145 posts categorized "Pending and New Legislation"

"Don't give me so much that you've given me nothing" - Remembering M. Caldwell Butler's Contribution to Bankruptcy Law

posted by Melissa Jacoby

Former Virginia Congressman M. Caldwell Butler died last week. He is widely known for his role in the Nixon impeachment proceedings, his efforts to limit extensions of the Voting Rights Act, and his support for ensuring legal representation for low-income individuals. But Congressman Butler is also a major figure in the history of bankruptcy law. He was a principal co-sponsor of the Bankruptcy Reform Act of 1978 that serves as the foundation of the modern bankruptcy system. Professor and lawyer Kenneth N. Klee worked closely with Congressman Butler on the House Judiciary Committee in the 1970s. I asked Professor Klee to share a few words of remembrance with us, which I repeat in their entirety here:

I first met M. Caldwell Butler in 1975 when he became the Ranking Minority Member of the Subcommittee on Civil and Constitutional Rights of the House Judiciary Committee. Caldwell was most interested in the Voting Rights Act legislation and finding a way for the South to get out from under the Act. In his view, Washington was improperly interfering with the sovereignty of the southern states based on predicate acts that had long since ceased to serve as a basis for federal control. He asked me to draft a series of amendments that would permit the South to extricate itself from the Voting Rights Act. The requirements to regain sovereignty were quite demanding, to the point that the amendments became known as the "impossible bailout."  Nevertheless, the amendments did not come close to passing. It was evident that there were no circumstances under which the majority in Congress wanted to let the southern states out from the Voting Rights Act.

Caldwell assumed his responsibilities over bankruptcy legislation with diligence and good cheer. His fabulous sense of humor carried us through many long markup sessions during which the members of the Subcommittee read the bankruptcy legislation line by line. He had a sharp legal mind and deep curiosity. He also was very practical and to the point. He was fond of telling me "don't give me so much that you've given me nothing."

It was a privilege and honor to work with him. The bankruptcy community should join in paying him tribute.

                        -- Ken Klee

Congressman Butler made another round of contributions to bankruptcy reform in the 1990s. The fact that they are not all reflected in today's Bankruptcy Code makes this story more pressing, not less. Well over a decade after he had returned to the practice of law in Virginia, Congressman Butler was appointed to the National Bankruptcy Review Commission, for which I was a staff attorney. Expressing satisfaction with the 1978 Code, the House Judiciary Committee directed this Bankruptcy Commission to focus, for two years, on "reviewing, improving, and updating the Code in ways which do not disturb the fundamental tenets of current law."  Not one to leave the heavy lifting to others, even in a pro bono post, Congressman Butler stepped up to the challenge of forging a compromise, among those with diverging politics and views, to improve the consumer bankruptcy system.

Continue reading ""Don't give me so much that you've given me nothing" - Remembering M. Caldwell Butler's Contribution to Bankruptcy Law" »

Operation Choke Point Hysteria: Are Choke Point's Critics Responsible for the Account Closings?

posted by Adam Levitin

At today's House Judiciary Committee hearing on Operation Choke Point it seemed that Choke Point's critics are conflating a fairly narrow DOJ civil investigation with separate general guidance given by prudential regulators.  In particular, Rep. Issa attempted to tie them together by noting that the DOJ referenced such guidance in its Choke Point subpoenas, but that's quite different than actually bringing a civil action on such a basis (or on the basis of "reputational risk"), which the DOJ has not done.  

There is a serious issue regarding the bank regulators' use of "guidance" to set policy. Guidance is usually informal and formally non-binding, but woe to the bank that does not comply--regulators have a lot of off-the-radar ways to make a bank's life miserable.  This isn't a Choke Point issue--this is a general problem that prudential bank regulation just doesn't fit within the administrative law paradigm.  There are lots of reasons it doesn't and perhaps shouldn't, but when it is discovered by people from outside of the banking world, it seems quite shocking, even though this is how bank regulation has always been done in living memory:  a small amount of formal rule-making and a lot of informal regulatory guidance.  By the same token, however, compliance with informal guidance is enforced informally, through the supervisory process, not through civil actions, precisely because the informal guidance is not actionable.  Yet, that is what Choke Point critics contend is being done--that DOJ is using civil actions to enforce informal guidance.  

I don't think that's correct (or at least it hasn't been shown).  But the conflation of DOJ action with prudential regulatory guidance may be creating the very problem Choke Point's critics fear.  

Bank compliance officers may be hearing what Choke Point critics are saying and believing it and acting on it.  If compliance officers believe that the DOJ will come after any bank that serves the high-risk industries identified by the FDIC or FinCEN, not just those that knowingly facilitate or wilfully ignore fraud, they will respond accordingly.  The safe thing to do in the compliance world is to follow the herd and avoid risks.  The attack on Operation Choke Point may well have spooked banks' compliance officers, who'd aren't going to parse through the technical distinctions involved.  

What matters is not what the DOJ actually does, but what compliance officers think the DOJ is doing, and they're likely to head the loudest voice in the room, that of Choke Point's critics.  So to the extent that we are having account terminations increasing after word got out of Operation Choke Point it might be because of Choke Point's critics' conflation of a narrowly tailored civil investigation with broad prudential guidance.  Ironically, we may have a self-fulfilling hysteria whipped up by Choke Point critics, who shoot first and ask questions later.  

The Puerto Rico Public Corporation Debt Enforcement and Recovery Act

posted by Melissa Jacoby


6/30 UPDATE: here's the  amended complaint.

The fast-moving legislation's title does not include the word bankruptcy. Materials distributed by the Puerto Rico government explain, though, that the bill is meant to provide chapter 9-like relief to Puerto Rico public corporations through one of two paths - one more prepack-like than the other. Calling the effort "dazzling," Cate Long notes, "[s]eldom have financial markets seen such an elegantly choreographed approach to haircutting sovereign debt."

However elegant, investors say the bill violates multiple provisions of the U.S. Constitution. Quiz yourself, or directly check out the action just filed in the U.S. District Court for the District of Puerto Rico seeking a declaratory judgment.  H/T Cate Long.

Puerto Rico flag courtesy of Shutterstock

The "New" New Legislation on Student Loans and Bankruptcy

posted by Melissa Jacoby

AbstractSenator Harkin's discussion draft of the Higher Education Affordability Act (described here) is expected to include a provision restoring bankruptcy relief from private for-profit student loans. A few years ago, I offered justifications for that move here. Prof. Scott Pryor agrees.

But wait, there's more. S.2471, The Medical Bankruptcy Fairness Act of 2014, introduced by Senator Sheldon Whitehouse, co-sponsored by Senator Elizabeth Warren. Section 6 would offer relief from student loans for some bankruptcy filers. Take a look. 

Abstract image courtesy of Shutterstock


Cooperation and Tolerance in Chapter 15

posted by Andrew Dawson

Chapter 15’s modified universalism structure requires cooperation between courts in different countries as well as tolerance for outcome differences under different bankruptcy laws. While in general it’s fair to say U.S. courts have been cooperative and tolerant, for some reason the issue of intellectual property licenses in bankruptcy brings out the worst in us.

In the appeal of Jaffe v. Samsung (the appeal of a case called In re Qimonda in the courts below), the Fourth Circuit recently held that a U.S. bankruptcy court can require a German court overseeing the liquidation of a German company to apply U.S. law when dealing with licenses of U.S. patents.

Congress is considering amending Chapter 15 to mandate a similar  result through the proposed Innovation Act, which would add the following language to Section 1522:

Continue reading "Cooperation and Tolerance in Chapter 15" »

Russian Courts Battling For Authority Over Consumer Bankruptcy

posted by Jason Kilborn

Polar_bear_brawlIn Russia, a debate is raging over which courts should administer consumer bankruptcy cases, the specialized commercial courts or the courts of general jurisdiction. The Russian commercial courts (Arbitrage courts) currently exercise jurisdiction over bankruptcies of individual small business people, as well as over cases involving artificial legal entities like corporations. Logically, then, in the current bill that would finally expand the Russian bankruptcy system to provide relief to consumers, the Arbitrage courts would handle such cases.

Oddly, President Putin in March issued an edict strongly suggesting that the bill be amended to assign jurisdiction to the general courts. The Supreme Court had already come down solidly on the side of the generalist courts, and in April, it threw its support behind Putin’s edict by introducing a bill into the legislature to amend the Code of Civil Procedure to preemptively assign consumer bankruptcy jurisdiction to the general courts, if and when a consumer bankruptcy bill ever becomes law. The explanatory notes to this bill make what seems to be a rather superficial and formalistic argument about consumer contracts “not bearing an economic character,” since they relate only to personal consumption, and noting that consumer cases will raise all manner of non-economic issues, such as family, housing, and labor, which the Arbitrage courts are ill-situated (if not constitutionally forbidden) to address. The next thing you know, they’ll introduce a distinction between “core” and “non-core” matters—that will really fire things up!

Continue reading "Russian Courts Battling For Authority Over Consumer Bankruptcy" »

Lessons Not Learned in Designing a Consumer Insolvency Regime

posted by Jason Kilborn

PennilessJudging by an Irish Times report today, the designers of the new Irish consumer insolvency system seem to be falling into two old familiar traps.

First, the focus of the story is on rumors that the proposed income guidelines for the new regime will make payment plans too parsimonious. Pressing debtors too hard in the name of "responsibility" is a recipe for disaster, as administrators of the French system learned decades ago. A discharge is a nice incentive to get debtors to really exert themselves for the benefit of creditors, but five or six years on an overly repressive budget will produce plan failure, all but guaranteed. Paul Joyce, Senior Policy Researcher at the Irish Free Legal Advice Centres (and an absolute prince of a guy) pointed out this danger in his fine policy analysis of the new regime. It will be a shame if the soon-to-be-released guidelines fail to heed Paul's and others' warnings.

Continue reading "Lessons Not Learned in Designing a Consumer Insolvency Regime" »

Article 9 and Bankruptcy Judges

posted by Melissa Jacoby

prior post addressed a proposed amendment to Article 9's official comments stating that the date of an Article 9 filing relates back to the initial filing date even if the debtor did NOT authorize the filing at that time. This post returns to that topic for two reasons. First, although it is risky to generalize, I sense that bankruptcy judges may still be unaware of this proposed amendment. This is relevant because bankruptcy judges often are on the "front lines" of Article 9 interpretation. Second, I have heard, indirectly, that at least some people want this amendment to lend approval to some lenders' current practice to routinely file without authorization during the loan application process. In other words, the loan is likely to be given within a few days, so no harm no foul. Maybe I misheard or misunderstood?  

Continue reading "Article 9 and Bankruptcy Judges" »

Recommended reading: Broome on Article 9 Financing Statements

posted by Melissa Jacoby

A few weeks ago I wrote about the importance of giving priority to an Article 9 financing statement only from the date on which the debtor  actually authorizes the filing, and a proposed official comment contrary to this position. My colleague Lissa Broome has just posted on SSRN an article she has written about another dimension of the issue: when secured parties file financing statements with an indication of collateral that is far broader than what the debtor authorized in the security agreement. She discusses recent cases that do not deter this activity as well as potential implications, including the chilling effect on future lending transactions.

When the debtor's signature was eliminated as a requirement for a valid financing statement in Revised Article 9, the drafters justified the change by technology: medium neutrality and facilitating paperless filing. Functionally, though, the implications go far beyond technology when you combine this change with the opportunity to file all-asset financing statements AND the broadest possible reading of the first to file or perfect rule discussed a few weeks ago.

Promoting Integrity in the UCC Article 9 Recording System

posted by Melissa Jacoby

On January 1, 2011, Larry files a UCC-1 financing statement against David indicating David's equipment as collateral. At this point, David doesn't even know Larry, has not given him a security interest, and has not authorized this filing. On February 1, 2012, David meets and borrows money from Larry and signs a security agreement listing equipment as collateral (which, under UCC 9-509, automatically authorizes the filing of a financing statement against equipment). What is the relevant date for determining Larry's priority? The language of Article 9 itself strongly implies that February 1, 2012 is the relevant date. UCC 9-509 makes clear that financing statements are not valid unless authorized by the debtor - a pretty minimal burden to cloud the debtor's title. But a little-discussed 2010 amendment to the official comments of Article 9 says otherwise: to the drafters, if the filing is later authorized, Larry gets the benefit of the 1/1/2011 filing date for purposes of the "first-to-file-or-perfect" rule and other priority rules or competitions. 

The most relevant portion of the new paragraph (an addition to comment 4 to 9-322) reads as follows:

Continue reading "Promoting Integrity in the UCC Article 9 Recording System " »

Consumer Friendly Forms for Bankruptcy

posted by Katie Porter

In many respects, bankruptcy is a one-size-fits-all legal process. Yes, there are ample differences in the law (and a world of difference in practice) between the bankruptcy of a large corporation and a typical consumer. But the Bankruptcy Code itself contains plenty of provisions of general applicability. A major example of the one-size-fits-all approach to bankruptcy is the official forms for filing a case. The basic petition and schedules are the same forms for Big Airline Co. and Mr. Joe Blow. The information on the forms is wildly different, with Big Airline Co. listing hundreds or even thousands of creditors, with many more digits in their debts, than Joe Blow. But the form for those debts--Schedule F--is the same form. That may all be changing soon.

The Bankruptcy Rules Committee began a Forms Modernization Project a few years ago, and one of its top agenda items has been creating new forms just for use in consumer bankruptcy cases. Although few people seem to be aware of the effort, a draft version of those new forms is available to the public and to my mind, well worth a look. To see the forms, go here, then click on September 2011, download the file, and look  at pp. 189-315 of the PDF (or tab 7.1 if you use the PDF index.) One thing that is obvious from the page numbers in the prior sentence is that the new forms are really long--way longer than the current forms as completed in the typical consumer case. The added length results in part from the development of extensive instructions for each form. Below is an example of a new form with some commentary on its notable new features.

Continue reading "Consumer Friendly Forms for Bankruptcy" »

How Does the New Federal Venue Law Affect Corporate Bankruptcy?

posted by Melissa Jacoby

On December 7, 2011, President Obama signed the Federal Courts Jurisdiction and Venue Clarification Act of 2011, H.R. 394, P.L. 112-63. The bill does not amend 28 U.S.C. 1408, the primary venue provision for bankruptcy cases in the U.S. Nonetheless, the changes should make us think again about the propriety of place of incorporation as a basis for chapter 11 venue (hat tip to Elizabeth Gibson, who figured this one out right away).

Continue reading "How Does the New Federal Venue Law Affect Corporate Bankruptcy?" »

The Slips Go to Capitol Hill

posted by Bob Lawless

Tomorrow, Katie Porter and I will be testifying at a subcommittee hearing for the Senate Committee on Banking, Housing and Urban Affairs. The title of the hearing is "Consumer Protection and Middle Class Wealth Building in an Age of Growing Household Debt." More information on the hearing is available here, which is also the same place the written witness statements and a link to streaming video eventually will appear. Part of the discussion will be the conditions that led Congress to create the Consumer Financial Protection Bureau and how those conditions remain with us.

Consumers, Cast Your Vote

posted by Katie Porter

The Consumer Financial Protection Bureau has launched the first project in its "Know Before You Owe" initiative with the release of proposed mortgage disclosures. While the CFPB did its homework in designing these forms, including getting feedback from a wide variety of sources, it is taking field-testing to a new level by asking American consumers to review two proposed forms. Consumers can then vote for the form that they think best conveys the key information needed to understand a home mortgage loan. The choices, named "Azalea" and "Camellia" for the fictional banks on the sample disclosures, are available here. (Simply click to view them as a PDF and then vote for your favorite.)

Continue reading "Consumers, Cast Your Vote " »

The Politics of State Bankruptcy and Resolution Authority

posted by Stephen Lubben

Channeling my inner Alan White, my Dealbook post this week talks about the politics of expanding chapter 9 and using chapter 11 in place of the Dodd-Frank resolution authority. In short, while I actually support both ideas, with some qualifications, embrace of these by the right as union busting and anti-bailout tools makes it unlikely to happen.

Market Governance Is About People (And How They Think)

posted by Annelise Riles

Hello everyone and thank you so much to Bob and Adam for bringing me into this exciting conversation. This week I want to raise with you a few thoughts about the way forward on financial regulation that have come out of interviewing and observing regulators in their interactions with market participants over ten years. My research has been mainly in Japan but involves some US components as well.

Continue reading "Market Governance Is About People (And How They Think)" »

Credit Cards to Payday Substitution?

posted by Adam Levitin

Over at Volokh Conspiracy, Todd Zywicki spent Christmas Eve crowing about a Wall Street Journal article about the boom in payday lending. Todd sees the article as vindication for his insistence that regulation of consumer credit will inevitably result in a substitution of another type of credit. For Todd, the substitution hypothesis makes regulation not just pointless, but actually harmful because it will eventually push consumers into the arms of loan sharks.  

There are a whole bunch of problems with the substitution hypothesis, as well as for Todd's interpretation of the WSJ article. Todd writes that: 

Maybe instead we ought to acknowledge that there will be unintended consequences, such as by making credit cards less available regulation will drive many consumers to substitute to more expensive types of credit, such as payday loans? And just wait until the well-intentioned bureaucrats at the CFPB really start protecting those poor folks, then they are really going to get it.

For starters, Todd doesn't accurately summarize the WSJ article. He implies that it was referring to credit cards in general. It wasn't.  It was referring to subprime credit cards. The WSJ article quotes a payday lender as stating, "We believe that we're starting to see a benefit of a general reduction in consumer credit, particularly ... subprime credit cards."  

It turns out that subprime credit cards are often as or more expensive than payday loans. The Credit CARD Act severely curtailed a type of subprime card called "fee harvester" cards. A 2007 NCLC study shows that the costs of fee harvester cards rival or exceed payday loans. So if there's substitution here, it might actually be a good thing. The article is certainly not evidence for middle class consumers getting driven into the arms of payday lenders. Instead, at best, it shows some substitution of fringe financial products and it isn't clear that it is harmful substitution. 

Continue reading "Credit Cards to Payday Substitution? " »

If you think this is tough . . .

posted by Stephen Lubben

My latest Dealbook post is up. In it, I argue that the difficulties of cross-border corporate bankruptcy show just how hard it will be to implement a cross-border resolution process, as Dodd-Frank contemplates.

Protecting the Subsidy

posted by Stephen Lubben

So the fight over leadership of the House Financial Services Committee has begun with an attack on Dodd-Frank, particularly with the claim from Spencer Bachus, one of men who would be chair, that Dodd-Frank would cost the US derivatives industry more than $1 trillion, and drive everyone to London and Zurich -- assuming the regulators in those jurisdictions are siting on their hands, which seems unlikely, but I digress.

The $1 trillion figure comes from ISDA, the industry group that is not particularly known for its measured, balanced approach to derivatives policy. But that's not really the issue -- after all, as long as we acknowledge what ISDA's goals are, they can't really be faulted for pursuing them with great vigor.

But if we're going to embrace ISDA propaganda press releases wholesale, we should at least get the facts straight and understand what is being asserted.

Continue reading "Protecting the Subsidy" »

Still Fighting

posted by Stephen Lubben

Me on derivatives and bankruptcy, post Dodd-Frank, over at Dealbook.

FDIC's Proposed Rules on Resolution Authority

posted by Stephen Lubben

My take, up on Dealbook. I've also authored a comment letter on the topic. The point is not to question the creation of a separate resolution authority -- that's already done -- but to question the creation of a whole new set of rules, that are largely the same but just so slightly different from those applied in chapter 11.

The Notary Fraud Condonation Act of 2010

posted by Adam Levitin

It looks as if the President will veto the Notary Fraud Condonation Act of 2010, formally known as Interstate Recognition of Notarizations Act of 2010.

Notary fraud is nothing new, and it's hardly foreclosure-specific. Requiring state courts to recognize out-of-state notarizations would be a significant invasion of the federal government into states' own rules of evidence. It's not equivalen to requiring recognition of other states' judgments. Some jurisdictions, like DC, recognize out-of-state notarizations, but one can easily understand why a state might not: how does a state court in Florida know what a proper Alaska or Hawaii or Vermont notarization looks like or what rules govern notaries in those jurisdictions? Is there supposed to be a seal? What does it look like? Does the signature need to be performed in the notary's presence or merely affirmed? If the notarization is fraudulent, is the out-of-state notary likely to be disciplined?

Will Dodd-Frank Reduce Safe Harbor Overreach?

posted by Stephen Lubben

As loyal Slips readers will no doubt recall, I've been something of a broken record (what's the modern version of that saying? Buggy mp3?) on the issue of the safe harbors in the Bankruptcy Code, especially as expanded by the 2005 Amendments. In short, I believe that that special treatment of derivative contracts is both more likely to increase systemic risk than reduce it, and incredibly overbroad, giving parties an incentive to disguise regular contracts as derivatives to get out of the automatic say and the operation of section 365.

But I wonder if the recently enacted Dodd-Frank financial reform legislation might reduce the temptation to claim that every routine supply contract is actually a protected swap. Under the legislation, a "Major Swap Participant" is subject to new capital and margin requirements, if not otherwise subject to prudential regulation. A big energy company that is routinely arguing in chapter 11 cases that their supply contracts are subject to the safe harbors might back itself into these capital and margin rules, especially given that the definition of "swap" under the reform legislation is quite similar to that under the Code.

The Code and the new Financial Reform Act

posted by Stephen Lubben

Unless you have been living under that rock, you probably know that the President signed the new Financial Reform Act yesterday. Good summaries of the various stages of implementation, and the overall Act are already available online.

But what is the effect of the new Act on the Bankruptcy Code?

Continue reading "The Code and the new Financial Reform Act" »

Secrets about Elizabeth Warren Revealed

posted by Katie Porter

I have known Elizabeth Warren for ten years, and I know her pretty well. I've been to her home; she's been to mine. She sent me baby gifts; I got her a 60th birthday present. We exchange Christmas cards,  . . . you get the idea.

Now she's a candidate for this big-time appointment as the Director of the New Consumer Financial Protection Bureau. And somehow there are these things about her that must be deep-dark secrets  because it seems like people do not know Elizabeth Warren at all. (As Bob Lawless has written, I think the debate is becoming about a caricature of Prof. Warren, not Prof. Warren the real person.) So here it is . . . Secrets about Elizabeth Warren Revealed.

Continue reading "Secrets about Elizabeth Warren Revealed" »

Too Big to Fail = Too Powerful to Pay

posted by Art Wilmarth
Scholars and industry analysts are currently debating whether the Dodd-Frank Wall Street Reform and Consumer Protection Act – passed on June 30 by the House and pending before the Senate – represents meaningful reform. On one issue, however, the outcome is already clear. The largest banks have defeated provisions that would require them to make a meaningful contribution toward the huge subsidies they receive as "too big to fail" (TBTF) institutions.

Continue reading "Too Big to Fail = Too Powerful to Pay" »

Guns and Bankruptcy

posted by Adam Levitin

Mike Konczal at Rortybomb has an interesting post about the Protecting Gun Owners in Bankruptcy Act of 2010 (the Pro-GOB Act).  This legislation would make firearms exempt from creditors' claims in bankruptcy.  I'm still not sure if it is a joke or real legislation; I haven't been able to find the text of a proposed bill.  Even if one thinks this legislation is a good idea (which it isn't), it is all sizzle, no steak.  It would be inapplicable to almost all bankruptcy cases.  It would only affect Chapter 7 debtors who own firearms and live in 16 states.  

Continue reading "Guns and Bankruptcy" »

The CFPB Auto Dealer Exemption--A Reminder of the Why We Should be Worried

posted by Adam Levitin

It looks like auto dealers are going to get their carve out from the CFPB.  I can't think of a policy argument for exempting auto dealers; maybe someone will provide one in the comments.  The used car dealer has long been the poster child for sharp dealing.  But it's worth reviewing the consumer protection problems with auto dealers, so that we realize what practices are being exempted from potential future regulatory oversight.  

Continue reading "The CFPB Auto Dealer Exemption--A Reminder of the Why We Should be Worried" »

Interchange Theory: Simultaneous Rent-Extraction from Both Merchants and Consumers

posted by Adam Levitin

Todd Zywicki and I have been having a back and forth on interchange in several forums.  Todd and Joshua Wright had an op-ed in the Washington Times, I responded with a letter to the editor, and then Todd came back with a blog post. I posted a detailed response to Todd in the comments to his post, but I will repost the core of the response here.  

In his blog post, Todd says that he can't understand my argument that in the credit card world there are economic rents (supracompetitive prices) being extracted from both merchants and consumers.  Todd thinks the only possible economic rents story is one of merchants being charged too much and consumers too little.  (Todd does not endorse this story, but he at least gives it theoretical credence.)  Therefore, Todd believes that any reduction in interchange income must be offset by an increase in consumer charges.

What follows is a brief outline of my argument that the current credit (and debit) card system simultaneously extracts economic rents from both merchants and consumers.  The corollary to my argument is that interchange regulation actually produces reductions in the economic rents paid by both merchants and consumers; it does not result in costs being shifted form merchant to consumer, but instead results in reduce profits for card issuers and card networks.  To this end, I present a rough sketch of the net impact of interchange reform in Australia; as surprising as it is, I do not believe this has been done before.  

Continue reading "Interchange Theory: Simultaneous Rent-Extraction from Both Merchants and Consumers" »

The CFPA Auto-Dealer Exemption

posted by Adam Levitin

The CFPA/B proposal that the House conferees have presented to the conference committee for the financial reform bill includes an exemption for auto-dealers (see the bottom of p. 13).  It's frankly an exemption that is impossible to justify except as special interest pleading.  They House proposal would exempt used-car salesmen for goodness sakes!  (There's also a less troubling pawn-shop carve-out).  

Today the Federal Reserve's Consumer Advisory Council (CAC) has submitted a letter of opposition to the auto-dealer carve-out to Chairmen Frank and Dodd.  This letter is an unprecedented move for the CAC, which is a non-partisan, expert body that does not usually weigh in on legislation.  I think it shows that there is absolutely no policy justification for the auto dealer carve-out.  

The Disingenuous Mr. Russell Simmons

posted by Adam Levitin

Russell Simmons (yes, the hip-hop entrepreneur and vegan advocate) is blogging away at Huffington Post against the Durbin interchange amendment.  Simmons claims that his card takes "the poor, the voiceless and the under-served" out "from the claws of payday lenders and check cashers, from humiliating lines waiting to cash their paychecks and then more lines to pay their bills." 

Gosh, you'd think that Russell Simmons was operating a charity. Somehow Simmons neglects to mention how much money he is pocketing from debit card swipe fees in addition to the $1/transaction "convenience fee" the RushCard charges its low-to-moderate income users.  (See here for more details on the RushCard.)  The RushCard is an alternative to check-cashing outlets, but that's all that it is--another high-cost financial service for the poor.  I'd be curious to know how much revenue the RushCard makes on interchange; I suspect it would still be quite profitable without it.  Maybe Russell will show us the books.

Russell Simmons is claiming to be the voice of minority communities and the poor on interchange.  He's not, and his personal financial interest in maintaining high interchange rates compromises him as an advocate on interchange, just as the fees on the RushCard compromise him as an advocate for the poor. 

It's worthwhile looking at what The Hispanic Institute, which has no financial stake in the matter, found in an empirical study it sponsored on interchange fees.  The study finds that there is a regressive cross-subsidy that has a disproportionate negative impact on low income minority communities.  

Simmons also misunderstands (perhaps deliberately) the Durbin amendment in his post; he complains that it regulates debit interchange while leaving credit interchange untouched, and that this dings the poor, while leaving the rich unscathed.  That's just wrong.   While part of the amendment deals only with debit cards, part covers all payment instruments, including permitting merchants to offer a discount for debit (how does that hurt the poor?).  The impact of reduced debit card interchange will inevitably be reduced credit card interchange rates for smaller ticket transactions where credit competes with debit. 

The logic of the Durbin amendment is straightforward:  debit transactions are just like checks, but with even lower fraud risk because of real-time authorization.  Checks clear at par throughout the entire banking system.  Therefore, debit should clear at par too (or close to it--the amendment is generous in this regard).  If debit clears at near par, credit interchange rates will drop, and because merchants are, in general, more price competitive than card issuers, the savings will be largely passed through to consumers.  The card industry will have to learn to live with reduced (but still substantial profits), which should incentivize the card industry to innovate to develop new, efficiencies or higher margin products.  Net result:  consumers win.

The End of Free Checking?

posted by Adam Levitin

The Wall Street Journal has a story that Bank of America is contemplating the end of free checking in response to the paring back of fee income due to regulatory reform.  Banks are undoubtedly already adapting to the past year's regulatory changes, and that means attempting to figure out where they can charge new fees or increase existing ones, without losing too many customers so that the net result of the fee structure shift would be a loss.  

Yet, I'm dubious that free checking will go the way of the dodo. Here's why:

Continue reading "The End of Free Checking? " »

Russell Simmons, Interchange Crusader

posted by Adam Levitin

It's amazing who the interchange debate will bring out of the woodwork.  Hip-hop entrepreneur Russell Simmons has been making the rounds on Capitol Hill (and on Huffington Post) urging Congress not to act on interchange reform.  Why is Simmons so engaged with this issue?  

The answer is because he makes a lot of money off of interchange from a very questionable product.  Simmons markets the "RushCard" a Visa-branded prepaid debit product marketed primarily to the black community.  The card provides a payment device for an ersatz deposit account, which allows cardholders to make transactions when cash is not accepted.  Remember that there is no extension of credit to the consumer on the RushCard.  Instead, like any prepaid debit product, the RushCard consumer is actually lending money to Bancorp Bank, the card issuer.  And, as we'll see, the consumer is actually paying money to make an interest-free loan to the Bancorp Bank.  

Simmon's claim is that the RushCard provides important access to financial services for the unbanked:  it's helps consumers avoid check cashing and bank account fees, has greater security than cash, is convenient, and it's "the prepaid card that provides respect." 

What's respect worth?  Well, take a look at the fee schedule below and decide for yourself.  

Continue reading "Russell Simmons, Interchange Crusader" »

Private Funds and Bankruptcy

posted by Michelle Harner

As the financial reform bills make their way through committee conference, I thought I would take this opportunity to reflect on the activities of private equity firms and hedge funds in bankruptcy. (For those of you interested in the bills’ efforts with respect to credit rating agencies, see my post here at Maryland’s new faculty blog.) Although the financial reform bills provide for some regulation of private funds (see here and here), some argue that the proposed measures are meaningless because of, among other things, exemptions and enforcement issues (see here and here). Others argue that even these measures hinder private funds’ business models (see here). Irrespective of your views on this debate, it is clear that the bills do not address the challenges posed by private funds in the distressed debt context.

Investing in distressed debt is not a new investment strategy, but private funds have been pursing it with increased vigor in recent years. And they have been doing so quite successfully. These funds generally yield above-market returns, and during the 1999-2004 economic bubble/burst, they averaged "double-digit returns, including 30 percent for the 2002 funds." The most recent recession has likewise provided ample opportunity for distressed debt investors. These opportunities are likely to continue for the next several years, as "U.S. companies have about $600bn . . . of leveraged loans to refinance . . . between 2011 and 2014."  (See here and here.)

Distressed debt investing generally involves a private fund purchasing the debt of a troubled company and then exploiting the leverage associated with that debt instrument when the company defaults or is about to default on the underlying obligation (see here and here). Some of these investors resemble pure traders and primarily seek to flip the debt for a quick return. Others are, however, using this investment strategy to influence corporate governance or make a control play for the company. (For data on investment strategies, see here.) These investors also are increasingly willing to extend postpetition loans (i.e., DIP financing) to troubled companies, often with the intent to credit bid the debt or otherwise convert it into equity to gain control of the company. As one commentator observed, "Investors in loan-to-own deals may earn an 18 percent return on the financing, plus get equity, compared with the potential for 12 percent returns and no equity on DIPs."

Now, I am not against private funds earning positive returns for their investors—that is of course the primary objective of for-profit endeavors. I also believe that these investors frequently provide much-needed liquidity to troubled companies; liquidity that otherwise would be unavailable and that can provide a second (or third, etc.) chance for the company to the benefit of all stakeholders. I am, however, concerned about the unlevel playing field on which these investors operate in many instances.

Continue reading "Private Funds and Bankruptcy" »

The Interchange Cross-Subsidy: False Analogies

posted by Adam Levitin

Zywicki's interchange paper repeats a claim made by other opponents of interchange regulation that cross-subsidies, even regressive ones, exist throughout the economy, so there's no reason to get worked up over the interchange cross-subsidy imposed by credit card network rules. 

Zywicki provides several examples of cross-subsidies in the consumer economy:  Starbucks charges the same price regardless of whether a consumer takes sugar and cream, so those who take their coffee black subsidize the sugar and cream of the others.  Supermarkets offer free parking, so the walkers subsidize the drivers. 

Zywicki's examples, however, are false analogies to the credit card interchange cross-subsidy from users of low cost payment methods (cash, debit, nonrewards credit) to users of high cost payment methods (rewards credit).  The Starbucks' cross-subsidy is Starbucks' business decision.   The free parking cross-subsidy is the grocery store's business decision.  But the interchange cross-subsidy is not the merchant's business decision.  It is the card network's business decision.  Card networks force merchants to impose a cross-subsidy.  It's an affront to the nose-picking rule of commerce:  you can pick your friends, you can pick your prices, but you can't pick your friends' prices....

With this in mind, it's worth examining another cross-subsidy caused by interchange.  Interchange fees are paid from acquirers to issuers.  The fees are the same for all banks.  Therefore, the safer banks are subsidizing the riskier banks in a card network.  But there's a catch.  The safer bigger banks often get rebates from the card network in addition to interchange fees. 

Two interesting points about this.  First, it shows that the card networks won't tolerate cross-subsidies for themselves. Second, it casts some doubt on the efficiency rationale for interchange fees--that one-size-fits-all fees are sensible as a way to avoid the transaction costs of individually negotiating every issuer-acquirer contract.  Truth is that 20 or so banks make up 95% of the credit card market.  The transaction costs for these banks to negotiate with each other is fairly low.  This points to the question of whether small banks should be in the card business at all.  Cards are very much an economy of scale business; smaller issuers tend to see cards as loyalty devices, not profit centers.  Would a 20-bank card market be a more efficient arrangement than the current networks with thousands of institutions? I'm not sure, but I think the efficiency of the interchange system is far from proven.

Zywicki on Interchange

posted by Adam Levitin

Todd Zywicki has a new paper out on interchange regulation, just in time to support the banks' push against the Durbin interchange amendment in conference committee. The paper doesn't present any new arguments or evidence.  Instead, it presents a highly polemical form of antiregulatory claims. 

There's an awful lot to criticize about this paper, starting with its complete unwillingness to engage with pro-regulatory arguments and evidence on anything beyond a strawman basis.  The omission of the findings of the Reserve Bank of Australia (and reliance on a MasterCard funded study instead) on the impact of Australian regulation is remarkable.  

But don't take my word for it.  Zywicki gets spanked around pretty soundly by the Australian economist Joshua Gans, who objects to the way his work is used by Zywicki in a "very selective and misconstrued way" in a paper whose "broad conclusions" are "flawed." 

Let me add my own broad objection (I'll probably blog on more of the details later).  Zywicki's general assumption about bank regulation is that if fee type A is regulated, then fee types B and C will increase to offset the regulation.  That might be the result; indeed, it is a variation on the whak-a-mole bank fee thesis (also here), that if fee A is banned, new fees B and C will sprout up. 

But there is another possible regulatory outcome that Zywicki never considers:  banks might simply have to endure lower profit margins.  If the consumer side of credit card pricing markets is competitive as Zywicki believes (I've got my doubts, which is the point of the whak-a-mole thesis), then the result should be smaller profit margins, instead of shifted fees.  Zywicki seems to take it as a given that banks must maintain profitability levels.  But they don't.  That's the nature of capitalism:  bank have a right to make a profit, but only through fair and legal competition. If a bank can't operate profitably under those conditions, should it really be in business? 

A Primer on the Consumer Financial Protection Agency

posted by Katie Porter

 With a financial reform billpassed in both the Senate and the House, it seems that a Consumer Financial Protection Agency is going to become a reality. It's interesting to look back at the original development of the idea and then see where we are now--and of course opening up comments for speculation on what the final agency will, and should, look like. If nothing else, the evolution of the names for the agency have been interesting--and remain unsettled! (It's a "Bureau" in the Senate bill, and an "Agency" in the House bill). For simplicity here, I call it the CFPA.

In 2007, Elizabeth Warren wrote a piece in the journal, Democracy, called Unsafe at Any Rate. At 9 pages long, it's well worth reading. It's a good reminder of the core principles underlying the need for such an agency and it underscores how a metaphor, exploding toasters are like credit cards, can help an academic idea take hold in the policy world. Prof. Warren later co-authored a full-length law review article with Prof. Oren Bar-Gill called Making Credit Safer, which among other things describes in more detail some of the behavioral economics research that supports the need for such an agency.

Now, in 2010, three years later, a consumer financial protection agency is part of both the House and Senateversions of the financial reform bill. Prof. Jeff Sovern, an expert in consumer law, has prepared a very helpful Powerpoint slideshow that highlights key differences in the bills. Here are some of the key differences:

Continue reading "A Primer on the Consumer Financial Protection Agency" »

Protecting Public Benefits from Garnishment

posted by Katie Porter

 Mark Budnitz at Georgia State University College of Law, in coordination with the National Consumer Law Center, is asking law professors to sign on to a letter supporting a proposal by Treasury and other federal agencies to mandate crucial protection for persons receiving federal benefits such as Social Security. Regular Credit Slips readers may remember that guestblogger Nathalie Martin's post on this problem, "Think Public Benefits are Exempt from Execution? Think Again." Prof. Budnitz succintly describes the problem. He writes:

"These funds are exempt under federal statutes.  Congress intended the funds to be beyond the grasp of creditors.  Nevertheless, these funds are routinely frozen and seized by debt collectors. When a debt collector obtains a judgment, it serves a garnishment order on the consumer's bank.  The bank freezes the consumer's account; often the bank turns over the garnished amount to the debt collector without first giving the consumer any notice.  Most banks simply honor the state court order; they do not examine the bank account to determine whether the funds are exempt.  For consumers whose primary or sole income are federal benefit payments (e.g., Social Security, SSI, veterans benefits), the effect is devastating.  The consumer often first learns of the bank's freeze when checks start to bounce.  He or she has no money for food, medicine and other necessities.  The proposed regulation would correct this problem.  It sets out a clear, uniform procedure for banks to follow. It prohibits the freezing and the seizure of exempt funds."

    Over twenty law professors have already signed on to Budnitz's letter.  In addition to supporting the proposed regulation, it recommends a few improvements. If you are a law professor and you want to sign onto this letter, please contact Prof. Budnitz who will give you further information. Members of the public will be able to comment soon; instructions are here.


posted by Stephen Lubben

Having been thinking about resolution authority for a while now, I'm coming to the conclusion that the resolution authority is not really designed to be used. Rather it is there for its deterrent effect. Like a nuclear bomb. It's atomic.

The resolution authority as drafted leaves a good deal unanswered. For example, who will run the bridge financial institution? FDIC? Resolving Citigroup as a whole is a lot different from resolving Citibank. And I tend to doubt many of the employees will stick around, since it has been made plain that the goal is a quick death for financial institutions. And because the resolution authority lacks a provision like §363(f), how is FDIC going to handle all the loss sharing that will be needed to make this work? All this uncertainty will undoubtedly foster a run on any institution that gets anywhere near the resolution authority.

So the goal must be deterrence -- make the executives so afraid of resolution authority that they become risk adverse. That might work for entities that are clearly "too big to fail," but what about a large hedge fund? At some point ex post they might be deemed systemically important, but ex ante what do they do?

Once again I'm left wishing the banking people had talked with the insolvency people before developing this resolution authority thing.

More Naked Credit Default Swaps--the Role of Dealers

posted by Adam Levitin

These post titles should definitely increase the hits on our blog...

I want to add another point to the debate:  CDS are often done through dealers, and a naked position for a dealer is different from a naked position for an end-user.  A CDS dealer's swaps desk is unlikely to have any long-term stake in the underlying asset.  Generally, a swap desk tries to execute perfectly matched swaps so that it will never have any exposure itself to the underlying assets, only counterparty risk.  (And dicey counterparties have to post collateral).  It isn't always possible to match swaps instantaneously, however, so the dealer will often enter into one swap hoping to find a match soon.  Until the dealer finds a match, the dealer has exposure.  Moreover, a dealer might be able to get a better price (and hence a bigger cut for itself) if it doles pieces of the swap into the market, rather than trying to move the whole swap position at once.  There might not be a lot of market appetite for a $25B swap position except at a steep discount(this goes for CDS as well as other types of swaps), but smaller pieces might be digestible.  Dealers tend to try and have everything cleaned up by the end of the quarter, but in between, the short-term exposure could be sizable.   If naked CDS were banned without a dealer exception, covered (i.e., not naked) CDS would become quite difficult to arrange and execute. 

Complicating this picture is that sometimes a swap dealer decides that the swap is an inherently good position given the price and holds the action itself.  This is all by way of saying that CDS go through a dealer market, not a broker market.  There might be a case for moving CDS to a broker market, but unless there's sufficient liquidity for the product, that'd be difficult. 

To illustrate the role of dealers, consider the Abacus deal.  It is usually presented as Goldman Sachs simply arranging a swap between Paulson and the CDO.  That's the economic essence of the deal, but not how it worked technically. 

Continue reading "More Naked Credit Default Swaps--the Role of Dealers" »

No Safe Harbor Reform, Yet

posted by Stephen Lubben

As some of you know, I've been working with Senator Bill Nelson and his staff on an amendment to the financial reform bill that would have rolled back the special treatment of derivatives under the Bankruptcy Code. Unfortunately, with today's cloture vote, it does not look like the amendment will get a floor vote. While the amendment was backed by many, including the chair of the judiciary committee and eventually the agriculture committee, Treasury and FDIC never got on board. The gulf between banking and bankruptcy persists.

Cautiously Optimistic

posted by Angie Littwin

The Washington Post is reporting that financial reform may make it out of the Senate largely intact. The current bill appears to have a strong consumer protection agency and to cover derivatives -- two crucial issues going forward. I personally won't believe it until I see it though. Keep your fingers crossed and your legislators emailed!

End User Exemptions

posted by Stephen Lubben

I've been talking with Mike at Rortybomb about derivatives and bankruptcy, and the pending financial reform legislation. But being a professor, I of course have more to say about the ongoing debate about exempting certain "end users" of derivatives from the proposed rule that all derivative trades go through a central clearing process and trade on an exchange.

The key complaint that "end users" have is this new trading and clearing structure will require collateral to be posted to ensure the "out of the money" party's ability to perform on the deal.  For railroads, manufacturers, and others who use derivatives as hedges, this means that cash or other cash-like stuff will be parked somewhere, unavailable for use. And their ability to use derivatives will be limited by their ability to post collateral.

First, I'm beginning to wonder about how you define "end user," which is why I've been using the obnoxious quotes up to this point. A hedge fund is an end user of derivatives. Really anyone who has an unbalanced position in derivatives could be considered an end user. Congress has to be really careful on this slippery slope.

Second, if the "end users" of the world think that getting out of clearing and exchange trading gets them out of posting collateral, they might want to think about that some more. There is nothing in the new law that would prevent a big bank from demanding both mark to market and "additional" collateral in connection with an OTC trade. Indeed, since these banks are going to be under increased regulation, they may be required to get collateral from big customers. So if the end users get their exemption, what have they achieved? Exposure to the risk that the big bank will fail, taking their collateral with it.

Amendment to Repeal Marquette

posted by Bob Lawless

Senator Sheldon Whitehouse is sponsoring an amendment to the financial regulation bill that would undo most of the damage from the Marquette National Bank decision. In Marquette, the Supreme Court ruled the National Bank Act preempted state interest rate regulation. Thus, a national bank in South Dakota lending to a consumer in California gets to follow the relatively lax interest rate laws of South Dakota. No matter that the high-rate loan might cause financial hardship for families in California--that's not South Dakota's problem.

I've long thought that overruling Marquette would be a wise move. The decision laid the groundwork for the the consumer credit culture we have today and is arguably one of the most momentous (but often overlooked) Supreme Court decisions of the last fifty years. Also, as an interpretation of a technical provision a 110-year old statute, Marquette might also win the prize for the Supreme Court decision with the most unintended consequences.

If you think interest-rate regulation is a bad idea, nothing in the Whitehouse amendment should bother you. It merely shifts the power to make decisions about interest-rate caps to the states and away from Washington bank regulators. California can enact laws appropriate for the conditions there, just like South Dakota can enact laws appropriate for its citizens. The Whitehouse amendment does not take any position on whether the appropriate law is a high cap, a low cap, or no cap at all. California or South Dakota or Delaware or any other state just would no longer be able to export their interest-rate laws to other states. It would allow the states to be laboratories of democracy, as the saying goes, and experiment with interest rate regulation. Also, it should be noted that the amendment would not apply to interest rates on home mortgages.

The predictable response from the banking industry will be that they cannot possibly operate and be subject to 50 different state laws. In the information technology age, however, compliance with different state interest rate statutes should be a trivial matter of computer programming. Also, the banking industry (and many other industries) capably navigate a whole thicket of laws on core state matters such as employment, taxation, and property. The Whitehouse Amendment deserves more attention than it is getting.

UPDATE: The text of the amendment is here, and an explanation of the amendment from Senator Whitehouse's office is here.

Resolution Authority: Dodd-Shelby Amendment

posted by Stephen Lubben

Still digesting the new Dodd-Shelby compromise, but so far the implications for resolution authority that I can see are:

  • Proceedings move from the Delaware bankruptcy court to the D.C. District Court.
  • There is a hard cap on the length of proceedings at 5 years (3 yrs. plus two 1 yr. extensions)
  • There is a new priority for employee wage claims, like the one found the Bankruptcy Code

The Financial Reform Legislation

posted by Stephen Lubben

Having been involved at the edges of the financial reform legislation for the past few weeks, a few observations to date:

  • Warren Buffett apparently supports derivative regulation, so long as it does not apply to him. "Me too" say Goldman, JP Morgan, Morgan Stanley, several dozen hedge funds, GM, Union Pacific, . . .:
  • ISDA and friends have a new argument for why derivatives should get special treatment under the Bankruptcy Code:  collateral.  "If regulators want everyone to use collateral to back up derivative trades, we need special treatment."  Why they can't be treated like every other secured creditor under the Code remains unexplained.
  • Another argument in favor of retaining special treatment, even made by those who work for the financial regulators, is that the move to central clearing requires special treatment. Unaddressed is the problem that many derivatives are still not centrally cleared, and won't be for a long time. And I worry that without the incentives that come from facing real bankruptcy risk, central clearing authorities will become little more than a kind of Central Services, routing paper (or electrons) between the relevant parties, and not performing the kind of counterparty risk assessment that clearing is supposed to bring.

Resolution Authority: Voting Rules

posted by Stephen Lubben

Presently both the new Financial Stability Oversight Counsel and the Federal Reserve Board must each vote to recommend action under the resolution authority, and each must do so by a 2/3 vote. More over, the Secretary then must decide if a petition actually will be filed.

This structure seems overly cumbersome, and essentially means that all three actors must agree before the resolution authority can be invoked. This might create problems in the future – for example, imagine a Secretary that objected to ever invoking the resolution authority.

Solution: Make the “and” into an “or” with regard to recommending action:  either the Counsel or the Board can recommend action by a 2/3 vote. And allow the two acting in unison to override the Secretary and file a petition with the Panel. The Secretary can have standing to object in front of the Panel.

Resolution Authority: Missing an Umpire

posted by Stephen Lubben

The current draft of the Dodd bill does not provide for a anyone comparable to the bankruptcy judge in a chapter 11 case. Instead, the proposed legislation allows parties to seek review of the receiver’s decision to allow or disallow a claim in the district court “for the district within which the principal place of business of the covered financial company is located (and such court shall have jurisdiction to hear such claim).”

First note that this means that case will start in Delaware with the Panel, but will likely end up in the Southern District of New York for claims resolution. Moreover, the court seems to be limited to hearing claims disputes – whereas it arguably might be better to have a general “referee” for all disputes. But most importantly, I doubt that the district court in the SDNY is the right place to resolve these matters. The SDNY district court is widely perceived to be slow in acting on bankruptcy appeals, and is often weighed down with a lengthy docket of criminal cases that understandably has priority on the judges’ time. Bankruptcy judges – particularly those that routinely handle large chapter 11 cases – are more accustomed to acting with the kind of speed that is required for these matters. Otherwise the FDIC will face the prospect of some district judge ruling against its treatment of a claim years after everyone thought the case was fully administered.

Solution: When picking the members of the Panel (see my last post), pick a fourth judge who will act as trial judge to resolve these issues.

Resolution Authority: The New Court

posted by Stephen Lubben

Under the Dodd bill, petitions to invoke the resolution authority are to be presented to a new Liquidation Authority Panel. Under section 202 of the bill, the Panel is to be comprised of three Delaware bankruptcy judges, selected by the Chief Judge. Presently there are seven bankruptcy judges in Delaware, including the Chief.

This seems like too small of a pool to select the judges from, and Wilmington seems like an unlikely place to hold the kind of secret hearings contemplated in this legislation. Moreover, most of the key governmental, legal, and financial actors in these matters are based in New York.

Solution:  Create a nationwide court, based in New York, utilizing the best bankruptcy judges from around the country. Having a bigger pool also provides a source for alternate members if a particular member is unavailable when the Panel is called. The Panel can share infrastructure with the SDNY bankruptcy court. Since the Panel’s role is essentially administrative, you might even consider having a non-judge on the Panel (e.g., a legal or finance academic). Finally, perhaps there should be annual education requirements for panel members so they stay up to date with the latest developments.

Resolution Authority: What's Wrong With the Dodd Bill

posted by Adam Levitin

The Dodd bill gets things right on first principles:  there needs to be some type of resolution authority, and it needs to provide the ability to impose haircuts on creditors.  The bill accomplishes that much.  But it goes way off the rails on a critical issue that has received virtually no discussion:  how the resolution authorization process is supposed to work.  

There's been a good deal of ink spilled recently over how to regulate systemic risk, but little consideration of the institutional design of resolution authority.  Who gets to decide to pull the plug on a troubled firm?   And who gets to decide to provide support for other firms or sectors of the economy?  

I would suggest that however we do this, the paramount value should be maximizing political accountability.  Resolution is a distributional matter, which makes it inherently political.  Indeed, systemic risk is really a political issue, not an economic issue--there's no accepted economic metric for systemic risk.  Instead, it is about social anxieties over loss distribution.  Determining the most politically accountable part of government is something that administrative law scholars endlessly debate, but there are some parts that are less accountable politically than others:  the courts and independent agencies (as opposed to cabinet agencies).  Thus, if we are concerned about political accountability, the Fed is the wrong place to vest decision-making authority.  Same for the courts. 

But this is exactly what the Dodd bill does.  First it, like the Frank bill in the House, create a systemic risk oversight council.  Sounds nice, sort of like the Justice League of financial regulation, but in practice it is likely to merely dilute accountability among regulators.  Second, a troubled firm can only be placed into resolution if (1) the Treasury Secretary, generally acting on the recommendation of a supermajority of the Fed Board and the FDIC, successfully petitions (2) a special panel of bankruptcy judges for the resolution.  Again, this mechanism invokes the participation of a number of regulators (including two of the least politically accountable), and then a rather odd subgroup of judges (3 Delaware bankruptcy judges), another politically unaccountable constituency. 

The goal of the Dodd bill seems to be to make resolution a scientific matter.  But it isn't, and we might do better by going for one that abandons the semblances of legalism and goes with accountability.  (Again, for those who want the fuller version of the argument, you can read it here.)


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