February 22, 2018

Treasury Proposes Dubious, Untested Chapter 14 Bankruptcies for Too Big to Fail Banks

The Trump Treasury has proposed changing Dodd Frank rules, supposedly to make resolving Too Big to Fail banks easier.

The Treasury yesterday proposed replacing the resolution scheme under Dodd Frank, called the Orderly Liquidation Authority, confusingly also called Title II liquidations, with a new type of bankruptcy, Chapter 14. While there was a lot not to like about the OLA, Chapter 14 is no better and in key respects, markedly worse.

The costly fallacy underlying Chapter 14 is the idea that big banks can be wound up without a taxpayer backstop. And despite Treasury’s chest thumping that taxpayer monies won’t be at risk, in fact, government funding is still available if needed.

And like it or not, that makes sense. The reality is that banks provide critical infrastructure for commerce, known as a payment system. Recall that in the crisis, the authorities had to guarantee money market mutual funds up to $250,000 because the Lehman implosion brought down the Reserve Fund, precipitating a run on mutual funds. Mutual funds are big participants in the repo market, which is critical for financing the trading of banks and large investors.

We’ve embedded the Treasury proposal at the end of this post. Note that some measures could be implemented by regulators directly, but the Chapter 14 scheme requires Congressional approval.

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