Abstract
In this Article, I argue that there are significant gaps in the federal system for resolving financial distress in a financial firm even after passage of the Dodd-Frank bill. These gaps represent potential sources of systemic risk—that is, risk to the financial system as a whole. They must be fixed.
But I should make clear at the outset that I do not argue that these gaps must be filled with the Bankruptcy Code. Rather, the point is that the various systems for resolving financial distress among financial firms must be integrated so that the result of financial distress is clear and predictable. Integrating all under the Bankruptcy Code is an option, but not the only way to achieve such clarity.
The first Part of this Article sketches the several existing systems for resolving financial distress in financial firms, including the new resolution authority created by the Dodd-Frank Act. By my count, there are at least six systems at work here, not counting state-by-state variations. Part II examines the coverage of these systems and the uncertainty created by the interaction of the same. For example, under current law, a large hedge fund might be “resolved” under chapter 11 of the Bankruptcy Code, or it might not be. The decision rests with the systemic risk counsel. Therefore, the fund’s counterparties will be unable to determine ahead of time which set of rules is incorporated into their contracts with the hedge fund. Undoubtedly, both will be priced with a further discount for the uncertainty. That is unlikely to be the optimal solution.
Part III of the Article then considers the ways in which the divide between finance and bankruptcy could be narrowed, if not eliminated. Ultimately, I doubt the plausibility of solving these issues with some grand solution like drafting a unified bankruptcy law. The political realities involved in getting a major piece of legislation through Congress are so daunting nowadays that it is something of a wonder that even Dodd-Frank, with all its limitations, passed. A unified system of financial distress, which would implicate both state and federal interests, seems almost more unlikely. Given this reality, I suggest incremental ways to move the myriad existing systems together. These suggestions exploit the new Financial Stability Oversight Counsel’s power to recommend changes in regulation to fill gaps left by the Dodd-Frank Act.
Recommended Citation
Stephen J. Lubben, Financial Institutions in Bankruptcy, 34 SEATTLE U. L. REV. 1259 (2011).
