoenig, who was in the audience, commented that if Tucker is concerned with regulator discretion, then he has a problem with the living will process as a whole. He added that his concern with TLAC is that it forces institutions into a single model that will force them to change their business models and increase leverage. He reiterated that strong equity is the best way to deal with contagion.
Living Wills
Guynn said the living will process is “still a little opaque” in terms of how the plans are graded, and commented that the fact that all institutions failed the test in the past implies problems with the process, not just the firms.
Tucker stated that “no one thinks” any major firm will be put through bankruptcy with the current state of the Bankruptcy Code, and if this is the case then it is a “terrible tragedy to waste all this effort on living wills.” He stressed the importance of discussing the Chapter 14 proposal.
For more information on this event, please click here.