Senate Banking Hearing on TBTF Bankruptcy Reform
Senate Banking Committee
Subcommittee on Financial Institutions and Consumer Protection
“The Role of Bankruptcy Reform in Addressing Too-Big-to-Fail”
Wednesday, July 29, 2015
Key Topics & Takeaways
- Bankruptcy vs. Title II: Sen. Toomey (R-Pa.) asked if the market currently believes that bankruptcy, and not Title II, would be used to resolve a major financial institution. Taylor answered that it does not, but that the creation of a Chapter 14 would allow for bankruptcy to work in a credible way.
- Toomey Bill: Guynn said the Taxpayer Protection and Responsible Resolution Act would create a framework that allows losses to be imposed on creditors without creating runs, which will improve the bankruptcy code and improve the single point of entry process by adding legal certainty.
- Title I: Johnson argued that the intention of the Dodd-Frank Act was clear – that banks must show that they are resolvable under the existing bankruptcy code or else regulators should move to change their structures to make them “presumably smaller, presumably safer.”
Witnesses
- Randall Guynn, Davis Polk & Wardwell LLP
- Dr. John Taylor, Stanford University
- Thomas Jackson, University of Rochester
- Simon Johnson, MIT Sloan School of Management
Opening Statements
In his opening statement, Chairman Pat Toomey (R-Pa.) said the Dodd-Frank Act did not put an end to too-big-to-fail (TBTF), but instead enshrined it into law. Further he stated that Orderly Liquidation Authority (OLA), rather than eliminating taxpayer bailouts, creates “an explicit and limitless ability to draw on taxpayer resources.” Toomey said the designation of firms as systemically important and the associated regulation risks turning the financial sector in “public utilities”
Toomey listed his major concerns regarding the use of OLA, including: 1) giving regulators too much discretion to force liquidation; 2) not giving firms an opportunity to restructure; 3) a lack of expertise within the Federal Deposit Insurance Company (FDIC) to manage a bridge entity; and 4) FDIC discretion in the treatment of comparably situated creditors.
Toomey then discussed legislation he introduced with Sen. John Cornyn (R-Texas), the Taxpayer Protection and Responsible Resolution (TPRR) Act, which he said would repeal OLA, forbid taxpayer bailouts, and reform the bankruptcy code in a way that mitigates economic risks when resolving complex financial institutions. He stressed that bankruptcy is the preferred method of resolution, and that his bill would make Title I of Dodd-Frank more credible.
In his opening statement, Ranking Member Jeff Merkley (D-Ore.) said he was interested in the Toomey-Cornyn proposal and how effective the bankruptcy code may be in resolving complex institutions. Title II, he noted, was meant to resolve highly complex institutions and mitigate the risks to financial stability, and he expressed doubt that the bankruptcy code could accomplish this same goal.
Witness Testimony
Randall Guynn, Davis Polk & Wardwell LLP
In his testimony, Randall Guynn said the single point of entry (SPOE) recapitalization strategy can work under the existing bankruptcy code if three conditions are met: 1) top-tier parent companies must have enough usable total loss-absorbing capacity (TLAC) that is subordinate to short-term debt; 2) the parent must have access to a secure liquidity facility, such as the Federal Reserve’s discount window, or enough liquidity on its balance sheet to self-insure against liquidity risk; and 3) groups must eliminate most cross-defaults in their derivatives contracts that would allow counterparties to drain liquidity. He noted that U.S. globally systemically important banks (GSIBs) have made substantial progress on all three fronts.
Guynn repeated that he believes SPOE can be done under the existing bankruptcy code, but that there is room for improvement. He said adding a new Chapter 14 along the lines of the TPRR Act “should achieve this goal.”
Dr. John Taylor, Stanford University
Dr. John Taylor, in his testimony, stressed that bankruptcy reform is essential to addressing TBTF. He explained that Chapter 11 is beneficial because it relies on the law, but that it has drawbacks for large financial institutions, including the slow process and the inexperience of judges regarding financial institutions. He said the inclusion in the TPRR Act of strict priority rules for bankruptcy and the use of expert judges, as well as the rapid creation of a recapitalized bridge company, would address these shortcomings and allow bankruptcy to operate more quickly.
Taylor opined that a new Chapter 14 would work better than Title II because: 1) it would limit the FDIC’s discretion and minimize the chance of bailouts; 2) decisions would be made by the reorganized private parties under court oversight; and 3) under Chapter 14, living wills would be much more feasible.
Thomas Jackson, University of Rochester
In his testimony, Thomas Jackson said the bankruptcy code can be amended modestly to facilitate the “best possible resolution” of a financial institution. He said the best possible resolution would meet four tests: 1) it minimizes losses and places them on pre-identified parties; 2) it minimizes systemic consequences; 3) it results in no government bailouts; and 4) it includes predictability that conforms to the rule of law.
Jackson said there is a “disconnect” between these premises and the current bankruptcy code, because the SPOE approach requires rapid recapitalization that “leaves behind” equity and loss-bearing debt while transferring all assets to bridge companies. The current bankruptcy code, he explained, cannot provide necessary assurance of this rapid recapitalization. He commented that bankruptcy judges may not feel comfortable in a short process without clear statutory authorization. The TPRR Act, Jackson said, provides for needed changes to the bankruptcy code. He stressed that “minor disagreements” should not hold back the legislation’s changes.
Simon Johnson, MIT Sloan School of Management
Simon Johnson, in his testimony, said all companies should be able to go bankrupt, and that all should be subject to the same bankruptcy code. He commented that if there is agreement that large institutions will have trouble going bankrupt, then there are “two routes forward,” to either change the bankruptcy code selectively for those firms, or to change the firms themselves. He stressed that the biggest issue with the resolution of major financial institutions is that they are global firms, and foreign regulators would not cooperate in a bankruptcy process. Because of this, he argued for a need to “change the global nature” of these institutions.
Johnson also called TLAC “a complete illusion” because “there is no such thing as loss-absorbing debt.” He advocated for banks to hold more equity as a key to addressing the bankruptcy issue.
Questions and Answers
TLAC
Toomey asked Gyunn to respond to Johnson’s argument that TLAC will not serve as loss-absorbing debt. Gyunn answered that he “obviously disagrees” with Johnson, as does the FDIC and the National Bankruptcy Conference. He explained that since TLAC debt converts to equity, it must be loss-absorbing.
Toomey asked if the status quo of OLA and the current bankruptcy code could increase the risk of a failure in the event of a market disruption. Taylor replied that Title I is not working because of problems with the existing bankruptcy code, so legislation would help for this purpose alone. He then added that he is concerned about the operations of Title II and the “great discretion” given to the FDIC that creates uncertainty. Jackson commented that the status quo may not increase the likelihood of failure, but that it “pushes everyone” to Title II proceedings under OLA.
Toomey asked if the market currently believes that bankruptcy, and not Title II, would be used to resolve a major financial institution. Taylor answered that it does not, but that the creation of a Chapter 14 would allow for bankruptcy to work in a credible way.
Sen. Elizabeth Warren (D-Mass.) said she was struck by Taylor’s point that the market does not believe the government would not bail out big banks, and stressed that this is why livings wills, regulatory structure, and Glass-Steagall are so important to change market beliefs.
Toomey then asked if the use of Title II could generate confusion in an institution’s reorganization and lead lawmakers to ignore OLA in favor of another massive bailout. Taylor replied that this is a real concern because the discretion given to the FDIC under Title II creates uncertainty on the part of creditors and could lead to significant pressure for a bailout.
Merkley asked if the witnesses would support the repeal of Title II. Johnson replied that the backstop of Title II is needed, but that banks should not be “left off the hook” for not changing their structures to be resolvable under bankruptcy. Jackson said TPRR would diminish the need for Title II, but that he would keep it as a backstop. Guynn added that even the FDIC would support legislation to make Title II less necessary, but that retaining Title II is useful for cooperation with foreign regulators.
Toomey asked if the TPRR reforms to create a panel of experienced judges to handle financial institution bankruptcies, force a 48-hour stay on financial contracts, and to create a bridge company, are important changes to the bankruptcy code. Guynn agreed that all three are useful reforms, and highlighted the importance of such a process being “spelled out in statute” to make judges’ legal authority clear.
Toomey pointed to “clear disagreement on one fundamental thing” with Johnson. He explained that while Johnson believes regulators should shrink the banks so that they can be resolved under the current code, he thinks the problem that should be addressed is the inadequacy of the bankruptcy code itself. He asked if the changes he has proposed to the bankruptcy code will lead the market to believe that bankruptcy can work and that it would be used. Taylor replied that it would, and that TPRR is a way to “go through bankruptcy without causing spillovers.”
Guynn said the bill would create a framework that allows losses to be imposed on creditors without creating runs, which will improve the bankruptcy code and improve the SPOE process by adding legal certainty.
Merkley noted that Taylor said the living will process is not working, and asked what can be done to improve it. Taylor answered that creating something like Chapter 14 would make it feasible for firms to submit living wills that are consistent with a bankruptcy process that does not require a government bailout.
Johnson countered that the intention of the Dodd-Frank Act was clear – that banks must show that they are resolvable under the existing bankruptcy code or else regulators should move to change their structures to make them “presumably smaller, presumably safer.”
Merkley noted concern that the Orderly Liquidation Fund (OLF) can become a taxpayer-funded bailout, but that the credit was envisioned as a way for the FDIC to provide fully-secured loans to sufficiently capitalized or recapitalized firms with the costs covered by the assets of a financial company. Guynn commented that the FDIC has announced that this is how they would use the OLF, but that the issue is that these standards are not embedded in statute.
Jackson said the bridge institution created through SPOE is recapitalized and should look immediately solvent to the market, and be able to “get its own liquidity.” However, he said the Federal Reserve’s emergency lending powers “would seem to be a good backup.” Johnson doubted that bankruptcy could work without some sort of government-provided financing.
Warren expressed concern that TPRR repeals Title II and does not establish a source for short-term liquidity. She asserted that it is not realistic to expect the market to provide short-term liquidity to a failing institution, and asked if this would “put us back where we were in 2008” when Congress had to either step up to provide a bailout or risk a financial meltdown. Johnson agreed that “you would face another moment like that.”
Toomey noted that his legislation has been criticized for not including a government funding mechanism, but stated that he believes the inclusion of one would put taxpayers at risk.
Executive Accountability
Warren criticized the Chairman’s bill for allowing Chief Executive Officers (CEOs) and bank management to keep their positions and compensation, and asked if the bill does enough to discourage senior management from taking big risks. Johnson answered that it does not.
Toomey countered that the bankruptcy loss does not “force senior executives to be fired” for any other types of companies.
Warren responded that non-financial firms do not threaten the whole economy when they fail, and suggested that this should “change the calculus” of whether the law should hold their executives accountable.
International Coordination
Johnson warned that the changes to the bankruptcy code being discussed cannot change expectations for what will happen with the major financial institutions because they operate globally, and foreign regulators will only cooperate in a Title II resolution, not a bankruptcy process.
Merkley asked if the bankruptcy system has sufficient power to address the complexity of “sprawling” holding companies with thousands of subsidiaries around the globe. Johnson alluded to discussions he has had with Bank of England officials who said they would cooperate with the U.S. under Title II, but that there is “no chance” they would cooperate with a bankruptcy process.
Guynn said the question of international cooperation is a “red herring” because SPOE only puts the U.S. parent company through bankruptcy, and so there would be no decisions for foreign regulators to make.
Johnson reiterated that European regulators will only work with the FDIC in a Title II process, noting that a memorandum of understanding exists with the Bank of England for this process but not for bankruptcy.
For more information on this event, please click here.
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Senate Banking Committee
Subcommittee on Financial Institutions and Consumer Protection
“The Role of Bankruptcy Reform in Addressing Too-Big-to-Fail”
Wednesday, July 29, 2015
Key Topics & Takeaways
- Bankruptcy vs. Title II: Sen. Toomey (R-Pa.) asked if the market currently believes that bankruptcy, and not Title II, would be used to resolve a major financial institution. Taylor answered that it does not, but that the creation of a Chapter 14 would allow for bankruptcy to work in a credible way.
- Toomey Bill: Guynn said the Taxpayer Protection and Responsible Resolution Act would create a framework that allows losses to be imposed on creditors without creating runs, which will improve the bankruptcy code and improve the single point of entry process by adding legal certainty.
- Title I: Johnson argued that the intention of the Dodd-Frank Act was clear – that banks must show that they are resolvable under the existing bankruptcy code or else regulators should move to change their structures to make them “presumably smaller, presumably safer.”
Witnesses
- Randall Guynn, Davis Polk & Wardwell LLP
- Dr. John Taylor, Stanford University
- Thomas Jackson, University of Rochester
- Simon Johnson, MIT Sloan School of Management
Opening Statements
In his opening statement, Chairman Pat Toomey (R-Pa.) said the Dodd-Frank Act did not put an end to too-big-to-fail (TBTF), but instead enshrined it into law. Further he stated that Orderly Liquidation Authority (OLA), rather than eliminating taxpayer bailouts, creates “an explicit and limitless ability to draw on taxpayer resources.” Toomey said the designation of firms as systemically important and the associated regulation risks turning the financial sector in “public utilities”
Toomey listed his major concerns regarding the use of OLA, including: 1) giving regulators too much discretion to force liquidation; 2) not giving firms an opportunity to restructure; 3) a lack of expertise within the Federal Deposit Insurance Company (FDIC) to manage a bridge entity; and 4) FDIC discretion in the treatment of comparably situated creditors.
Toomey then discussed legislation he introduced with Sen. John Cornyn (R-Texas), the Taxpayer Protection and Responsible Resolution (TPRR) Act, which he said would repeal OLA, forbid taxpayer bailouts, and reform the bankruptcy code in a way that mitigates economic risks when resolving complex financial institutions. He stressed that bankruptcy is the preferred method of resolution, and that his bill would make Title I of Dodd-Frank more credible.
In his opening statement, Ranking Member Jeff Merkley (D-Ore.) said he was interested in the Toomey-Cornyn proposal and how effective the bankruptcy code may be in resolving complex institutions. Title II, he noted, was meant to resolve highly complex institutions and mitigate the risks to financial stability, and he expressed doubt that the bankruptcy code could accomplish this same goal.
Witness Testimony
Randall Guynn, Davis Polk & Wardwell LLP
In his testimony, Randall Guynn said the single point of entry (SPOE) recapitalization strategy can work under the existing bankruptcy code if three conditions are met: 1) top-tier parent companies must have enough usable total loss-absorbing capacity (TLAC) that is subordinate to short-term debt; 2) the parent must have access to a secure liquidity facility, such as the Federal Reserve’s discount window, or enough liquidity on its balance sheet to self-insure against liquidity risk; and 3) groups must eliminate most cross-defaults in their derivatives contracts that would allow counterparties to drain liquidity. He noted that U.S. globally systemically important banks (GSIBs) have made substantial progress on all three fronts.
Guynn repeated that he believes SPOE can be done under the existing bankruptcy code, but that there is room for improvement. He said adding a new Chapter 14 along the lines of the TPRR Act “should achieve this goal.”
Dr. John Taylor, Stanford University
Dr. John Taylor, in his testimony, stressed that bankruptcy reform is essential to addressing TBTF. He explained that Chapter 11 is beneficial because it relies on the law, but that it has drawbacks for large financial institutions, including the slow process and the inexperience of judges regarding financial institutions. He said the inclusion in the TPRR Act of strict priority rules for bankruptcy and the use of expert judges, as well as the rapid creation of a recapitalized bridge company, would address these shortcomings and allow bankruptcy to operate more quickly.
Taylor opined that a new Chapter 14 would work better than Title II because: 1) it would limit the FDIC’s discretion and minimize the chance of bailouts; 2) decisions would be made by the reorganized private parties under court oversight; and 3) under Chapter 14, living wills would be much more feasible.
Thomas Jackson, University of Rochester
In his testimony, Thomas Jackson said the bankruptcy code can be amended modestly to facilitate the “best possible resolution” of a financial institution. He said the best possible resolution would meet four tests: 1) it minimizes losses and places them on pre-identified parties; 2) it minimizes systemic consequences; 3) it results in no government bailouts; and 4) it includes predictability that conforms to the rule of law.
Jackson said there is a “disconnect” between these premises and the current bankruptcy code, because the SPOE approach requires rapid recapitalization that “leaves behind” equity and loss-bearing debt while transferring all assets to bridge companies. The current bankruptcy code, he explained, cannot provide necessary assurance of this rapid recapitalization. He commented that bankruptcy judges may not feel comfortable in a short process without clear statutory authorization. The TPRR Act, Jackson said, provides for needed changes to the bankruptcy code. He stressed that “minor disagreements” should not hold back the legislation’s changes.
Simon Johnson, MIT Sloan School of Management
Simon Johnson, in his testimony, said all companies should be able to go bankrupt, and that all should be subject to the same bankruptcy code. He commented that if there is agreement that large institutions will have trouble going bankrupt, then there are “two routes forward,” to either change the bankruptcy code selectively for those firms, or to change the firms themselves. He stressed that the biggest issue with the resolution of major financial institutions is that they are global firms, and foreign regulators would not cooperate in a bankruptcy process. Because of this, he argued for a need to “change the global nature” of these institutions.
Johnson also called TLAC “a complete illusion” because “there is no such thing as loss-absorbing debt.” He advocated for banks to hold more equity as a key to addressing the bankruptcy issue.
Questions and Answers
TLAC
Toomey asked Gyunn to respond to Johnson’s argument that TLAC will not serve as loss-absorbing debt. Gyunn answered that he “obviously disagrees” with Johnson, as does the FDIC and the National Bankruptcy Conference. He explained that since TLAC debt converts to equity, it must be loss-absorbing.
Toomey asked if the status quo of OLA and the current bankruptcy code could increase the risk of a failure in the event of a market disruption. Taylor replied that Title I is not working because of problems with the existing bankruptcy code, so legislation would help for this purpose alone. He then added that he is concerned about the operations of Title II and the “great discretion” given to the FDIC that creates uncertainty. Jackson commented that the status quo may not increase the likelihood of failure, but that it “pushes everyone” to Title II proceedings under OLA.
Toomey asked if the market currently believes that bankruptcy, and not Title II, would be used to resolve a major financial institution. Taylor answered that it does not, but that the creation of a Chapter 14 would allow for bankruptcy to work in a credible way.
Sen. Elizabeth Warren (D-Mass.) said she was struck by Taylor’s point that the market does not believe the government would not bail out big banks, and stressed that this is why livings wills, regulatory structure, and Glass-Steagall are so important to change market beliefs.
Toomey then asked if the use of Title II could generate confusion in an institution’s reorganization and lead lawmakers to ignore OLA in favor of another massive bailout. Taylor replied that this is a real concern because the discretion given to the FDIC under Title II creates uncertainty on the part of creditors and could lead to significant pressure for a bailout.
Merkley asked if the witnesses would support the repeal of Title II. Johnson replied that the backstop of Title II is needed, but that banks should not be “left off the hook” for not changing their structures to be resolvable under bankruptcy. Jackson said TPRR would diminish the need for Title II, but that he would keep it as a backstop. Guynn added that even the FDIC would support legislation to make Title II less necessary, but that retaining Title II is useful for cooperation with foreign regulators.
Toomey asked if the TPRR reforms to create a panel of experienced judges to handle financial institution bankruptcies, force a 48-hour stay on financial contracts, and to create a bridge company, are important changes to the bankruptcy code. Guynn agreed that all three are useful reforms, and highlighted the importance of such a process being “spelled out in statute” to make judges’ legal authority clear.
Toomey pointed to “clear disagreement on one fundamental thing” with Johnson. He explained that while Johnson believes regulators should shrink the banks so that they can be resolved under the current code, he thinks the problem that should be addressed is the inadequacy of the bankruptcy code itself. He asked if the changes he has proposed to the bankruptcy code will lead the market to believe that bankruptcy can work and that it would be used. Taylor replied that it would, and that TPRR is a way to “go through bankruptcy without causing spillovers.”
Guynn said the bill would create a framework that allows losses to be imposed on creditors without creating runs, which will improve the bankruptcy code and improve the SPOE process by adding legal certainty.
Merkley noted that Taylor said the living will process is not working, and asked what can be done to improve it. Taylor answered that creating something like Chapter 14 would make it feasible for firms to submit living wills that are consistent with a bankruptcy process that does not require a government bailout.
Johnson countered that the intention of the Dodd-Frank Act was clear – that banks must show that they are resolvable under the existing bankruptcy code or else regulators should move to change their structures to make them “presumably smaller, presumably safer.”
Merkley noted concern that the Orderly Liquidation Fund (OLF) can become a taxpayer-funded bailout, but that the credit was envisioned as a way for the FDIC to provide fully-secured loans to sufficiently capitalized or recapitalized firms with the costs covered by the assets of a financial company. Guynn commented that the FDIC has announced that this is how they would use the OLF, but that the issue is that these standards are not embedded in statute.
Jackson said the bridge institution created through SPOE is recapitalized and should look immediately solvent to the market, and be able to “get its own liquidity.” However, he said the Federal Reserve’s emergency lending powers “would seem to be a good backup.” Johnson doubted that bankruptcy could work without some sort of government-provided financing.
Warren expressed concern that TPRR repeals Title II and does not establish a source for short-term liquidity. She asserted that it is not realistic to expect the market to provide short-term liquidity to a failing institution, and asked if this would “put us back where we were in 2008” when Congress had to either step up to provide a bailout or risk a financial meltdown. Johnson agreed that “you would face another moment like that.”
Toomey noted that his legislation has been criticized for not including a government funding mechanism, but stated that he believes the inclusion of one would put taxpayers at risk.
Executive Accountability
Warren criticized the Chairman’s bill for allowing Chief Executive Officers (CEOs) and bank management to keep their positions and compensation, and asked if the bill does enough to discourage senior management from taking big risks. Johnson answered that it does not.
Toomey countered that the bankruptcy loss does not “force senior executives to be fired” for any other types of companies.
Warren responded that non-financial firms do not threaten the whole economy when they fail, and suggested that this should “change the calculus” of whether the law should hold their executives accountable.
International Coordination
Johnson warned that the changes to the bankruptcy code being discussed cannot change expectations for what will happen with the major financial institutions because they operate globally, and foreign regulators will only cooperate in a Title II resolution, not a bankruptcy process.
Merkley asked if the bankruptcy system has sufficient power to address the complexity of “sprawling” holding companies with thousands of subsidiaries around the globe. Johnson alluded to discussions he has had with Bank of England officials who said they would cooperate with the U.S. under Title II, but that there is “no chance” they would cooperate with a bankruptcy process.
Guynn said the question of international cooperation is a “red herring” because SPOE only puts the U.S. parent company through bankruptcy, and so there would be no decisions for foreign regulators to make.
Johnson reiterated that European regulators will only work with the FDIC in a Title II process, noting that a memorandum of understanding exists with the Bank of England for this process but not for bankruptcy.
For more information on this event, please click here.