Bankruptcy Is Better Than a Bailout

Norbert Michel / December 19, 2013

Today Senators John Cornyn (R–TX) and Pat Toomey (R–PA) introduced the Taxpayer Protection and Responsible Resolution Act to begin repairing some of the damage caused by the Dodd–Frank regulations.

The 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act increased regulations on virtually every aspect of the financial sector and even broadened the government’s reach into the non-banking sector. One of that act’s most troubling aspects is the creation of seizure authority—politely called “orderly liquidation authority”—for firms perceived by regulators to be failing.

While orderly liquidation sounds pleasant, Title II of Dodd–Frank achieves it by allowing federal regulators to seize troubled financial firms—with minimal judicial review—and close down their affairs. Title II also authorizes the Federal Deposit Insurance Corporation (FDIC) to hold taxpayers responsible for the most worthless assets on a company’s books. The time-tested bankruptcy system, with its legal protections and judicial supervision, is a far better system.

The Taxpayer Protection and Responsible Resolution Act replaces Dodd–Frank’s flawed liquidation process with a new Chapter 14 of the bankruptcy code. This proposal would:

• Require regulators to prove that a company poses an imminent threat to the U.S. financial system before initiating a resolution;
• Put a federal bankruptcy judge in charge of the process;
• Transfer the company’s assets (and certain short-term obligations) to a solvent “bridge” company that would continue to operate outside of bankruptcy; and
• Prohibit the Federal Reserve from giving the new bridge company a taxpayer-funded line of credit.

This sensible proposal would go far toward solving the problems of “too big to fail” that were exacerbated by the Dodd–Frank Act, and repealing that act’s Title II would bring much needed stability to the financial sector. The Taxpayer Protection and Responsible Resolution Act or a similar proposal should be the starting point to eliminate what Title II of Dodd–Frank created—a new opportunity for unrestrained government intervention in financial markets.