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THE ROLE OF BANKRUPTCY REFORM IN 

ADDRESSING TOO BIG TO FAIL 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER 

PROTECTION 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO 

BIG TO FAIL 

JULY 29, 2015 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman 

MICHAEL CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana 

WILLIAM D. DUHNKE III, Staff Director and Counsel 

MARK POWDEN, Democratic Staff Director 

DAWN RATLIFF, Chief Clerk 

TROY CORNELL, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

PATRICK J. TOOMEY, Pennsylvania, Chairman 

JEFF MERKLEY, Oregon, Ranking Democratic Member 

MIKE CRAPO, Idaho 

DEAN HELLER, Nevada 

MIKE ROUNDS, South Dakota 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MARK KIRK, Illinois 

TIM SCOTT, South Carolina 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

MARK R. WARNER, Virginia 

ELIZABETH WARREN, Massachusetts 

JOE DONNELLY, Indiana 

GEOFFREY OKAMOTO, Subcommittee Staff Director 

LAUREN OPPENHEIMER, Democratic Subcommittee Staff Director 

(II)

C O N T E N T S 

WEDNESDAY, JULY 29, 2015 

Page 

Opening statement of Chairman Toomey .............................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Merkley ............................................................................................... 3 

WITNESSES 

Randall D. Guynn, Partner, Davis Polk & Wardell, LLP .................................... 4 

Prepared statement .......................................................................................... 27 

John B. Taylor, Hoover Institution Senior Fellow in Economics, Stanford 

University ............................................................................................................. 6 

Prepared statement .......................................................................................... 66 

Thomas H. Jackson, President Emeritus, University of Rochester ..................... 7 

Prepared statement .......................................................................................... 76 

Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, MIT Sloan 

School of Management ......................................................................................... 9 

Prepared statement .......................................................................................... 129 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Letter from the National Bankruptcy Conference submitted by Senator 

Merkley ................................................................................................................. 134 

(III)

(1) 

THE ROLE OF BANKRUPTCY REFORM IN 

ADDRESSING TOO BIG TO FAIL 

WEDNESDAY, JULY 29, 2015 

U.S. SENATE, SUBCOMMITTEE ON FINANCIAL

INSTITUTIONS AND CONSUMER PROTECTION, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittee met at 10:01 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Patrick J. Toomey, Chairman of the 

Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN PATRICK J. TOOMEY 

Chairman TOOMEY. The Committee will come to order. 

Good morning, everyone. I want to start by thanking my Ranking 

Member, Senator Merkley, for joining us this morning in addressing a very important topic. I especially want to thank the witnesses 

for taking the time to be here this morning, but also for the very, 

very thoughtful and considerable effort that was put into really 

very comprehensive and very interesting testimony. So, thank you 

for submitting that. Thanks for being here this morning. 

I need to explain a little interruption that we are going to have 

in this hearing this morning. We have votes scheduled on the Senate floor at 10, two votes, it is my understanding. So, Senator 

Merkley and I have agreed that the best way to handle this would 

be for Senator Merkley and I to give our opening statements and 

then we will recess for the votes. We will come back as quickly as 

we can. Hopefully, the Members of the Committee will be able to 

vote quickly on that second vote and return, and then we will welcome the testimony from the witnesses. So, with that understood, 

I will proceed with my opening statement and then I will recognize 

Senator Merkley. 

About 5 years ago, President Obama signed into law the DoddFrank Act, and he said at the time that, quote, ‘‘There will be new 

rules to make clear that no firm is somehow protected because it 

is too big to fail.’’ Unfortunately, in my view, the Dodd-Frank Act 

did not end too big to fail. In fact, it enshrined it in law. 

In 2008, taxpayers were forced to pump certainly hundreds of billions of dollars in bailouts to floundering financial institutions. In 

response, in my view, rather than eliminating taxpayer bailouts, 

the Dodd-Frank legislation created an orderly liquidation authority 

which contains an explicit and limitless ability to draw on taxpayer 

resources. 

2 

Let me be clear, I opposed the 2008 Wall Street bailouts then. 

I oppose them today. And, I do not want to see any bailouts in the 

future. 

But, Dodd-Frank created an explicit bailout mechanism and it 

appears that the attempt to avoid using that is through massive 

regulation. We have a number of problems with this approach. 

First, the SIFI designation itself, in my view, confers this too-bigto-fail status, and the over-regulation that then is the attempt to 

avoid the bailout risks turning the financial sector into, essentially, 

public utilities. The regulations impose huge costs, both directly in 

terms of compliance costs and a diversion of resources, and the indirect costs that come when overly regulated firms are unable to 

lend as much as they otherwise would, unable to innovate as much 

as they otherwise would. 

And, I think we should remember that regulators are neither omniscient nor perfect. An institution is likely to eventually fail despite the regulators’ best efforts. They simply will not see it coming. And, in fact, I think a persuasive argument has been made 

that the regulations could even increase the likelihood of failures 

by correlating risks. 

Now, Dodd-Frank deals with the possibility of a SIFI failure 

through the orderly liquidation authority, and I think there are 

many serious problems with this mechanism. One is regulators 

have an almost limitless discretion to force the liquidation. 

Second, there is really, under the legislation, there is no opportunity for a restructuring, which should be an option available to 

a failing institution. 

Three, the FDIC is essentially designated to control the bridge 

entity that is created in the orderly liquidation authority, and I do 

not know that anyone really believes that the FDIC has the expertise to run a Lehman Brothers, for instance. 

The FDIC has unlimited discretion in how to treat comparably 

situated creditors, and I think that is completely inconsistent with 

every principle of bankruptcy. It is blatantly unfair. Some creditors 

could be favored relative to others who are similarly situated. I 

think you could argue that failure of a financial institution becomes, in fact, more likely because this discretion in the hands of 

the FDIC might cause a reasonable fear and suspicion on the part 

of some creditors that they might end up being on the short end 

of the stick in a resolution, and so they have an incentive to pull 

their lines of credit at the first sign of trouble. 

And, as I said earlier, the orderly liquidation authority explicitly 

contemplates a taxpayer bailout. It creates the orderly liquidation 

fund and the Congressional Budget Office has scored the cost of 

this fund as a little over $20 billion over the next 10 years. That 

is their quantification of the risk the taxpayers will have to step 

in and fund this. 

So, Senator Cornyn and I, and I want to thank Senator Crapo, 

who I believe is a cosponsor of the legislation, we have introduced 

the Taxpayer Protection and Responsible Resolution Act that addresses this too big to fail and this bailout risk head-on. It repeals 

what I think is a dangerous and subjective orderly liquidation authority. It explicitly forbids taxpayer bailouts of failing institutions. 

And it replaces the orderly liquidation authority with a transVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
3 

parent, objective, and rule-based bankruptcy process by reforming 

the Bankruptcy Code so that it is able to handle the resolution of 

a large, complex institution. 

The reforms that we make in our legislation makes the Title I 

resolution of Dodd-Frank, I think, more credible. In my view, Title 

I of the Dodd-Frank Act is not inherently a bad idea, since an institution should go through some resolution planning. But, it has to 

be realistic, and that requires a Bankruptcy Code that can handle 

it. 

I think bankruptcy is superior to the orderly liquidation authority because creditors and shareholders should shoulder the losses 

if a financial institution fails, not taxpayers. Bankruptcy is transparent. It is a rule based process. And, it minimizes the risk of a 

creditor run in times of uncertainty. It is superior to OLA, also, because it maximizes the value of an estate by allowing either liquidation or a reorganization. And, as we have contemplated the 

change in bankruptcy, it would allow for a bridge bank to ensure 

that you would not have systemic risks in the event of such a failure. 

So, today, we are fortunate we will be hearing from some of the 

world’s leading experts on this question of how best to resolve a 

large, complex financial firm. Again, I want to thank the many experts who have helped with input on this legislation, the experts 

who are here today as witnesses. I look forward to their testimony 

and the question and answer period at the end. 

At this time, I will recognize Senator Merkley for his opening 

statement. 

STATEMENT OF SENATOR JEFF MERKLEY 

Senator MERKLEY. Thank you very much, Mr. Chairman, and I 

also thank the witnesses for bringing their expertise and perspectives to bear on this issue, the role of bankruptcy and the issue of 

too big to fail. 

I will be particularly interested to hear what the testimony is in 

regard to the proposal that Senator Toomey and Senator Cornyn 

have put together and how effective the Bankruptcy Code would be 

in resolving large and complex financial institutions without the orderly liquidation authority granted to regulators in Title II of the 

Wall Street Reform bill. 

While reforming the Bankruptcy Code may prove to be useful, I 

am not sure that bankruptcy alone will be enough to successfully 

resolve the complex, interconnected financial institutions without 

disrupting financial stability and the global economy, and certainly 

that was the purpose of Title II, which was put together on a bipartisan basis with a major role by Senators Corker and Warner. 

And, of course, the interesting conundrum here is that the whole 

goal is to end too big to fail, and as Senator Toomey has presented, 

that is also his goal and bringing a different perspective to bear, 

and so your insights will be very beneficial. 

In 2008, before Wall Street Reform and Title II, Lehman Brothers filed for bankruptcy. Here we are in 2015 and they are still in 

bankruptcy proceedings and they are struggling through the complexities of a large interconnected investment bank, and their demise did, indeed, have an impact on the broader economy. So, it is 

4 

just a small lens on the challenge that Title II was seeking to address. 

So, as we wrestle with this, we here as policymakers do not 

spend our entire life on a single topic. You all bring intense expertise to bear, and I welcome hearing those insights. 

Thank you very much. 

Chairman TOOMEY. Thank you, Senator Merkley. 

The vote has been called, so at this time, the Subcommittee will 

recess and we will resume our work as soon as we are able to get 

back from the votes. 

[Recess.] 

Chairman TOOMEY. The Committee will come to order. 

Again, my apologies for this delay. Senator Merkley is on his way 

back, but he has indicated that we should get started, and given 

the patience that our witnesses have already exhibited, I would 

like to do that. 

So, let me first extend a warm welcome to our panel of distinguished witnesses. Mr. Randall Guynn is a partner at Davis Polk 

& Wardell, LLP; Professor John B. Taylor from the Hoover Institution Senior Fellow in Economics at Stanford University; Professor 

Thomas H. Jackson, President Emeritus, University of Rochester; 

and Professor Simon Johnson, the Ronald A. Kurtz Professor of Entrepreneurship at MIT Sloan School of Management. 

Each of you will be recognized for 5 minutes to give an oral summary of your testimony. Your full written testimony will appear in 

the record. 

Mr. Guynn, please proceed. 

STATEMENT OF RANDALL D. GUYNN, PARTNER, DAVIS POLK & 

WARDELL, LLP 

Mr. GUYNN. Chairman Toomey, Ranking Member Merkley, and 

Members of the Subcommittee, thank you for the opportunity to 

testify at this important hearing. 

During the past few years, I have spent a significant portion of 

my time working on resolution plans for a number of U.S. and foreign banking organizations under Title I of the Dodd-Frank Act. I 

believe that virtually all of the most systemically important banking groups in the U.S. with global operations, known as U.S. G– 

SIBs, are now safe to fail under the single point of entry recapitalization strategy known as SPoE, for single point of entry. 

I have included a step-by-step illustration of SPoE in my written 

statement. Essentially, it means that only the top tier parent of a 

U.S. banking group is placed into a Title II receivership or a bankruptcy proceeding. The operating subsidiaries remain open and operating and their losses are effectively pushed up to the parent. 

The SPoE strategy was invented by the FDIC under Title II, but 

my colleagues and I quickly realized that it could work under the 

existing Bankruptcy Code if three conditions were met. First, the 

top tier parent must have enough usable TLAC, which is defined 

as the sum of the parent’s regulatory capital and long-term unsecured debt. To be usable, however, the parent’s TLAC must be 

structured so that it is legally subordinate to the group’s shortterm debt. The purpose of this structuring is so that all the group’s 

losses can be imposed on its TLAC investors before any losses are 

5 

imposed on its short-term debt. This will allow losses to be imposed 

on the private sector without causing the deposits and other shortterm debt to run, which is what can threaten financial stability 

and result in bailouts. 

I understand that all six of the U.S. G–SIBs that relied on the 

SPoE strategy in their 2015 resolution plans now have, on average, 

usable TLAC equal to 25 percent of their risk-weighted assets, 

which is five times the amount of usable TLAC they had on the eve 

of the 2008 financial crisis, as shown in Exhibit F of my written 

testimony. This should be enough usable TLAC to recapitalize all 

of them at full Basel III capital levels if they fail under conditions 

twice as severe as the 2008 financial crisis. 

Second, the group must have access to a secured liquidity facility, such as the Fed’s discount window, or enough liquidity on its 

balance sheet to self-insure against liquidity risk throughout the 

SPoE process. I understand that all six of the U.S. G–SIBs that relied on SPoE in their 2015 plans now have enough liquidity on 

their balance sheets to execute SPoE in a severely adverse economic scenario without accessing Government liquidity support. Indeed, they have been forced to be so liquid that it is substantially 

reducing the amount of credit they can supply to the market. 

Third, the group must eliminate most cross-defaults in its derivative contracts that would allow counterparties to drain liquidity out 

of the group the way they did in Lehman based on the parent’s 

bankruptcy when the rest of the group is still open and operating 

and performing on those contracts. Most of the U.S. G–SIBs have 

agreed to adhere to a new international agreement called the ISDA 

Protocol. Under that protocol, 18 of the largest counterparties have 

agreed to waive their cross-defaults in their ISDA contracts with 

each other. While the regulators are in the process of expanding 

the ISDA protocol to cover a wider range of financial contracts and 

counterparties, the Federal Reserve has characterized the ISDA 

Protocol as a major accomplishment in making the U.S. G–SIBs 

safe to fail. 

As you know, Title II of Dodd-Frank can only be lawfully invoked 

if the Bankruptcy Code is not up to the task of resolving an institution. While I believe that SPoE can be done under the existing 

Bankruptcy Code, I think there is room for improvement. I believe 

that even the FDIC would agree that we should try to improve the 

Bankruptcy Code so that the circumstances that allow Title II to 

be lawfully invoked are reduced to the bare minimum. In my view, 

a sufficient reason for doing so is that the Bankruptcy Code is more 

consistent with the rule of law and more predictable than Title II. 

Adding a new Chapter 14 to the Bankruptcy Code along the lines 

of the proposed Taxpayer Protection and Responsible Resolution 

Act should achieve that goal. 

I welcome any questions that any Members of the Subcommittee 

might have. Thank you. 

Chairman TOOMEY. Thank you, Mr. Guynn. 

Professor Taylor, please proceed. 

6 

STATEMENT OF JOHN B. TAYLOR, HOOVER INSTITUTION 

SENIOR FELLOW IN ECONOMICS, STANFORD UNIVERSITY 

Mr. TAYLOR. Thank you, Chairman Toomey, Ranking Member 

Merkley, for inviting me to testify here. 

I think bankruptcy reform is essential to addressing the problem 

of too big to fail. A reform that handles large financial firms and 

makes failure feasible under clear rules without spillovers would 

greatly reduce the probability of Government bailouts. 

As you know, much work has been devoted to this issue in the 

last few years, and I think good reform bills have been introduced, 

including the Taxpayer Protection and Responsible Resolution Act, 

but also the Financial Institutions Bankruptcy Act of 2015 in the 

House. 

Chapter 11, of course, has many benefits, including its basic reliance on the rule of law. But for large, complex financial institutions, it has shortcomings. The existing bankruptcy process may be 

too slow. Bankruptcy judges may not have enough financial experience. But perhaps most importantly with Chapter 11, it is difficult 

to both operate a failing financial institution and stop runs. 

To deal with these shortcomings, a new chapter is needed, like 

Chapter 14 in the Taxpayer Protection and Responsible Resolution 

Act. Such a reform would use the rule of law and shift priority 

rules of bankruptcy. However, proceedings would have Article III 

judges and special masters. And Chapter 14 could operate much 

faster, ideally over a weekend, and leave operating subsidiaries 

outside of the bankruptcy entirely. 

It would do this, as you know, by moving the original financial 

firm’s operations to a new bridge company that is not in bankruptcy. This bridge company would be recapitalized by leaving behind long-term unsecured debt. The aim, of course, is to let a failing firm go into bankruptcy in a predictable, rules-based manner 

without spillovers while people continue to use its financial services, just as people flew on American Airlines planes, bought Kmart 

sundries, and tried on Hartmarx suits during the bankruptcies of 

those companies. 

To understand how this would work in practice to resolve a large 

financial institution, our research at the Hoover Institution at 

Stanford has looked into how it would have worked in the case of 

Lehman Brothers in 2008, and work by Emily Kapur, a summary 

of which I have attached to my testimony, is very illustrative for 

getting a sense of how this new proposal would work in practice. 

In my views, Chapter 14 would work much better than Title II 

of Dodd-Frank. In the case of Title II, the FDIC would have to exercise considerable discretion, and I think in some cases the uncertainty might be so severe that it will lead policymakers to large 

bailouts anyway. Even if the Title II process were used, bailouts 

would be likely, as the FDIC might wish to hold some creditors 

harmless in order to prevent spillovers. The perverse effects of 

these kinds of bailouts occur whether or not the extra payment 

comes from the Treasury, financed by taxpayers, or from a fund, 

financed by financial institutions, or even from smaller payments 

to other creditors. 

Moreover, under Title II, the FDIC and its bridge bank would 

make the decisions. In contrast, under bankruptcy reorganization, 

7 

private parties motivated and incentivized by profit and loss considerations would make the key decisions about the direction of the 

firm, of course, perhaps, subject to Bankruptcy Court oversight. 

I think another advantage of Chapter 14 reform is that it would 

facilitate greatly the resolution process now under Dodd-Frank. As 

you know, those resolution plans submitted by the large financial 

firms have been rejected by the Fed and the FDIC, but with Chapter 14, I think they would be feasible and have a much better 

chance of passing the law. 

So, in sum, Mr. Chairman, Mr. Ranking Member Merkley, I 

think reform of the bankruptcy law is essential for ending Government bailouts. If it is accompanied by an increase in capital and 

capital structured debt, such a reform would go a long way to ending the too-big-to-fail problem. 

Thank you very much. 

Chairman TOOMEY. Thank you, Professor Taylor. 

Professor Jackson, please proceed. 

STATEMENT OF THOMAS H. JACKSON, PRESIDENT EMERITUS, 

UNIVERSITY OF ROCHESTER 

Mr. JACKSON. Good morning, Chairman Toomey, Ranking Member Merkley, and other Members of the Subcommittee. It is an 

honor to have the opportunity to testify before you on a subject 

near and dear to my heart, the title, ‘‘The Role of Bankruptcy Reform in Addressing Too Big to Fail’’. 

Specifically, I would like to focus my comments on the role bankruptcy law can and should play in the best possible resolution of 

a troubled financial institution and how modest but important 

amendments to the Bankruptcy Code can facilitate that outcome. 

First, what do I mean by the best possible resolution of a troubled financial institution? I mean a resolution process that meets 

four important tests. First, one that both minimizes losses and 

places them on appropriate pre-identified parties. Second, one that 

minimizes systemic consequences. Third, one that does not result 

in a Government bailout. And, fourth, one that is predictable in a 

sense of conforming to the rule of law in the myriad decisions that 

are made. 

The central role envisioned for bankruptcy law in Dodd-Frank is 

reflected in two places. First, it is embodied in the notion of resolution plans or living wills. Under Title I, they are specifically to be 

focused on and tested against a bankruptcy resolution process. 

Second, it is also reflected in the statutory requirements for implementing an administrative resolution proceeding, the orderly 

liquidation authority under Title II. Such a resolution proceeding 

cannot be commenced without a finding that the use of bankruptcy 

law would have a serious adverse effect on U.S. financial stability. 

But, I think there is a disconnect between these premises and today’s Bankruptcy Code. There is an emerging consensus that the 

best resolution system, one that meets the first three standards I 

noted above, involves a debt-based loss-bearing capacity known in 

advance that can be jettisoned in a rapid recapitalization of a financial institution. In the U.S., this system is represented by the 

FDIC’s single point of entry proposal for the recapitalization of a 

financial institution holding company. 

8 

But, even with required loss-bearing capacity, when compared to 

the FDIC’s current proposal, the current Bankruptcy Code, in my 

view, is what we would say, close but no cigar. Yes, Chapter 11 of 

the Bankruptcy Code is increasingly used to effectuate a going concern sale of a business, sometimes rapidly through a prepackaged 

plan, but it will struggle to do this in the case of a financial institution. 

The essence of a recapitalization is leaving behind equity and the 

loss-bearing debt to bear the losses and the transfer of everything 

else—assets, liabilities, rights, licenses, and subsidiaries—to a 

bridge company that, because of the stripping off of the loss-bearing debt, is presumably both solvent and in a position to deal with 

the needs of its subsidiaries, and this must be done with great 

speed so as to restore market confidence without a contagion-producing run. 

The current Bankruptcy Code, I believe, cannot provide the necessary assurance of a rapid recapitalization of this sort. Even with 

the announcement of a new protocol by the International Swaps 

and Derivatives Association that ends the ability to immediately 

terminate qualified financial contracts in a resolution proceeding, 

the problem remains, it currently only applies to the 18 largest 

global financial institutions and it does not deal with change of 

control provisions and licenses or other nonexecutory contracts. 

Nor is it certain to me that a judge under the current Bankruptcy Code would feel comfortable even with a resolution plan authorizing the transfer and, hence, recapitalization in a period such 

as 48 hours without clear statutory authorization. This will lead, 

in my view, either to ineffective resolution plans and/or the reality 

that OLA under Title II will, contrary to expressed desires, become 

the default resolution mechanism. 

What is required in addition to specified debt-based loss absorbency capacity known in advance that is being addressed separately, 

it requires explicit statutory authorization for a rapid 48-hour 

transfer of a holding company’s assets, liabilities, rights, and subsidiaries minus loss-absorbing debt and equity to a bridge institution and stays and overrides of provisions to allow that to happen. 

The Taxpayer Protection and Responsible Resolution Act provides the core changes to the Bankruptcy Code to make it a credible resolution mechanism, as does the House bill enacted last session. Both neatly provide the necessary amendments to bankruptcy 

law to permit this rapid recapitalization. Think of it as taking the 

structure that is there of the going concern’s sale under Section 363 

of the Bankruptcy Code and putting it on the necessary steroids to 

deal with a large financial institution. 

While there can be robust debates on several choices made, as I 

illustrate in my written statement, these minor disagreements 

should, in my view, not hold back the consideration or enactment 

of these bankruptcy provisions, nor should non-bankruptcy-related 

considerations. We need these amendments to the Bankruptcy 

Code. 

And, again, I would like to thank the Subcommittee for allowing 

me this opportunity to express my views. And, of course, I would 

be delighted to take questions. 

Chairman TOOMEY. Thank you, Professor Jackson. 

9 

Professor Johnson. 

STATEMENT OF SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF 

MANAGEMENT 

Mr. JOHNSON. Thank you, Senator, and thank you for holding a 

hearing on such an important and timely topic. 

I would like to make three points. First, I think all companies 

in the United States should be able to go bankrupt. I think you 

could regard it as a right of American corporations. I do not understand why some companies should have access to a different Bankruptcy Code than other companies. If you are going to change the 

code, and I am completely open to that, I think it should be available to all companies on an absolutely equal footing. 

If we start to say some companies have different access, some 

companies can get different kinds of protection from their creditors, 

surely, we open again the question of is that better or worse, and 

if it is better, if I am getting some additional protection from my 

creditors, do I not want to be in that category, and you have just 

created a version of ‘‘too big to something’’ that you said you were 

trying to avoid. 

The essence of the various bankruptcy proposals that we have 

before us in the public debate, all of which are, obviously, very well 

thought through and extremely detailed, I think it really comes 

down to this, Senator, which is are we providing debtor-in-possession financing from the public sector in some form to a bankruptcy 

court or not? If we are not, then the private sector has to provide 

the funding, which they will not. That is why it is called a crisis. 

The idea that we can rely on these companies to always have 

enough liquidity on their balance sheet to avoid this issue, I think, 

is unrealistic. Again, that is why it is a crisis, because they run out 

of liquidity. 

Now, if the Government is providing debtor-in-possession financing, that is a different ballgame altogether. But, I have a lot of concerns about that, Senators, as I think you must. So, if, let us say, 

we come to a point where the Treasury—it would be the Treasury, 

not the Fed, I believe—is providing a loan of $10, $20, $50 billion 

to a bankruptcy court, what is the political legitimacy of that? 

What is the economic expertise and management skills being 

brought to bear on that by the bankruptcy judge or whatever trustees they put into place? I think the backlash, justifiable backlash 

you would get against that would be enormous, and I really do not 

think that is a good idea from the economic point of view. 

Now, if we agree that some large financial firms would have 

trouble going bankrupt, or if they went bankruptcy under the current code we would risk re-running a version of the Lehman scenario, I think there are actually two routes forward. One is to try 

and change the code selectively for those firms, and I am very worried about that. The other is to change the firms, and as I think 

we agree—certainly the witnesses seem to be agreeing—under 

Dodd-Frank, the presumption is that all firms would be able to go 

bankruptcy and Title II is there as a backup, last resort, just in 

case the regulators got it wrong in the living will planning process 

and find at the very last moment, as they did in the Lehman weekVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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end, for example, after the Barclays deal fell apart, they find that 

the consequences, or they begin to think the consequence of that 

bankruptcy could be cataclysmic for the system. 

Now, where, exactly, is the pressure point going to be and how 

does it compare with current structures? I think it is pretty obvious, and again, we saw it in the Lehman case. It is global. It is 

cross-border. 

For example, the FDIC—and I think the living wills process and 

the resolution planning process has been helpful. It has revealed a 

lot of details that are very useful, including the following. The 

FDIC has a Memorandum of Understanding with the Bank of England on how they would cooperate in the event of resolution. That 

cooperation would not apply if we were following Title I bankruptcy. 

The global nature of these firms really matters. If Lehman or 

any other firm today were put into bankruptcy, the U.K. and other 

regulators around the world would immediately move to seize assets, just as they did in September 2008. Now, that is extremely 

not helpful. You are not going to change that by amending the U.S. 

Bankruptcy Code. You would need a treaty between countries to cooperate in the event of bankruptcy, and I really do not think you 

are going to get a treaty. You need to change the global nature of 

these businesses and/or make them considerably smaller, firewall 

them off international. 

The TLAC, the total loss absorbing capacity that we have started 

to talk about, is a complete illusion, Senator. There is no such 

thing as loss absorbing debt. When the debt goes down, you find 

the person who was holding that contingent debt did not fully understand the risk. You find they were highly leveraged. You find 

they were an insurance company. You find they were an AIG. You 

find that they were held by money market funds. It is September 

2008. Again, you need equity. You need a lot of loss absorbing equity on the balance sheet at the holding company level of all these 

global companies. 

We have inched toward reasonable equity levels measured on 

that basis. We have not made much progress. The amount of equity 

on the balance sheet of our largest banks is between 4 and 5 percent measured on a leverage basis. That means 95 to 96 percent 

debt, 4 to 5 percent equity. And they gamble massively in the global markets every day. That is the point on which we should be focusing, and that is how you address the bankruptcy issues, as well. 

Thank you. 

Chairman TOOMEY. Thank you, Professor Johnson. 

Well, let me just start—let me just follow up on this, and maybe 

this will give an opportunity for Mr. Guynn to respond to something that Mr. Johnson said, because, Mr. Guynn, you indicated in 

your testimony that one of the essential features of having a successful resolution of bankruptcy is loss absorbing capital, which intuitively makes sense to me, but Professor Johnson said, among 

other things, maybe the creditors do not understand the nature of 

the risk. I find that implausible, frankly, but how would you respond to his concern that TLAC is not adequate? 

Mr. GUYNN. Yes. Well, I obviously disagree with Professor Johnson, and I think the FDIC disagrees and so does the National 

11 

Bankruptcy Conference. The fact of the matter is that if you convert debt to equity in a bankruptcy proceeding, it is loss absorbing 

just like equity. There is no difference between the two. And, it 

does not matter whether you do that through a direct bail-in or a 

bridge bail-in—what I think Professor Jackson refers to as a oneentity or a two-entity recapitalization. The single point of entry 

method using a bridge financial company is a two-entity recapitalization, where you basically transfer all of the assets of the failed 

company to the bridge and you leave behind in a receivership or 

bankruptcy its long-term debt. The debt gets converted to equity in 

that new company. So, it is loss absorbing and I do not know why 

Professor Johnson says otherwise. 

Chairman TOOMEY. Let me move on to another issue here, and 

this is for Professors Taylor and Jackson. Do you think it is fair 

to say that the nature of the orderly liquidation authority as it exists now, together with the Bankruptcy Code as it exists now, actually could increase the risk of a failure in the event that there were 

some volatility, disruption, problems in the markets? 

Mr. TAYLOR. Well, I think, currently, the first part of DoddFrank Title I, where the living wills are submitted and approved, 

that is not working, and I think the problem is the existing Bankruptcy Code. So, a revision of that would help. I think it is very 

important for that purpose alone. 

I also, as I indicated in my testimony, am concerned about Title 

II’s operations of high degree of discretion given to the FDIC, the 

uncertainty that might cause, and, therefore, the possibility of additional uncertainty and risk from that. So, I would agree that 

there is a problem with that, as well. 

Chairman TOOMEY. Professor Jackson. 

Mr. JACKSON. I am not sure I would think it increases the likelihood of a failure. I think what you would have now—— 

Chairman TOOMEY. And could I just interrupt for a second—— 

Mr. JACKSON. Yes. 

Chairman TOOMEY. ——just because an increase begs the question of relative to what, and I mean relative to a bankruptcy mechanism that works. 

Mr. JACKSON. Yes. I think it does in the following way, or at 

least it pushes everybody to Title II OLA resolution proceedings, 

which is expressly contrary to the express desire even in DoddFrank for Title II itself, because currently, even with the ISDA Protocol, for most of these financial institutions, Title II stays the derivative contracts for the period necessary to enter the bridge company. A bankruptcy has exemptions from the automatic stay for 

qualified financial contracts and is unable to do that. So, it is a big 

mover away from being able to use bankruptcy, and I suspect it is 

a hang-up on the resolution plans, which need to show what happens under bankruptcy, not under Title II. 

Chairman TOOMEY. And, Mr. Guynn, the legislation that I have 

introduced with Senator Cornyn, the way I think of it, it has got 

three main changes that it makes to the Bankruptcy Code. One is 

it creates a panel of experienced judges who would handle the filing of a bankruptcy. The second is it creates these temporary 48- 

hour stays on derivative instruments in particular, but some othVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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ers. And then, of course, it creates the bridge company, which is 

similar to what is contemplated in OLA. 

In your view, are each of these three items important reforms to 

bankruptcy, and would you just care to comment on them. 

Mr. GUYNN. Sure. I think all three of them are actually very useful reforms. Obviously, having a set of bankruptcy judges or Article 

III judges who have experience, or view it as their mandate to develop expertise, about financial institution failures is a good thing. 

It is going to work better. 

As far as having a stay for 48 hours, that is a also good idea. 

Most derivatives contracts are actually booked at the operating 

subsidiary level, so you tend not to have a termination of those contracts under SPoE unless the contracts contain cross defaults to 

the parent’s failure. There are very few derivatives at the parent 

level and they tend to be inter-company, so they typically will not 

be terminated. But, having a 48-hour stay is very useful, and in 

particular, your bill also would override cross-defaults, which is actually very useful. Otherwise, you have to rely on something like 

the ISDA Protocol, which I discussed earlier. 

The last one—I have forgotten the last thing you mentioned—— 

Chairman TOOMEY. The bridge company. 

Mr. GUYNN. Oh, the bridge company. This is helpful, and also, 

I think, combined with the express authority to be able to transfer 

quickly the assets to a bridge. I think that convincing bankruptcy 

judges they have the authority do a quick transfer to a bridge is 

probably the biggest challenge under the current Bankruptcy Code. 

It can be done, we believe it will work, but it will require education 

of bankruptcy judges themselves to say, yes, you have this authority. The bankruptcy judge did a quick sale in Lehman within 4 

days. You are not actually doing a sale here. You are just moving 

the ongoing operations into a bridge company that will be held for 

the benefit of the bankruptcy estate. Nevertheless, having the legal 

authority clearly spelled out in a statute will eliminate the legal 

uncertainty as to the authority of the judge to do it. 

Chairman TOOMEY. Thank you, Mr. Guynn. 

Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chairman, and 

thank you all for your presentations. 

Professor Taylor, you mentioned that you do not believe the living wills are working, but I just want to check in. In terms of Title 

I living will, the concept behind it, my impression is that all of you 

support that work being done, is that correct? 

Mr. TAYLOR. Yes, I support that. 

Senator MERKLEY. And, Mr. Taylor, or Professor Taylor, are 

there a couple things that, specifically, you would like to see done 

to improve the working of those living wills? 

Mr. TAYLOR. I think, in particular, if there was a—something 

like Chapter 14 or something like the proposed bill here, it would 

make it feasible for the companies to submit the resolution plans, 

living wills, that are consistent with a bankruptcy without Government bailout. It is now very difficult to do that. The whole idea of 

having an operation that is in bankruptcy and preventing it from 

running under existing law is hard, and so they say, well, we need 

some help. We need some extra support. So, there is that inconsistVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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ency. So, Chapter 14, I think, resolves that, because you can operate the institution. Its businesses will still be operating through 

this bridge company. 

Senator MERKLEY. Thank you. 

And, Professor Johnson, any insight on that particular piece of 

the puzzle? 

Mr. JOHNSON. Yes, Senator. I think the Dodd-Frank intention is 

pretty clear and consistent, actually, which is given the existing 

code, which was not modified as part of Dodd-Frank along this dimension, the banks have to show that they are able to be resolved 

through bankruptcy without causing large systemic risks, which, I 

agree, means that most likely they would have to be liquidated or 

wound down, and the fact that we are having this conversation 

tells you that many people out there in the business community are 

very concerned about the systemic implication of such a winddown, which means, according to the logic of Dodd-Frank, if you 

are not going to amend it, that the regulators should be moving to 

make these banks much safer, presumably smaller, presumably 

simpler, and much easier to unwind through liquidation. 

Senator MERKLEY. Thank you. 

I want to turn to the orderly liquidation fund, which I think is 

part of the point that the Chairman is making, concerned that that 

turns into a taxpayer-funded bailout. I wanted to check in on that 

point with all of you. The OLF line of credit available through the 

FDIC was envisioned to enable the FDIC to provide fully secured 

loans at above-market rates to sufficiently capitalized or recapitalized firms, and thus the lender of last resort facility. And, losses— 

under that OLF, the losses are imposed on the shareholders, longterm unsecured debt holders, the holders of other liabilities, but 

not on taxpayers. And, the FDIC would have to proceed to cover 

those costs either through the assets of the failed company or eventually post hoc assessments on surviving financial institutions. 

Now, I believe Mr. Guynn and Professor Jackson, that you all 

were two of the principal authors of a report that addressed this, 

and if I understood it correctly, I thought that that made some 

sense. But, I wanted to ask you all about that now. 

Mr. GUYNN. Yes. Thank you. So, the standards that you actually 

recited are the classic standards that Bagehot set out more than 

a century ago for central bank lender of last resort liquidity, and 

the FDIC has announced that it would use the orderly liquidation 

fund according to those standards. The statute itself does not actually bind them to that. So, that is why, to the extent people sometimes criticize the OLF, it is because those standards are not embedded in the statute. But, the FDIC has said that that is how it 

would use the OLF, and so that is the appropriate way to use it. 

Senator MERKLEY. So, with that caveat, it makes sense to you? 

Mr. GUYNN. Yes. 

Senator MERKLEY. OK. And Professor Jackson. 

Mr. JACKSON. Yes. I think that one of the great advantages of 

single point of entry, either under Title II or under the Chapter 14 

procedure, is that the bridge institution—and I think it works better in bankruptcy because it is not under the supervision of the 

FDIC—is a company that is recapitalized, should look immediately 

14 

solvent to the market participants, and generally should be able to 

get its own liquidity in a vast variety of circumstances. 

There may be some, such as a liquidity freeze across institutions, 

a little bit like happened in 2008, 2009, where that will not be possible, and in those cases, it seems to me, and now speaking about 

bankruptcy specifically, the Federal Reserve Board’s ability to lend 

to institutions where there has been a multiple industry problem 

strikes me as a solid back-up that would not need to be changed. 

Senator MERKLEY. Thank you. 

Professor Johnson. 

Mr. JOHNSON. Senator, I used to be the Chief Economist at the 

International Monetary Fund and I worked on a lot of crises over 

the past 30 years. There is never liquidity in the market. That is 

why it is a crisis. And, the financing terms of this fund would be 

absolutely critical. 

I do agree that the FDIC has drawn up some sensible rules. I 

do not think that this bankruptcy scenario would work at all in 

terms of avoiding systemic risk unless there is some sort of additional Government-provided financing, and I do not think you want 

to provide that kind of Government financing to a bankruptcy corp. 

Senator MERKLEY. Thank you. 

Chairman TOOMEY. Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. I apologize for 

being late. We are trying to cover three hearings at the same time. 

So, let us get to the key point we are talking about here. No financial institution should be too big to fail, and to me, that means 

three things. If a bank is on the verge of failure, we should be capable of shutting it down without bringing down the entire financial system. The shutdown should not require a dime of taxpayer 

money. And the shutdown should not create moral hazard by letting the bank’s executives escape accountability. 

Now, the Chairman recently introduced a bill that creates a new 

process for liquidating our biggest financial institutions and repeals 

the existing process found in Title II of Dodd-Frank, and I appreciate the Chairman’s efforts, but I am concerned that his proposal 

creates more problems with each of the three standards that I just 

laid out. 

The Chairman’s bill does not create any established source of 

short-term liquidity, the point we were just talking about here, for 

any failing institution, instead relying on the market to provide 

funding for that failing institution. 

So, just so we have got the record clear on this, Professor Johnson, let me ask you, is it realistic to expect the market to provide 

short-term liquidity for a failing institution in a time of crisis? 

Mr. JOHNSON. No, that would not be a realistic expectation. 

Senator WARREN. All right. And, in fact, I thought I heard you 

say, Professor Jackson, the answer is, let the Fed bail them out if 

it is a short-term liquidity crisis. 

Mr. JACKSON. No. My—the failed institution—one of the great 

advantages, I think, of the bridge company is it immediately transfers a failed institution into two different entities, an entity that 

has—— 

Senator WARREN. I understand that—— 

Mr. JACKSON. OK. 

15 

Senator WARREN. ——Professor Jackson. I understand how this 

works. I just listened to your testimony just now and you said, gee, 

if we had a crisis like 2008 and liquidity dried up, as Professor 

Johnson said it most likely will in this kind of circumstances—— 

Mr. JACKSON. But it would be under—— 

Senator WARREN. ——it would say, let the Fed take care of it. 

Mr. JACKSON. It would be under the circumstances where it was 

not directed at the particular institution but to a broader liquidity 

problem. 

Senator WARREN. But—— 

Mr. JACKSON. And, I—— 

Senator WARREN. But you are talking about putting taxpayer 

dollars in, and to me, that is what too big to fail is all about. 

Mr. JACKSON. Taxpayer dollars into an industrywide issue that 

would not distinguish between the institution that was in the resolution proceedings and the ones that were not. 

Senator WARREN. So, in other words—let me just wrap this back 

around. Professor Johnson, would not the Chairman’s bill just put 

us back where we were in the 2008 crisis so that Congress would 

either have to step up with a taxpayer bailout or risk the entire 

meltdown of the financial services industry and potentially the 

economy? 

Mr. JOHNSON. Yes. I fear you would have another Hank 

Paulson–Ben Bernanke moment when they come to you and say, 

if you do not give us a large amount of money with few strings, 

there will be a global cataclysm. 

Senator WARREN. Well, and I think that is what we are all trying 

to avoid here. 

You know, there is one other part to this that I want to talk 

about, besides the fact that the Government should not be—the 

taxpayers should not be put in the position of having to choose between either watching the economy implode or having to bail out 

these big financial institutions, and that is the question of moral 

hazard built into this. 

The Chairman’s bill lets the CEO and the management team of 

the bank keep their jobs and all of their past compensation. That 

is the same sweet deal that the bankers got in 2008. So, Professor 

Johnson, let me ask, do you believe that the Chairman’s bill does 

enough to discourage senior management from taking on big risks 

that threaten the entire financial system? 

Mr. JOHNSON. I think, Senator, that it does not do enough. I 

think that was a major issue in the run-up to 2007 and I fear it 

could absolutely happen again. 

Senator WARREN. All right. Thank you. 

I know this is a complicated issue and I appreciate the Chairman’s contribution to this conversation, but I have serious concerns 

about any proposal that would once again force Congress to face 

another bailout decision and would once again let CEOs get all of 

the upside of taking big risks but none of the downside on this. I 

think we need more accountability in the system, not less. 

Thank you, Mr. Chairman. 

Chairman TOOMEY. Thank you. 

So, to begin the second round, let me just ask a question. If a 

car company or an airline goes into bankruptcy, does the BankVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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ruptcy Code force the senior executives all to be fired as a result 

of that? Professor Jackson. 

Mr. JACKSON. No. 

Chairman TOOMEY. No. But, I guess some believe that the financial institution should be uniquely subject to that. 

Let me ask this question. Dodd-Frank as written specifically says 

that the default setting for a resolution should be bankruptcy. Professor Taylor, do you think right now, as a practical matter, the 

market believes that the default setting for the failure of a big financial institution would be bankruptcy, or—— 

Mr. TAYLOR. No, I do not believe so, Mr. Chairman. I think that 

is the purpose of the proposal you have, Chapter 14, whatever you 

call it. It is to allow that to happen, to have a bankruptcy in a credible way. 

Chairman TOOMEY. But, the point is that right now, that is not 

perceived to be a credible alternative. 

Mr. TAYLOR. That is correct. 

Chairman TOOMEY. Despite the fact that Dodd-Frank contemplates that that should be the preferred path. 

You say in your testimony, Mr. Taylor, that under Title II, it 

would likely—that the confusion of how a firm would be reorganized would likely lead policymakers to ignore the orderly liquidation authority in the heat of a crisis and resort to massive taxpayer 

bailouts as in the past. So, as I understand it, you are saying that 

the current structure that we have very much contemplates, or it 

would very much resort to this taxpayer bailout. Could you elaborate on that a little bit. 

Mr. TAYLOR. Well, that is a real concern with the Title II and the 

orderly liquidation authority, the resolution process. The FDIC 

would effectively have discretion about which creditors benefit, 

which do not. It would not necessarily use the priority scheme of 

bankruptcy, which is very clear in the law. I think that uncertainty 

would make people nervous, and a policymaker in a very responsible position would, quite frankly, I think, be tempted to go 

through a bailout like we saw before in 2008. So, I am concerned 

about that. 

Chairman TOOMEY. And, the last question for Professor Taylor, 

I think, if I understood the Senator from Massachusetts articulate 

three concerns about what ought to happen in the event of a failure, one would be the possibility of shutting down the institution, 

one would be not costing taxpayer money, and the third would be 

firing the executives. But, then my legislation was criticized for 

not, I think, for not having the Government providing any financing facility, debtor-in-possession facility, which seems to me to be 

the exact mechanism that would put taxpayers at risk. Is that your 

view, Mr. Taylor? 

Mr. TAYLOR. Yes. I think the importance of a bankruptcy concept 

is the people who are holding this debt are the ones that are going 

to suffer. They are at risk. And, if there is a sufficient amount, and 

Mr. Guynn indicated, that will resolve this operation. It is important to get a sufficient amount, to be sure. But, they will suffer the 

losses. That deals with the moral hazard issue. That has a much 

better sense of risk taking and it does put people at risk if the Government goes through with a proposal like this. 

17 

Chairman TOOMEY. So, Mr. Guynn, it seems to me that—one of 

the things that I have been concerned about for a long time is that 

regulators have generally, and I am reluctant to paint with too 

broad a brush here, but I do perceive a sense on the part of many 

regulators that their job is to make it impossible for a financial institution to fail, which might suggest that they do not have a great 

deal of confidence in the current resolution mechanism. But, 

whether or not that is their motivation, is there a danger, in your 

view, that could result from over-regulation in the attempt by regulators to make it impossible for an institution to fail, and if so, 

what is the downside of over-regulation? 

Mr. GUYNN. Well, obviously, over-regulation can be a drag on the 

banking system, which will then be a drag on lending and a drag 

on the broader economy. I actually think that the banks have a lot 

more liquidity and capital and loss absorbing capacity than they 

have had before. So, it is very different from 2008. In fact, in my 

written testimony, I have an exhibit that shows that they actually 

have five times the amount of cash and high-quality liquid assets 

now than they had in 2008. 

And, I actually think that it is possible for banks to have too 

much liquidity. In fact, I mean, Governor Tarullo gave a great 

speech on this subject last November, where he talked about two 

extremes: banks being required to self-insure against liquidity risk, 

even in a failure situation under an SPoE, and he also talked about 

the other extreme, where they are over-reliant on lender of last resort facilities, and suggested that there needed to be a balance between those two. 

The fact of the matter is that the banks currently have been 

forced to become and have become arguably too liquid in order to 

show that the SPoE resolution strategy under the Bankruptcy Code 

is credible. So, the real question is whether forcing them to do that 

is good public policy or not or whether there should be more of a 

balance. 

Chairman TOOMEY. Thank you. 

Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chairman. 

I want to go back to this issue of liquidity at the time of crisis. 

So, we have a major firm that perhaps they are unable to provide 

the funds to complete a 24-hour repurchase agreement. There are 

various other things that are unfolding very quickly. They are in 

crisis. And, the general understanding was that if you want—you 

have three possible situations there. They can turn to liquidity to 

the private markets. They can turn to liquidity in something like 

the OLF, where it is—liquidity is ultimately funded by both the 

company assets or an assessment on the banking world. Or, you 

just proceed with a chaotic collapse. 

And, I think the theory was that the chaotic collapse did not 

work very well in 2008. It created a contagion that spread from 

company to company. You had a fire sale on one set of assets, Lehman Brothers, that diminished the value of those assets held in the 

other companies, and it was not a pretty outcome, and that private 

liquidity is not going to materialize in that situation. They would 

not be in crisis if they could access private liquidity. So, therefore, 

turning to a structured liquidity funded by both ultimately the asVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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sets of the company and the FDIC assessment would be the most 

logical result. 

And, so, I think at least three of you have supported the idea of 

the OLF within Title II, but I just wanted to, since this is kind of 

at the heart of this discussion as to whether this is the most logical 

path, I just wanted to start and run across, have all four of you 

comment on this. Professor Johnson. 

Mr. JOHNSON. Well, yes, Senator, today, because the living wills 

process has not been followed through. It is a failure of implementation of Dodd-Frank. Dodd-Frank absolutely requires, and I think 

that, largely, the discussion shows this, that these banks have to 

become simpler and much easier to resolve under the existing 

Bankruptcy Code and we have not done that. So, yes, there is this 

fallback on the OLA, and I think you are right to be uncomfortable. 

We should not be jumping straight to Title II. We have not worked 

through Title I properly. 

Senator MERKLEY. OK. So, that taken, we need to do a lot more 

work to implement Title I. But, at this point, would you support 

the repeal of Title II, or is that backstop an important one to have? 

Mr. JOHNSON. You need to backstop, Senator. But, the regulators 

have to understand, and I think it is very helpful to have this kind 

of hearing to make the point to them that it is not satisfactory to 

just fail to follow through on the intent of Dodd-Frank and to let 

the large banks off the hook with regard to their resolvability 

under bankruptcy under the existing Bankruptcy Code. Nobody on 

this panel is saying that that is feasible, right. 

Senator MERKLEY. Right. 

Mr. JOHNSON. That is a failure of implementation of Dodd-Frank. 

Senator MERKLEY. Very good. 

Professor Jackson. 

Mr. JACKSON. With respect to the orderly liquidation fund, I 

think the concept is good. I think it has the potential of being 

abused. I do not think it needs to be mirrored or replicated in the 

bankruptcy process where the bridge company is not under FDIC 

authority, should be recognized as solvent. I do think, and I think 

it is distinct from a bailout, it should have the same access rights 

to Fed funds as other institutions do at a time of liquidity—— 

Senator MERKLEY. But, you are not arguing at this point for a 

repeal of Title II? 

Mr. JACKSON. I actually—I think Title II—I think, one, if you do 

these bankruptcy reforms, you are going to diminish enormously 

the need to rely on Title II, which is explicitly part of Dodd-Frank 

to begin with. That is step one. You will get a lot—without repealing it, you will make it actually a much less likely scenario. 

Second, I think the world may unfold in uncertain circumstances, 

so I would like to see it there as a backup—— 

Senator MERKLEY. Thank you. Thank you. 

Professor Taylor, keep it as a backup or repeal it? 

Mr. TAYLOR. Well, I am sorry. With respect to the 2008 situation, 

there was so much confusion about how each company would be 

handled, Bear Stearns, Lehman Brothers, AIG. The advantage of 

having something like this reform of the Bankruptcy Code is it 

would, in principle, be a uniform treatment for these firms. There 

is in the law currently a backstop, 13(3) of the Fed. I think it needs 

19 

to be implemented in a way that is clear, penalty rate, for example, 

or the rule of how it would be operated—— 

Senator MERKLEY. Because I am running out of time, just get to 

the heart of it. Do you feel that with that additional provision that 

you referred to that we can eliminate Title II, or would you keep 

it as a backstop? 

Mr. TAYLOR. OK. So, I would really just want to repeat, if you 

like, Professor Jackson on this. I think whether you have Title II 

or not, you need this reform. 

Senator MERKLEY. OK, that is fine—— 

Mr. TAYLOR. My preference—— 

Senator MERKLEY. ——but that is not the question I am asking—— 

Mr. TAYLOR. ——would be not to have Title II and have this reform. But, whether you have it or not, this reform is essential. 

Senator MERKLEY. The Chairman is going to cut me off. That is 

why I am asking you to be succinct. But, what Professor Jackson 

said was that changes may make it far less necessary, but you 

should keep it as a backstop, and you are echoing that sentiment 

in your concluding sentence there? 

Mr. TAYLOR. Actually, I am sorry to take so much time with this, 

but I have written it. Problems with Title II, I think, is problems 

as it exists. I would prefer if it goes. However, the reality—if that 

stays, I would really support so much having the Chapter 14 or 

whatever this bill is. I think it is very important to make this 

whole operation work. 

Senator MERKLEY. I had so many other questions I was going to 

try to get to. I am not going to make it, so I will just complete this 

panel. Mr. Guynn. 

Mr. GUYNN. So, I think even the FDIC would support this legislation, making bankruptcy better so that Title II is only needed in 

the smallest number of circumstances. But, I think it is useful to 

retain Title II for at least one reason, and that is to preserve crossborder cooperation by foreign regulators. The U.S. is almost unique 

in having a tradition of reorganization in bankruptcy. Outside the 

United States, the regulators just do not associate it with bankruptcy. When they hear the word bankruptcy, they think liquidation, and so it is actually useful to have Title II just so they know 

that there is a backup of something that looks more like their special resolution regimes, which they associate with recapitalization 

or reorganization. Ironically, we call Title II the orderly liquidation 

authority. They associate Title II more with reorganization or recapitalization regimes. 

Chairman TOOMEY. Thank you. 

Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. 

So, the Chairman asked the question about why deal with moral 

hazard and suggested that to say that bank executives of these 

large too-big-to-fail banks, if they bring down an entire institution, 

should have some responsibility for that. And, so, I just want to 

ask the question again. When a big construction company fails, he 

asked the question, are the executives fired under Chapter 11 and 

the answer is no. But, does a big construction company, if it fails, 

threaten the entire economy? Professor Johnson. 

20 

Mr. JOHNSON. No, hopefully not—— 

Senator WARREN. Hopefully not, at least—— 

Mr. JOHNSON. ——not historically. 

Senator WARREN. Yes. And, do we see the Secretary of the Treasury or the Federal Reserve Chair coming in to tell the American 

people that they need to bail out a big construction company? 

Mr. JOHNSON. No, we have not experienced that. 

Senator WARREN. All right. So, I think—and then the question 

is, does that change the calculus on whether or not we need to find 

devices in the law for holding the executives of the biggest financial 

institutions accountable if they threaten to wreck the economy 

again. Professor Johnson. 

Mr. JOHNSON. I am absolutely in favor of holding them accountable, and just to add a small fact to this, the corporate executives 

of the top 14 U.S. financial companies made $2.5 billion in compensation between 2000 and 2007. The most compensated five of 

them made $2 billion of that. They were the people who took on 

the risks of all the big companies that you know very well, the 

AIGs, Countrywide, Lehman, Bear Stearns. They are the ones who 

brought down the system. So, the moral hazard is front and center 

of our concerns here. 

Senator WARREN. All right. Thank you. Thank you, Professor 

Johnson. 

And, I just want to go to one other point, and that is I very much 

am struck by your point, Professor Taylor, and that is that markets 

do not believe that, if pressed, the United States Government 

would not bail out the too-big-to-fail banks right now. I think that 

was your point, right? 

Someone asked a question, the law right now says that we will 

not. If we pass five laws that say we are never going to bail them 

out, will that change whether or not the markets believe that, if 

pressed, if the economic system is at risk, if a too-big-to-fail bank 

threatens to bring down the entire economy, that what will happen 

is that the American Government and the American taxpayer will 

be put on the hook to bail them out? 

Mr. TAYLOR. Senator, the purpose of this bill, or Chapter 14—— 

Senator WARREN. I am not asking you that question. 

Mr. TAYLOR. Well, that is how I would answer it. 

Senator WARREN. Well, what I heard you say is that no one believes—— 

Mr. TAYLOR. With the current bankruptcy law. 

Senator WARREN. All right. Let me ask it a different way. In 

2008, did we have a law that said that the Federal Government 

would bail out the biggest financial institutions if they threatened 

to bring down the entire economy? 

Mr. TAYLOR. No. We had the—— 

Senator WARREN. No. We had no law on it, right? And yet, when 

faced with the choice of either watching the economy collapse or 

bailing out the biggest financial institutions, what did Congress do 

at that point? 

Mr. TAYLOR. They bailed them out. 

Senator WARREN. They bailed out the biggest financial institutions. 

21 

The question for me, and this was the one that the Chairman 

asked—I understand, we are trying to get to the same place. We 

are not at loggerheads over this part of it. The question is, realistically, how do you get there. And for me, that is why things like the 

living wills are so important and why they intersect powerfully 

here. It is why regulatory structure is so important. It is why 

Glass-Steagall is so important. The things that keep us away from 

coming to the precipice of banks that can bring down the entire 

economy. 

So, I appreciate the point, and I really do. I am not trying to 

argue with you about where we are trying to get. It is just a question of whether or not passing one more law to promise, promise, 

promise we will not bring down the economy will change—will not 

bail out big banks—will change anything if we are put in the position of it is either bail out the big bank or watch the economy collapse, and that is the part I am worried about. 

Mr. Chairman, thank you. 

Chairman TOOMEY. Well, and I thank the Senator from Massachusetts and I appreciate her participation and her thoughtfulness 

on this. 

I would just—it seems there is a pretty clear disagreement about 

one fundamental aspect here. It is my view, and I would like to get 

the input from our witnesses, that the way in which to ensure that 

the market does believe that resolution in a bankruptcy is adequate and to ensure that taxpayers are not at risk, Professor Johnson has one approach, which is shrink the banks. It strikes me that 

one could view that as the tail wagging the dog a little bit, because 

maybe the cause of the problem is the inadequacies of the Bankruptcy Code. And, so, if we correct the inadequacies of the Bankruptcy Code and we do it in a way that taxpayers are not at risk, 

then we do not have to bother with deciding exactly which line of 

business on a Tuesday a given bank can do as we do now. 

So, I guess my question for Professor Taylor is, is it your view 

that if we made these changes to the Bankruptcy Code, which Congress is, of course, entirely free to do if it chose to, that the market 

would believe that the Bankruptcy Code would work and, therefore, 

would be used, and, therefore, we would not face this question of 

must we bail out the banks or face a systemic crisis. 

Mr. TAYLOR. Yes. That is really the whole purpose, in my view, 

is to give—when the policymakers in the future come to Congress 

and ask for a bailout, you say, there is an alternative. You have 

this bill, this Chapter 14, which is the way to go through bankruptcy without causing spillovers, without causing this damage. 

And, so, no, we do not need a bailout. We will not do that. We have 

this alternative, which is much more credible. 

Chairman TOOMEY. Now, Mr. Guynn, I think you said earlier 

that you think it is entirely possible that the Bankruptcy Code 

might be adequate as it is currently written, but that it would be 

much better if it had these changes. If it did have these changes, 

is it your view that there would be a broad consensus that a failure 

of a large firm could be safely resolved through bankruptcy? 

Mr. GUYNN. Yes. But let me answer that by responding to Senator Warren because I think she was characterizing your Chapter 

14 proposal of having a provision that says, ‘‘Thou shalt not bail 

22 

out banks.’’ The only law that has something in it like that is actually Title II. What is important are not statements saying you will 

not bail them out, but, rather, frameworks that allow you to set up 

a mechanism so that, in fact, you can safely impose losses on creditors without creating runs, and that is what your bill actually 

would do, and that is why it would help. 

Although I do believe that one can resolve institutions using the 

single point of entry strategy under the existing Bankruptcy 

Code—and that is the key, it is being able to do it under that strategy—it is much better and it will be legally much more certain 

with your bill being enacted. 

And, let me just mention that all the key regulators around the 

world believe that is actually the single point of entry will avoid 

bailouts, and if you look at all the regulators in the U.S., you have 

former FDIC Chairman Sheila Bair saying, ‘‘This is a viable strategy.’’ You have Governor Tarullo saying, ‘‘best potential for the 

early resolution of the systemic financial firm.’’ Fed Chairman 

Janet Yellen, ‘‘very promising.’’ Governor Jay Powell, ‘‘a classic 

simplifier making theoretically possible something that seemed impossibly complex.’’ President Dudley of the New York Fed, ‘‘very 

much endorse the FDIC’s single point of entry framework.’’ Tom 

Baxter, General Counsel of the New York Fed, calling single point 

of entry a ‘‘visionary breakthrough idea.’’ Again, your bill would facilitate doing that under the Bankruptcy Code. 

So, the point is, is that if we can actually amend the Bankruptcy 

Code to make it absolutely certain that SPoE can be carried out 

successfully under the Bankruptcy Code, then, in fact, it will reduce the need for Title II, which, I think, is a good thing, because 

SPoE will now be carried out under a system that is rule based and 

predictable, and it is really the strategy that everybody believes 

works. No one is arguing whether Title II or bankruptcy are better. 

It is really the strategy, and the thing that you want to accomplish 

with your bill, and I think your bill accomplishes it, is to create a 

framework of bankruptcy law that will facilitate the single point of 

entry strategy being able to be carried out. 

Chairman TOOMEY. Professor Johnson, I want to give you a 

chance to respond, because I know you want to say something, but 

if you could do that briefly. I do have a quick question for Professor 

Jackson before my time expires. 

Mr. JOHNSON. I think you put the question brilliantly and with 

great clarity, Senator. And unfortunately, changes to the Bankruptcy Code being discussed today cannot create the expectation 

that this is what would happen to these firms because they are so 

global, and because we have agreed, actually, completely, that 

there can be no cooperation between global authorities in the event 

of these failures. 

And in Footnote 14 [of my testimony], I put a link to a corporate 

data base where they do a visualization of all the interconnections 

between these pieces of these banks across borders, and I really 

hope that you and your staff will look at it and look at the complexity there and think about how that unravels when the regulators do not cooperate in the event of bankruptcy. And, that is 

what Mr. Guynn said. They will not cooperate, only in the event 

of resolution, Title II, and we are trying to avoid Title II. So, under 

23 

bankruptcy, there will be no cooperation. It will be a grab for assets globally and the whole thing will collapse. 

Chairman TOOMEY. Thank you, Professor Johnson. 

Let me touch on something. Professor Jackson, we have not 

talked about much yet, but I think it is worth mentioning. It is my 

understanding in Title II, the orderly liquidation authority, the 

bridge company that is contemplated is actually established as a 

Government entity—— 

Mr. JACKSON. Yes. 

Chairman TOOMEY. ——exempt from taxes. The FDIC appoints 

the management team. So, does the FDIC have the expertise to 

really oversee and manage an organization like this, and what are 

the implications of having this as a Government entity? 

Mr. JACKSON. Well, I am quite concerned in terms of—I think 

markets regulate better than regulators most of the time, and that 

is why the bridge institution in bankruptcy is preferable to an 

FDIC running an institution. I am very uncomfortable with the 

idea that it is a Government entity exempt from taxation, because 

that prefers it over the other institutions that it is competing 

against. I think that is a big mistake in Dodd-Frank, to have done 

that in the first place. 

Commenting a little bit, I think the bankruptcy process that your 

bill invokes, I actually think—and here, I disagree a little bit with 

both Randy and with Professor Johnson, is something that I think 

the FDIC will back and the FDIC can sell it to the foreign regulators. They can make it clear that this—you are not concerned 

about the claims resolution process that might drag on for a year 

or 2 years in bankruptcy. You are talking about a recapitalization 

that occurs through the bankruptcy process, ends up with a bridge 

company that is not in bankruptcy 48 hours later. I do not think 

that is a particularly hard thing to sell to regulators with the backing of the FDIC, which I think they would back. 

Chairman TOOMEY. Thank you. 

Senator Merkley. 

Senator MERKLEY. Thank you very much. 

I wanted to submit for the record a letter from the National 

Bankruptcy Conference, if there is no objection to that. 

Chairman TOOMEY. Without objection. 

Senator MERKLEY. I found it interesting. It was addressed to the 

Judiciary Committee here in the Senate. It is from June 18 of this 

year. But, they wanted to share some comments. They noted that 

the National Bankruptcy Conference is a nonpartisan, not-for-profit 

organization of 60 of the Nation’s leading bankruptcy judges, professors, and practitioners, and it has provided advice to Congress 

on bankruptcy legislation for 80 years. 

They did proceed to share in bullet form some of their concerns, 

and then this letter expands on each of them. The first point they 

make is that the Conference believes that a bankruptcy process 

might not be best equipped to offer the expertise, speed, and decisiveness needed to balance systemic risk and other competing goals 

in connection with resolution of a SIFI. 

The Conference strongly believes that laws in place with regard 

to a regulator-controlled SIFI resolution process, like the Federal 

Deposit Insurance Act and orderly liquidation authority under Title 

24 

II, should continue to be available, even if special provisions are 

added to the Bankruptcy Code. 

They expand on that later, and then they note in their fourth 

bullet that the—and I will just summarize here—that any procedure contemplating the use of bankruptcy to recapitalize a SIFI 

should not include provisions that limit the availability of lender 

of last resort liquidity to a recapitalized firm, and then they expand 

on why that is important. 

And, of course, this is all directed toward that moment of chaos 

that we saw when companies that we may have thought were going 

to be incredibly strong and here forever suddenly find themselves 

having made big bets that go bad and the world changes overnight. 

But—so, I have submitted that for the record, but I wanted to 

turn to one piece of this puzzle that I thought maybe could have 

a little bit more expanded discussion, and this is the challenge of 

the international structure of these firms, where some of these 

firms may have, as I understand it, a thousand subsidiaries scattered across the globe and the bankruptcy process in the United 

States kind of extends to our borders, and whether there is sufficient power within the bankruptcy system to address the complexity of this sprawling holding companies. So, in that regard, in 

terms of the international dimensions, I just thought I would invite 

comment from any of you who would like to share. 

Yes, Mr. Johnson. 

Mr. JOHNSON. So, I have talked about this a great deal with 

counterparts in other parts of the world, and I will tell you what 

a senior former Bank of England official says. And, off the record, 

I will tell you afterwards exactly who this is and you can check it 

yourself. He says that there is a good chance they would cooperate 

with the FDIC if you are pursuing a Title II-type resolution. He 

says there is no chance, none, that the U.S. regulators would cooperate if you are following a Title I bankruptcy under current 

process. And, I am afraid that would also apply—well, you can 

show them this law and—— 

Chairman MERKLEY. The U.S. regulators or that the—— 

Mr. JOHNSON. The U.K. regulators, your foreign regulators—— 

Chairman MERKLEY. OK. 

Mr. JOHNSON. Thank you—would not cooperate with the U.S. 

bankruptcy process. So, then you have Lehman-type chaos. That is 

the core of Lehman-type chaos. 

And, by the way, Senator, my understanding is the record number of subsidiaries right now is not 1,000, it is 15,000, one of these 

large companies, with very complicated interconnections that 

change on a daily basis. So, you have got to unravel that with no 

cooperation internationally. It collapses. It collapses like a house of 

cards, and that is what happened in September 2008. 

Chairman MERKLEY. Thank you. 

Other perspectives? 

Mr. GUYNN. Yes. So, can I just explain why that is a red herring 

when you are using the bankruptcy for a single point of entry 

strategy. In a single point of entry, the only entity that actually 

goes into any kind of bankruptcy proceeding is the U.S. parent. The 

U.K. subsidiaries stay open and operating. They are recapitalized. 

They have enough liquidity. So, there really is not any decision for 

25 

the U.K. regulatory authorities to do or to cooperate with in that 

situation. So, I think it is really overblown. 

Part of the reason for actually inventing single point of entry was 

to address the cross-border issues that would have arisen if you actually put an institution into a receivership or insolvency proceeding with branches in different countries, where if you tried to 

do a transfer to a bridge, you would actually need approval of regulatory authorities and counterparties if you were to transfer, for instance, a bank to a bridge bank. Those issues are avoided when you 

do the single point of entry under this bill. So, that is basically my 

response. 

Chairman MERKLEY. OK. So, Professor Taylor, and then we will 

return to Professor Johnson. 

Mr. TAYLOR. Just very briefly, I think one way to get a handle 

on this important question is to think about what would have happened in the case of Lehman Brothers had this existed, and we 

have worked through that in a lot of detail. And, assuming that the 

existing bail-in mechanism in the European Union exists, and it 

works fine. It is just exactly what Mr. Guynn and Mr. Jackson are 

talking about. There is not that much need for coordination. I cannot believe the regulators would stiff us on something like this. 

There is plenty of time to communicate, and it works together with 

our current bail-in process. 

Chairman MERKLEY. So, dramatically different points of view. 

Professor Johnson’s, and then, Mr. Guynn, you are noting that it 

is a red herring, and Professor Taylor, that it would work just fine. 

Back to Professor Johnson. 

Mr. JOHNSON. Senator, I work on international policy coordination issues for a long time. This is not a red herring and nobody 

is stiffing anyone. They have a legal requirement in the United 

Kingdom and other jurisdictions to protect their own taxpayers, 

protect people who have claims on the legal entities there. In the 

event of the failure of Lehman, the concern of the U.K. was, or the 

question was, who owns what within that complex set of firms. The 

cash is in London at this moment. Perhaps it belongs to the U.K. 

company. Perhaps it belongs to the U.S. company. Perhaps it belongs to the Cayman company. We freeze the cash. The first thing 

we do is we freeze the cash. 

Now, under Title II, and that is the point of the Memorandum 

of Understanding between the FDIC and the Bank of England, the 

Bank of England has agreed to back off for as long as they believe 

that you are doing the single point of entry under Title II. So, we 

will see if that works. 

That is not available under bankruptcy. That is not what they 

will do if you are pursuing either bankruptcy with these current 

complex global entities under the existing code or under the code 

with the modifications being suggested by the panel or by the 

Chairman today. That is not the world in which we live. 

Senator MERKLEY. Thank you. And, the world within which we 

live is limited in time, and thank you very much, all of you, for 

bringing your expertise to bear on this. I think we are going to 

have more discussions as time passes and you have added a great 

deal. Thank you. 

26 

Chairman TOOMEY. And, I want to thank all of the witnesses, as 

well. I think we have had a very helpful, very constructive discussion at advancing the cause and the understanding of this issue. 

So, I want to thank the witnesses and thank the Ranking Member 

for attending and participating. 

The hearing is adjourned. 

[Whereupon, at 11:54 a.m., the hearing was adjourned.] 

[Prepared statements and additional material supplied for the 

record follow:] 

27 

1My practice focuses on providing bank regulatory advice to the largest and most systemic 

U.S. and foreign banking organizations, as well as to a wide range of U.S. regional, midsize, 

and community banks. This focus includes advice on mergers and acquisitions, capital markets, 

and other transactions when the target or issuer is a banking organization. I am the editor of 

Regulation of Foreign Banks and Affiliates in the United States (Thomson Reuters: 8th ed. 

2014), the leading treatise in the area. 2See, e.g., Randall D. Guynn, ‘‘Framing the TBTF Problem: The Path to a Solution’’, in Across 

the Divide: New Perspectives on the Financial Crisis (Hoover Institution and Brookings Institution: Martin Neil Baily and John B. Taylor, eds., 2014); John F. Bovenzi, Randall D. Guynn, 

and Thomas H. Jackson, ‘‘Too Big to Fail: The Path to a Solution, A Report of the Failure Resolution Task Force of the Financial Regulatory Reform Initiative of the Bipartisan Policy Center’’ 

(BPC Report); Randall D. Guynn, ‘‘Resolution Planning in the United States’’, in The Bank Recovery and Resolution Directive—Europe’s Solution for ‘‘Too Big To Fail’’? (De Gruyter: Andreas 

Dombret and Patrick Kenadjian, eds., 2013); Randall D. Guynn, ‘‘Are Bailouts Inevitable?’’, 29 

Yale Journal on Regulation 121 (2012); Debate Between Dean Paul Mahoney of the University 

of Virginia School of Law and Randall D. Guynn, ‘‘Are Bailouts Inevitable?’’ (available at: 

http://volokh.com/2011/03/04/uva-debate-are-bailouts-inevitable-under-dodd-frank/). 3Guynn, ‘‘Framing the TBTF Problem’’, supra note 2, at 282–286. 

4 International Swaps and Derivatives Association, Inc., ISDA 2014 Resolution Stay Protocol 

(Nov. 4, 2014). 5Financial Stability Board, ‘‘Adequacy of Loss-Absorbing Capacity of Global Systemically Important Banks in Resolution’’, Consultative Document (Nov. 10, 2014). 6See, e.g., Bankruptcy Not Bailout: A Special Chapter 14 (Hoover Institution: Kenneth E. 

Scott and John B. Taylor, eds., 2012); Making Failure Feasible: How Bankruptcy Reform Can 

End ‘‘Too-Big-To-Fail’’ (Hoover Institution: Kenneth E. Scott, Thomas H. Jackson, and John B. 

Taylor, eds., 2015). 7Thomas H. Jackson, ‘‘Building on Bankruptcy: A Revised Chapter 14 Proposal for the Recapitalization, Reorganization, or Liquidation of Large Financial Institutions’’, in Making Failure Feasible, supra note 6, at 23; David A. Skeel, Jr., ‘‘Financing Systemically Important Financial Institutions’’, in Making Failure Feasible, supra note 6, at 62; John B. Taylor, ‘‘Preface’’, 

in Making Failure Feasible, supra note 6, at xii; William F. Kroener III, ‘‘Revised Chapter 14 

2.0 and Living Will Requirements Under the Dodd-Frank Act’’, in Making Failure Feasible, 

supra note 6, at 247. 

PREPARED STATEMENT OF RANDALL D. GUYNN 

PARTNER, DAVIS POLK & WARDELL, LLP 

JULY 29, 2015 

Thank you for inviting me to testify on the role of bankruptcy reform in addressing too big to fail (TBTF). I am the head of the Financial Institutions Group at 

Davis Polk & Wardwell LLP. 1 I am also the Cochair of the Failure Resolution Task 

Force of the Financial Regulatory Reform Initiative of the Bipartisan Policy Center. 

I have written a number of articles and participated in a number of debates on the 

nature of the TBTF problem and how to solve it. 2 Like most U.S. and foreign regulators, financial industry groups, think tanks, rating agencies, and other stakeholders, 3 I believe that the most promising solution to the TBTF problem for most 

of the U.S. and foreign banking organizations that have been designated by the Financial Stability Board (FSB) as global systemically important banking groups (G– 

SIBs) is the single-point-of-entry (SPoE) recapitalization within resolution or bankruptcy strategy. 

During the past few years, I have spent a significant portion of my time working 

on resolution plans for a number of U.S. and foreign banking organizations under 

Section 165(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act 

(the Dodd-Frank Act). I have also represented a number of financial industry trade 

organizations, including The Clearing House Association, the Securities Industry 

and Financial Markets Association, the Global Financial Markets Association, and 

the Financial Services Forum on issues related to recovery and resolution planning, 

including the ISDA Resolution Stay Protocol (the ‘‘ISDA Protocol’’) 4 and the FSB’s 

proposal on total loss-absorbing capacity (TLAC). 5 I am here today, however, in my 

individual capacity and not on behalf of any client, although I expect to be asked 

by clients to help them evaluate the various proposals for bankruptcy reform. 

Congress is currently considering two bankruptcy reform proposals that are designed to address the TBTF problem. Both are based on the pioneering work of the 

Hoover Institution on a proposed new Chapter 14 of the Bankruptcy Code. 6 The 

House passed H.R. 5421, the Financial Institutions Bankruptcy Act (FIBA), last 

year, and is considering a nearly identical version of it this year. Two years ago, 

Senators Cornyn and Toomey introduced S. 1861, the Taxpayer Protection and Responsible Resolution Act (TPRRA). This year, they have introduced a substantially 

revised version of TPRRA. Both the Senate and House bills are modeled on the 

SPoE portion of what the Hoover Institution calls Chapter 14 2.0. 7 That portion of 

28 

8See supra note 7. 

9 Cf. Thomas Huertas, Safe To Fail: How Resolution Will Revolutionise Banking (Palgrave 

Macmillan: 2014). 10Douglas Diamond and Philip Dybvig, ‘‘Bank Runs, Deposit Insurance, and Liquidity’’, 91 

Journal of Political Economy 401 (1983); Daniel K. Tarullo, Member, Board of Governors of the 

Federal Reserve System, Remarks at The Clearing House 2014 Annual Conference, New York, 

New York, at 2 (Nov. 20, 2014). 11 BPC Report supra note 2, at 1; ‘‘Guynn, Are Bailouts Inevitable?’’, supra note 2, at 127– 

129. 12Guynn, ‘‘Are Bailouts Inevitable?’’, supra note 2, at 129. See also Thomas F. Huertas, ‘‘A 

Resolvable Bank’’, in Making Failure Feasible, supra note 6, at 129 (‘‘A resolvable bank is one 

that is ‘safe to fail’: it can fail and be resolved without cost to the taxpayer and without significant disruption to the financial markets or the economy at large.’’). 13 Huertas, supra note 7, chapter 1, at 4–20. 14Martin J. Gruenberg, Acting Chairman, FDIC, Remarks to the Federal Reserve Bank of 

Chicago Bank Structure Conference (May 10, 2012). 15FDIC and Bank of England, Joint Paper, ‘‘Resolving Globally Active, Systemically Important, Financial Institutions’’ (Dec. 10, 2012); Martin J. Gruenberg, Chairman, FDIC, and Paul 

Tucker, Deputy Governor, Financial Stability, Bank of England, ‘‘Global Banks Need Global Solutions When They Fail’’, Financial Times, Op. Ed. (Dec. 10, 2012; Bank of England, ‘‘The Bank 

of England’s Approach to Resolution’’ (October 2014). 16Directive 2014/15/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms 

and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/ 

EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) 

No. 1093/2010 and (EU) No. 648/2012, of the European Parliament and of the Council. 17 BPC Report, supra note 2, at 33–35. 

the revised version of the original Chapter 14 proposal is designed specifically to facilitate an SPoE strategy (or what Professor Jackson calls the one-entity or two-entity recapitalization approach) under the Bankruptcy Code. 8

This statement first discusses the nature of the TBTF problem. It then describes 

the SPoE strategy, including how it works, how it inevitably results in a substantial 

shrinkage of the failed banking group and why it is a viable solution to the TBTF 

problem. It then discusses the changes made since the 2008 global financial crisis 

to make U.S. banking groups more resilient against failure. Next, it describes the 

major structural changes that have been made by the U.S. G–SIBs so that they are 

safe to fail. 9 Finally, it discusses how bankruptcy reform can improve the ability 

of the Bankruptcy Code to address too big to fail. 

1. Nature of the TBTF Problem 

The TBTF problem arises if policymakers do not believe they can allow certain 

large, systemically important banking groups to fail and impose losses on their private sector investors without risking the sort of contagious runs by short-term creditors or a disruption in critical operations that can destabilize the financial system. 10

Faced with a dilemma between taxpayer-funded bailouts and a potential collapse of 

the financial system, policymakers tend to choose bailouts as the lesser of two 

evils. 11 If there were no viable solution to that dilemma, bailouts would almost certainly be inevitable. 12 Thomas Huertas provides a good discussion of why TBTF is 

a problem and why it should be solved in Safe To Fail: How Resolution Will 

Revolutionise Banking. 13

2. The Single-Point-of-Entry Strategy 

But there is a viable solution if certain conditions are satisfied. It is called the 

SPoE resolution strategy. That strategy was originally developed by the FDIC under 

Title II of the Dodd-Frank Act. 14 It was subsequently endorsed by the Bank of England as the most promising strategy for dealing with failed G–SIBs without the 

need for taxpayer-funded bailouts and without causing the sort of contagion that 

can destabilize the financial system. 15 The European Union added language to its 

Bank Recovery and Resolution Directive authorizing resolution authorities at both 

the member state and union levels to resolve European banking and other financial 

organizations using the SPoE strategy. 16 The Failure Resolution Task Force at the 

Bipartisan Policy Center recognized that the SPoE strategy could be carried out 

under existing Chapter 11 of the Bankruptcy Code, but recommended that a new 

Chapter 14 be enacted to increase the legal certainty of SPoE under the Bankruptcy 

Code. 17

a. How SPoE Works 

Under the SPoE strategy, the top-tier parent of a U.S. banking group would be 

put into a special resolution proceeding under Title II of the Dodd-Frank Act or a 

Chapter 11 bankruptcy proceeding. The FDIC under Title II or the debtor-in-possession in a Chapter 11 proceeding would establish a new financial holding company 

29 

18 BPC Report, supra note 2, at 23–32. 19See the FDIC’s Web site, https://www.fdic.gov/regulations/reform/resplans/index.html, or 

the Federal Reserve’s Web site, http://www.federalreserve.gov/bankinforeg/resolutionplans.htm. The firms that used the SPoE strategy as their principal strategy were Bank of 

America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and State Street. The 

firms that did not use the SPoE strategy as their principal strategy were the Bank of New York 

Mellon and Wells Fargo. The principal strategy used by those firms was a multiple-point-ofentry (MPoE) strategy whereby the businesses of their flagship banks were transferred to bridge 

banks and then, over time, broken up and sold in an FDIC receivership and their material 

nonbank subsidiaries were sold to third parties as going concerns or wound down in their respective insolvency proceedings. 20 BPC Report, supra note 2, at 23–32. 21 Id. at 24, 30. 22 Id. at 25. 23 Id. at 30. 

(FHC) called a bridge FHC (because it is a temporary bridge to an exit from the 

receivership or bankruptcy proceeding). All of the assets of the failed parent, including is ownership interests in its operating subsidiaries, would be transferred to the 

bridge FHC. This would be done in a bankruptcy proceeding, with court approval, 

pursuant to Section 363 of the Bankruptcy Code. All of the shares and long-term 

unsecured debt of the failed parent would remain behind in the receivership or 

bankruptcy proceeding. Only a limited amount of critical operating liabilities, such 

as those to the electric company or critical vendors as well as parent guarantees, 

would be assumed by the bridge FHC, making it essentially debt-free. 

The parent or bridge FHC would recapitalize any operating subsidiaries that suffered losses by forgiving intercompany receivables or otherwise contributing assets 

to the subsidiaries. It would do so because the franchise values of operating subsidiaries are almost always substantially greater than their liquidation values. Thus, 

recapitalizing the operating subsidiaries should maximize their value for the benefit 

of the failed parent’s stakeholders. 

At least in a bankruptcy proceeding the bridge FHC would be transferred to an 

independent trust, which would hold the interest in the bridge FHC for the benefit 

of the bankruptcy estate. The trustees of the trust would include experienced and 

highly regarded bankers, former regulators and others. The trust would enter into 

an agreement approved by the bankruptcy court that would spell out the duties of 

the trust to the bankruptcy estate. One key benefit of the trust would be to help 

gain public confidence in the stability of the bridge FHC. 

Once the business transferred to the bridge FHC stabilizes, the FDIC or the trust 

would convert the bridge to an ordinary bank holding company (New HoldCo) and 

sell all or a portion of the shares in New HoldCo to the public and distribute the 

net proceeds and any unsold shares to the receivership or bankruptcy estate. The 

net proceeds and any unsold shares would then be distributed to the failed parent’s 

stakeholders in accordance with the priority of their claims. 

A step-by-step illustration of how an SPoE strategy works is included in the BPC 

Report, 18 and attached to this Statement as Exhibit A. 

b. Principal Strategy Under Title I Resolution Plans 

All but two of the U.S. G–SIBs recently disclosed in the public summaries of their 

2015 resolution plans submitted under Section 165(d) of the Dodd-Frank Act that 

their principal strategies for being resolved under the Bankruptcy Code is an SPoE 

strategy under existing Chapter 11 of the Bankruptcy Code. 19

c. What Comes Out of the SPoE Hopper Is Not What Goes In 

As shown by the step-by-step illustration of the SPoE strategy in the BPC Report, 20 and attached to this Statement as Exhibit A, the SPoE strategy results in 

the resolution, not the resurrection of a failed banking group. The banking group 

that emerges from an SPoE strategy is always significantly smaller than it was before its top-tier parent failed. Under the stylized balance sheets used in the BPC 

Report, the banking group that emerged from the SPoE was half the size of the 

banking group just before its top-tier parent failed (total assets dropped from 100 

to 50), as illustrated by Figures 1 and 7. 21 This is mainly a function of the fundamental nature of the SPoE process, as illustrated by Figure 2 in the BPC Report 

(where total assets dropped from 100 to 59, to reflect the hypothetical losses suffered by the group). 22 But it may also result from the sale of certain assets during 

the SPoE process if that would be consistent with maximizing the value of the firm 

and minimizing its losses for the benefit of the top-tier parent’s stakeholders left 

behind in the Title II receivership or bankruptcy proceeding, as illustrated by Figure 6 in the BPC Report. 23

30 

24See supra note 19. 25 Id. 26 Id. (see public summaries for Bank of America and JPMorgan Chase). 27 Id. (see pubic summary for State Street). 28 Id. (see public summaries of Citigroup, Goldman Sachs and Morgan Stanley). 29 Huertas, supra note 12, at 129. 30 Id., at 29–30. I believe that I was the first person to suggest this sort of separation and 

subordination of capital structure liabilities to operating liabilities in connection with the Financial Stability Board’s Private Sector Bail-in Initiative, of which I was a member. That concept 

is now embedded in the FSB’s TLAC proposal. See FSB, supra note 5. It was developed in response to what I found to be a persuasive criticism of the FDIC’s discretion to discriminate 

among similarly situated creditors in Section 210(b)(4) of Title II of the Dodd-Frank Act, as long 

as the disfavored creditors receive at least as much as they would have received in a liquidation 

under Chapter 7 of the Bankruptcy Code (the ‘‘no creditor worse off than in liquidation’’ or 

‘‘NCWOL’’ principle). Kenneth E. Scott, ‘‘A Guide to the Resolution of Failed Financial Institutions: Dodd-Frank Title II and Proposed Chapter 14’’, in Bankruptcy Not Bailout, supra note 

6, at 11–12, 17 (‘‘For my purposes, a bailout occurs when some favored claimants on a failed 

financial firm are given more than what they would receive in an ordinary bankruptcy, at the 

expense of others.’’). When I tried to analyze why the FDIC needed the power to discriminate 

among similarly situated creditors, it seemed to me that the only legitimate reason was to be 

able to treat short-term unsecured creditors as if they were senior to long-term unsecured creditors during a financial panic in order to stem runs and contagion. A rule of separation and subordination seemed superior to a discretionary power to achieve the same end since the discretionary power arguably resulted in an unexpected transfer of value from one group of creditors 

to another without compensation, meaning it could give rise to moral hazard since the favored 

creditors would not internalize the costs of their unexpected favored position. In contrast, with 

a clear nondiscretionary rule of separation and subordination in place, the market would force 

short-term unsecured creditors to internalize the costs of their preferred status by reducing the 

amount of interest or other return they could demand. At the same time, it would allow longterm unsecured debt holders to demand a return that was sufficient to compensate them for 

the increased risk they would bear. 

This shrinkage principle is illustrated by the public summaries of the 2015 Title 

I resolution plans recently filed by the U.S. G–SIBs. 24 According to the firms that 

used the SPoE strategy as their principal strategy, 25 the firm that emerged from 

the SPoE process was substantially smaller than the firm that entered the process. 

For example, Bank of America and JPMorgan Chase reported that their main bank 

subsidiaries would shrink by approximately 33 percent and their broker-dealer subsidiaries would shrink by 66–80 percent. 26 State Street reported that its flagship 

bank would shrink by 50 percent and it might sell its investment management businesses outside of insolvency proceedings as going concerns. 27 Citigroup, Goldman 

Sachs, and Morgan Stanley all reported that they would cease to exist because they 

would sell their operations to third parties in public or private offerings or wind 

them down outside of any insolvency proceedings as part of the SPoE process. 28 The 

shrinkage principle in the SPoE strategy, of course, is quite different from breaking 

up healthy banks for political reasons. Any shrinkage occurring as part of the SPoE 

strategy is simply a by-product of incurring losses and attempting to maximize the 

value of the enterprise and minimize its losses for the benefit of the failed parent’s 

stakeholders. 

d. SPoE Is a Viable Solution 

The SPoE strategy is a viable solution to the TBTF problem if three essential conditions are satisfied. 

(1) Sufficient Usable TLAC 

First, the failed parent must have enough TLAC (i.e., combined equity and longterm unsecured debt) for the business that is transferred to the bridge FHC to be 

fully recapitalized after suffering losses in a sufficiently severe adverse economic 

scenario and the TLAC must be usable. By usable, I mean the group’s losses can 

be imposed on the parent’s private sector TLAC investors without fostering runs by 

the group’s short-term creditors, which in turn can foster contagion throughout the 

financial system. 29 The key to being able to do so is separating the TLAC and other 

capital structure liabilities from short-term unsecured debt and other operating liabilities, and making the capital structure liabilities subordinate to the operating 

liabilities (or conversely making the operating liabilities senior to the capital structure liabilities). 30 As a result, both shareholders and long-term unsecured debt investors are expected to bear losses, a result that would be fundamentally different 

from the 2008 global financial crisis when long-term bondholders were generally insulated from losses and only shareholders bore losses. 

31 

31Other less practical ways are to amend outstanding long-term senior unsecured debt to 

make it contractually subordinate to short-term unsecured debt or to persuade Congress to 

enact a statutory priority scheme that makes long-term unsecured debt subordinate to shortterm unsecured debt. 32Diamond and Dybvig, supra note 10. 33Skeel, supra note 7, at 65–67. 34Dodd-Frank Act, §210(n) (Orderly liquidation fund). 35Skeel, supra note 7, at 63. 36Tarullo, supra note 10, at 5–6. 37 Id. at 6, 18. 38See, e.g., James R. Kearl, Economics and Public Policy: An Analytical Approach 422–427, 

792 (Pearson: 6th ed., 2011). 39See, e.g., Tarullo, supra note 10, at 5–6. 40 Indeed, reserve requirements are a type of liquidity regulation. Id. at 18, note 18. 

The easiest way for U.S. bank holding companies to make TLAC usable is to 

make it structurally subordinate to the group’s short-term unsecured debt. 31 This 

can be achieved by moving any short-term unsecured debt from the parent to its 

operating subsidiaries. The TLAC investors will then absorb all losses incurred by 

the group before any of the short-term unsecured creditors suffers any losses. Because the TLAC would act as a shield against losses by the short-term creditors, 

imposing losses on TLAC investors should reduce the incentive of the group’s shortterm unsecured creditors to run. To the extent this subordination framework makes 

short-term unsecured debt less risky, the market will force short-term unsecured 

creditors to internalize the costs of their preferred position (and thereby eliminate 

any moral hazard) by decreasing the returns they would otherwise be able to demand on short-term unsecured debt. 

(2) Sufficient Liquidity 

Second, the business transferred to the bridge FHC must have access to a sufficient amount of liquidity in a Title II or bankruptcy proceeding for the business to 

be stabilized after it has been transferred to the largely debt-free bridge FHC. If 

the business does not have sufficient liquidity, it may be forced to sell illiquid assets 

at fire-sale prices, which can cause an otherwise solvent bridge FHC to become insolvent. 32 A well-capitalized bridge FHC should be able to obtain secured liquidity 

from the market under normal market conditions. 33 But if the market for secured 

liquidity is dysfunctional, as it typically is during a financial crisis, the FDIC has 

the power to supplement the amount of secured liquidity available from the market 

in a Title II proceeding. 34

There is no similar Government source of back-up secured liquidity in a bankruptcy proceeding, and TPRRA would prohibit the Federal Reserve bank from making advances to a covered financial company or a bridge financial company for the 

purpose of providing court-approved debtor-in-possession financing. 35 A U.S. G–SIB 

that is required to show it can be resolved under the Bankruptcy Code without any 

access to secured liquidity from a Government source will be forced to hold far more 

cash and other high quality liquid assets (HQLAs) than otherwise in order to show 

it will have enough liquidity in a hypothetical, future bankruptcy proceeding. Such 

a requirement will reduce the amount of credit the U.S. G–SIBs can supply to the 

market. 36 It will also provide an incentive for U.S. G–SIBs to hoard liquidity during 

a financial crisis, when it is most needed by the market. 37

To illustrate the impact of such a liquidity requirement on the supply of credit, 

consider how the money multiplier works. If all banks were subject to a 10 percent 

reserve requirement (RR), it would mean that they are required to set aside $10 in 

cash for every $100 in loans they make. Since the potential money multiplier is 1/ 

RR, it also means that every dollar of central bank money injected into the banking 

system by the Federal Reserve has the potential to multiply into 10 times the 

amount of money and credit throughout the banking system. 38 If the reserve requirement is increased to 20 percent, the amount of potential credit available to the 

system will shrink by 5 times the amount of central bank money (-500 percent) 

originally injected into the system. The point is not to say whether 10 percent or 

20 percent is the correct reserve requirement, but to illustrate that there is a tradeoff between the amount of the reserve requirement and the amount of money and 

credit that can potentially be made available to the market. 39

Liquidity requirements have the same effect on the supply of money and credit 

as reserve requirements. 40 If U.S. G–SIBs are required to hold twice as much cash 

and HQLAs as they would be required to hold if a Government source of secured 

liquidity were available in a hypothetical, future bankruptcy proceeding, the potential amount of credit they can supply to the market will shrink in advance by approximately 5 times the amount of central bank money (-500 percent) originally inVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00035 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
32 

41Walter Bagehot, Lombard Street: A Description of the Money Market (1873). 42See David A. Skeel, Jr., supra note 7, at 65, 74–75, 81–85. Indeed, Professor Skeel argues 

that Congress should amend Section 13(3) of the Federal Reserve Act to expressly authorize the 

Federal Reserve to provide secured liquidity to bridge financial companies and their operating 

subsidiaries in order to facilitate an SPoE strategy under the Bankruptcy Code. Id. at 65. 43 BPC Report, supra note 2, at 19. 44Tarullo, supra note 10, at 9. Paul Tucker, The lender of last resort and modern central 

banking principles and reconstruction, BIS Papers No. 79 (Sept. 2014). 45See Davis Polk, A Guide to the Laws, Regulations ,and Contracts of the Financial Crisis, 

chapter 3 (Margaret Tahyar, ed., September 2009). 46Tarullo, supra note 10, at 6, 18. 

jected into the system by the Federal Reserve. In other words, there is a serious 

tradeoff between the potential amount of credit the U.S. G–SIBs can provide to the 

market now and the benefits of prohibiting the Federal Reserve from using any of 

its lender-of-last-resort (LOLR) facilities to provide liquidity to fully recapitalized 

bridge FHCs in a future, hypothetical bankruptcy proceeding. Assuming that the 

Federal Reserve would provide such liquidity in accordance with the classic rules 

laid down by Walter Bagehot 41—i.e., only on a fully secured basis to solvent bridge 

FHCs at appropriate above-market interest rates—it would seem as if the risk of 

loss to the Federal Reserve and the risk of creating any moral hazard would be essentially zero. It therefore seems as if the tradeoff strongly favors the availability 

of a properly structured LOLR facility to serve as a back-up source of secured liquidity in a bankruptcy proceeding. 42

For the reasons described in the BPC Report, it is important for policymakers to 

distinguish between capital and liquidity. 43 Government programs like the Troubled 

Asset Relief Program (TARP) provided equity capital to both viable and troubled financial firms. TARP bailed out the private sector investors of otherwise insolvent 

firms by protecting them against losses without requiring those investors to compensate the Government for providing such protection. In contrast, traditional 

LOLR facilities provide only temporary fully secured liquidity at above-market interest rates to solvent firms with sufficient capital. If properly structured, such facilities expose the Government to no risk of loss and require borrowers to adequately compensate it for the small amount of liquidity risk it assumes. 44 Thus, it 

is fair and appropriate to label Government injections of capital such as those made 

under the Capital Purchase Program of TARP as bailouts, 45 but it is wrong to label 

properly structured LOLR facilities as bailouts. 

(3) Mitigation of QFC Cross-Defaults 

Third, and related to the second, a material amount of the qualified financial contracts (QFCs) at the group’s operating subsidiary level must not contain cross-defaults to the parent’s failure. Alternatively, any such cross-defaults must be overridden contractually, for example, as provided by the ISDA Protocol or a similar contractual arrangement or by regulation or statute. Otherwise, such cross-defaults 

would allow the QFCs to be terminated and drain liquidity out of the group even 

if the operating subsidiaries have been recapitalized and are performing on those 

QFCs. In addition, collateral securing the QFCs would be dumped on the market, 

putting downward pressure on asset values. Such a potential drainage of liquidity 

would require U.S. G–SIBs to carry even more cash and HQLAs in order to be sure 

they would have enough liquidity in a hypothetical, future bankruptcy proceeding, 

putting further pressure on their ability to supply credit to the market and increasing their incentive to hoard liquidity during a financial crisis. 46

3. U.S. Banking Groups Are More Resilient 

U.S. banking groups have taken substantial actions to make themselves more resilient against failure since the 2008 global financial crisis. For example, as shown 

in Exhibit B, the largest, most systemic banking groups have nearly twice as much 

capital as they had on the eve of the 2008 financial crisis. They are also projected 

to have more capital in a stressed environment than they had actual capital in 

2008. This makes them more resilient against insolvency. They also have significantly more liquid balance sheets, making them more resilient against runs, as illustrated in Exhibit C. They have three times (3X) the amount of HQLAs compared 

to 2008, and five times (5X) the amount of cash. They have also reduced their reliance on short-term wholesale funding, as shown in Exhibit D. U.S. regulatory standards increase with the size and complexity of U.S. and foreign banking organizations, as shown in Exhibit E. 

33 

47 Cf. Huertas, supra note 9. 48See, e.g., Douglas G. Baird, Elements of Bankruptcy 225–226 (5th ed. 2010). In contrast, 

the FDIC has the discretion to treat similarly situated creditors differently under Section 

210(b)(4) of the Dodd-Frank Act as long as the disfavored creditors receive at least as much as 

they would have received in a liquidation under Chapter 7 of the Bankruptcy Code. 49See Huertas, supra note 12, at 129. 50Government Accounting Office, ‘‘Large Bank Holding Companies: Expectations of Government Support’’, at 25–26 (July 2014). Moody’s Investors Service, ‘‘Rating Action: Moody’s Concludes Review of Eight Large U.S. Banks’’ (Nov. 14, 2013). 51GAO, supra note 50. 52 Id. at 50–52. 53Tarullo, supra note 10, at 5–6, 18. 

4. U.S. G–SIBs Are Safe To Fail Under the Bankruptcy Code 

The U.S. G–SIBs have made major structural changes so that they will be safe 

to fail under the Bankruptcy Code. 47

a. More Usable TLAC 

The most important structural change that almost no one has heard of relates to 

usable TLAC, as illustrated on Exhibit F. The U.S. G–SIBs had, on average, nominal TLAC equal to approximately 17 percent of their risk-weighted assets (RWAs) 

in 2008. 

Unfortunately, only tangible common equity turned out to be loss-absorbing without risking contagion because of how the TLAC was structured, and tangible common equity amounted to only 5 percent of RWAs. Losses could not legally be imposed on long-term senior unsecured debt without causing contagion because it 

ranked equally with short-term senior unsecured debt issued at the parent level. 

There was no provision in the Bankruptcy Code that allowed bankruptcy courts to 

discriminate among similarly situated creditors unless it would maximize the value 

of the enterprise for the benefit of the disfavored creditors. 48 Although losses could 

theoretically have been imposed on subordinated debt, preferred equity and trust 

preferred securities without causing contagion, the market was confused about the 

relative priority among those instruments and long-term senior unsecured debt so 

policymakers worried about causing contagion if such securities were allowed to suffer any losses. 

Today the U.S. G–SIBs have, on average, nominal TLAC equal to approximately 

25 percent of RWAs, as illustrated by Exhibit F. More importantly, they have restructured their TLAC so that it is all usable to absorb losses without causing contagion. 49 This means that they have five times (5X) the amount of usable TLAC 

(which consists of both equity and long-term unsecured debt) compared to what they 

had during the 2008 global financial crisis. They have achieved this result by moving virtually all of the short-term unsecured debt that used to be issued by their 

top-tier parent companies to their operating subsidiaries. Long-term senior unsecured debt can now be left behind in an FDIC receivership or bankruptcy proceeding 

of the parent without imposing losses on the group’s short-term unsecured debt. 

This amount of TLAC should be enough to recapitalize the business transferred to 

a bridge FHC at full Basel III capital levels under conditions twice as severe as the 

2008 global financial crisis. 

Both the market and the regulators expect this structural change to make U.S. 

G–SIBs more resolvable under the Bankruptcy Code, as shown on Exhibit G. For 

example, Fitch and Moody’s have eliminated any uplift on the ratings of U.S. G– 

SIBs based on an expectation of Government support because Government bailouts 

are no longer expected. 50 Standard & Poor’s has indicated that it may eliminate any 

uplift based on an expectation of Government support. 51 The spreads on long-term 

unsecured debt of U.S. G–SIBs are now higher than the spreads on long-term unsecured debt issued by other U.S. banks. 52

b. Increased Liquidity 

As noted above, the U.S. G–SIBs have substantially more cash and HQLAs than 

in 2008. Several of them have increased their cash and HQLAs in order to show 

they would have enough liquidity to carry out an SPoE resolution strategy under 

Chapter 11, assuming no access to secured liquidity from any Government LOLR 

facility. This new liquidity requirement may have already started to result in a 

higher effective liquidity requirement than either the Basel III liquidity coverage 

ratio or net stable funding ratio. It raises serious public policy questions whether 

this new liquidity requirement is justified in light of the negative impact it may already be having on the potential amount of credit that the U.S. G–SIBs are able 

to provide to the U.S. economy. 53

34 

54The adhering U.S. G–SIBs are Bank of America, Citigroup, Goldman Sachs, JPMorgan 

Chase, and Morgan Stanley. See ISDA Press Release (Oct. 11, 2014). 55The adhering non-U.S. G–SIBs Are Bank of Tokyo-Mitsubishi UFJ, Barclays, BNP Paribas, 

Credit Agricole, Credit Suisse, Deutsche Bank, HSBC, Mizuho Financial Group, Nomura, Royal 

Bank of Scotland, Societe Generale, Sumitomo Mitsui Financial Group, and UBS. Id. 56Financial Stability Board, Press Release (October 11, 2014). 57Federal Reserve and FDIC, Joint Press Release (October 11, 2014). 58See Statement of Donald S. Bernstein Before the Subcommittee on Regulatory Reform, 

Commercial and Antitrust Law of the House Committee on the Judiciary at 6–7 (July 9, 2015). 59 Id. at 8–9. 60 Id. at 9. 

c. Mitigation of QFC Cross-Defaults 

Five of the eight U.S. G–SIBs 54 are among the 18 G–SIBs 55 that agreed to adhere to the new ISDA Resolution Stay Protocol. As summarized in the slide attached 

as Exhibit H, the ISDA Protocol overrides cross-defaults in ISDA financial contracts 

among the 18 adhering G–SIBs based on a parent’s or other affiliate’s bankruptcy 

or entry into resolution. The adhering U.S. G–SIBs have also supported regulations 

to expand the principles of the ISDA Protocol to more counterparties and financial 

contracts. No similar mechanism existed during the 2008 financial crisis. According 

to the Financial Stability Board, ‘‘[w]ith the adoption of the [ISDA] protocol by the 

top 18 dealer G–SIBs in November, over 90 percent of their OTC bilateral trading 

activity will be covered by stays of either a contractual or statutory nature.’’ 56 The 

FDIC and the Federal Reserve described the ISDA Protocol as ‘‘an important step 

toward mitigating the financial stability risks associated with the early termination 

of bilateral, OTC derivatives contracts triggered by the failure of a global banking 

firm with significant cross-border derivatives activities.’’ 57

d. Other Actions 

The U.S. G–SIBs have also made a number of other structural changes and taken 

a number of other actions to make themselves more resolvable under the Bankruptcy Code. These include restructuring and other actions to ensure the continuity 

of shared services throughout the resolution process, improving operational capabilities, and preserving access to financial market utilities. In addition, the U.S. regulatory agencies have taken significant actions to improve coordination with foreign 

regulators. 58

e. Regulator Recognition 

The regulators have noticed how much progress the U.S. G–SIBs have made in 

making themselves safe to fail under the Bankruptcy Code. FDIC Chairman Martin 

Gruenberg has described the progress as transformational and impressive, and perhaps underappreciated. See Exhibit I for a representative set of quotes from selected 

regulators. 

5. Role of Bankruptcy Reform in Addressing Too Big To Fail 

While I believe that the actions taken above should make SPoE feasible under the 

existing Bankruptcy Code, bankruptcy reform would enhance the ability of the 

Bankruptcy Code to address too big to fail by making four key additions: 

• Clarifying that bank holding companies can recapitalize their operating subsidiaries prior to the commencement of bankruptcy proceedings. 

• Clarifying that Section 363 of the Bankruptcy Code can be used to transfer the 

recapitalized operating subsidiaries to a new holding company using a bridge 

company structure. 

• Adding provisions that permit a short stay of close-outs and allow the assumption and preservation of qualified financial contracts, and overriding ipso facto 

(bankruptcy) defaults or cross-defaults that might impede the resolution process. 

• Providing for some form of fully secured liquidity resource that would offer financing to help stabilize the recapitalized firm and prevent fire sales until access to market liquidity returns. 59

The first two of these features would increase the certainty of application of current law to actions that must be taken in connection with an SPoE strategy in bankruptcy. 60

The third of these features currently is being addressed by contractual 

workarounds like the ISDA Protocol, but it would be far better if the Bankruptcy 

Code were amended to include a provision similar to Section 210(c)(16) of the DoddVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00038 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
35 

61 Id. 62Skeel, supra note 7, at 65 (arguing that Congress should amend Section 13(3) of the Federal 

Reserve Act to expressly permit the Federal Reserve to make secured liquidity available to a 

bridge financial company and its operating subsidiaries to facilitate an SPoE resolution under 

the Bankruptcy Code). 63 Bernstein, supra note 58, at 9. 64Professor Skeel would go a step further and argue that Congress should amend Section 

13(3) of the Federal Reserve Act to expressly authorize the Federal Reserve to provide secured 

liquidity to a bridge financial company and its operating subsidiaries to facilitate an SPoE resolution under the Bankruptcy Code. Skeel, supra note 7, at 65. While I agree with Professor 

Skeel’s view, I believe that it would be worth enacting TPRRA even if it does not contain such 

an express authorization. 65Letter dated June 18, 2015, from the National Bankruptcy Conference to the Honorable 

Tom Marino, Chairman of the House Subcommittee on Regulatory Reform, Commercial and 

Antitrust Law, the Honorable Hank Johnson, the Ranking Member of that Committee, the Honorable Chuck Grassley, the Chairman of the Senate Committee on the Judiciary, and the Honorable Patrick J. Leahy, Ranking Member of that Committee (NBC Letter), at 7. 66Tarullo, supra note 10, at 5–6, 18. 67 Under Section 203(b)(2) of the Dodd-Frank Act, Title II can only be lawfully invoked if the 

resolution of a covered financial company under the Bankruptcy Code would have serious adverse effects on financial stability in the United States. The resolution of such a company under 

the Bankruptcy Code is more likely to have serious adverse effects on U.S. financial stability 

if the Federal Reserve is prohibited from providing secured liquidity to solvent entities at appropriate above-market interest rates to facilitate resolution under the Bankruptcy Code. 68 NBC Letter, supra note 65, at 3–5. 69See supra note 67. 

Frank Act that provides for the override of cross-defaults under QFCs in an SPoE 

resolution under the Bankruptcy Code. 61

The last of these features is currently being addressed by the substantially increased liquidity reserves on the balance sheets of most of the U.S. G–SIBs, though 

once they have been recapitalized in an SPoE resolution, there is no reason why traditional, secured LOLR facilities should not be available to nonbankrupt, fully capitalized, going concern subsidiaries of the firms. 62 The availability of such liquidity, 

if properly structured, would involve no risk of loss to taxpayers and would help to 

mitigate any panic run on subsidiary liquidity after the holding company commences its bankruptcy proceedings. 63

Although TPRRA includes most of these features, it contains a provision that 

would prohibit the Federal Reserve from providing liquidity to a bridge FHC for the 

purpose of providing court-approved debtor-in-possession financing under the Bankruptcy Code. I believe this provision should be deleted. 64 My view is consistent with 

the position recently taken by the National Bankruptcy Conference (NBC), which 

essentially made the same observation and recommendation. 65 In addition, if 

TPRRA fails to allow the Federal Reserve to provide secured liquidity to a bridge 

FHC under the Bankruptcy Code, the U.S. G–SIBs may be forced to hold more cash 

and HQLAs than otherwise. This will sharply reduce the amount of credit they can 

make available to the market and give them a powerful incentive to hoard liquidity 

during a financial crisis, when it is most needed by the market. 66 Finally, the absence of a Government LOLR facility in a bankruptcy proceeding will increase the 

range of circumstances under which Title II can be lawfully invoked. 67

TPRRA would also repeal Title II of the Dodd-Frank Act. Largely for the reasons 

stated by the NBC, 68 I believe this would be inadvisable. While I would prefer that 

a new Chapter 14 be added to the Bankruptcy Code to minimize the circumstances 

under which Title II can be lawfully invoked to the bare minimum, 69 I believe that 

there is value in preserving Title II for several reasons. First, it may be necessary 

to have a provision like Title II to be able to have a Government source of backup secured liquidity in the event of a liquidity famine in the market during a future 

financial crisis. Second, there may be certain unforeseeable emergency circumstances that would justify a compromise with the rule of law in favor of allowing 

the FDIC to exercise the broad range of discretion granted by Title II, which a bankruptcy court does not have under the Bankruptcy Code. 

Third, foreign jurisdictions do not have a tradition of recapitalizations or reorganizations under their insolvency laws. As a result, foreign regulators associate insolvency laws with liquidations, not recapitalizations or reorganizations. To provide for 

recapitalizations or reorganizations of financial firms, these foreign jurisdictions 

have created special resolution regimes (SRR) run by administrative agencies rather 

than courts. These SRRs are substantially similar to Title II of the Dodd-Frank Act 

and the bank resolution provisions in the Federal Deposit Insurance Act. As a result, many foreign regulators have an almost impossible time understanding or accepting that an SPoE strategy can be executed effectively under the Bankruptcy 

Code. It is therefore useful to preserve Title II to foster cross-border confidence and 

36 

cooperation in the U.S. resolution process. Such confidence and cooperation would 

almost certainly be undermined if Title II were repealed. 

Conclusion 

While the U.S. G–SIBs have made substantial progress showing that an SPoE 

strategy can be executed under existing Chapter 11, bankruptcy reform has the potential to increase the legal certainty of that outcome. Indeed, I believe that the proposed TPRRA would increase the ability of the Bankruptcy Code to address too-bigto-fail with two modifications. First, the provisions prohibiting the Federal Reserve 

from providing advances to bridge financial companies in a bankruptcy proceeding 

for the purpose of providing it with debtor-in-possession financing should be deleted. 

Second, while it is desirable for TPRRA to reduce the circumstances under which 

Title II of the Dodd-Frank Act can be lawfully invoked to the bare minimum, it 

should not entirely repeal Title II. 

37 

38 

39 

40 

41 

42 

43 

44 

45 

46 

47 

48 

49 

50 

51 

52 

53 

54 

55 

56 

57 

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60 

61 

62 

63 

64 

65 

66 

1Mary and Robert Raymond Professor of Economics at Stanford University, George P. Shultz 

Senior Fellow in Economics at Stanford’s Hoover Institution, and former Under Secretary of 

Treasury for International Affairs, 2001–2005. I am most grateful to Emily Kapur for advice 

and suggestions in preparing this testimony which draws directly from her research on how a 

Chapter 14 reform of the bankruptcy code would work in practice. 2See, for example, the work of the Resolution Project at Stanford University’s Hoover Institution in the books by Scott, Jackson, and Taylor (2015), Scott and Taylor (2012), Scott, Shultz, 

and Taylor (2010), the Bipartisan Policy Center report by Jackson, Guynn, and Bovenzi (2013), 

the Cleveland Fed study by Fitzpatrick and Thomson (2011), the Board of Governors of the Federal Reserve (2011), and Government Accountability Office (2011). 

PREPARED STATEMENT OF JOHN B. TAYLOR 

HOOVER INSTITUTION SENIOR FELLOW IN ECONOMICS, STANFORD UNIVERSITY

JULY 29, 2015 

Chairman Toomey, Ranking Member Merkley, and other Members of the Subcommittee on Financial Institutions and Consumer Protection, I thank you for the 

opportunity to testify at this important hearing on ‘‘The Role of Bankruptcy Reform 

in Addressing Too Big To Fail’’. 1

Bankruptcy reform is essential to addressing the problem of too big to fail. A welldesigned reform that handles large financial firms and makes failure feasible under 

clear rules without disruptive spillovers would greatly reduce the likelihood of Government bailouts. It would thereby diminish excessive risk-taking, remove uncertainty due to an inherently ad hoc bailout process, and cut the implicit subsidy to 

‘‘too big to fail’’ firms. 

In the 7 years since the financial crisis, much economic research and legal analysis has been devoted to finding the best way to proceed with bankruptcy reform. 2

And good reform bills have now been introduced in the Senate, ‘‘The Taxpayer Protection and Responsible Resolution Act’’ (TPRRA) and in the House, ‘‘The Financial 

Institution Bankruptcy Act of 2015’’. 

Current Bankruptcy Law and the Failure of Large, Complex Financial Institutions 

Under current bankruptcy law, a failing firm can be reorganized under a Chapter 

11 proceeding in which losses are calculated according to prescribed and open procedures, known in advance. If the failed firm’s liabilities exceed its assets, then the 

shareholders are wiped out. The remaining difference between liabilities and assets 

is then allocated among creditors in the order of priority stipulated by the law, 

which is also known in advance. The creditors’ debts are written down and, sometimes, converted into equity in the reorganized firm. In the end, the firm continues 

in business with either the old or new managers. Chapter 11 ensures that creditors 

bear losses and this reduces moral hazard and excessive risk-taking. 

Thus, Chapter 11 has many benefits. However, Chapter 11 is designed as a general procedure for a wide variety of businesses. Large complex financial institutions 

present special considerations which warrant a reform of the bankruptcy code. The 

existing bankruptcy process is likely to be too slow for the fast moving markets that 

these types of firms deal in. The bankruptcy judges might not have enough financial 

experience to understand the market implications of their judicial decisions. Many 

exceptions to bankruptcy (for example, for brokerage and insurance companies) also 

complicate Chapter 11 proceedings for large multiproduct financial firms. 

Perhaps most importantly, under Chapter 11 it is difficult to maintain adequately 

the operations of a large complex financial institution that is failing in ways that 

will prevent a run. Because of Government policymakers’ concerns about the systemic consequences of such a run, use either Title II of the Dodd-Frank Act or a 

direct bailout. 

Concerns over the experience with Lehman Brothers’ Chapter 11 may make it 

more likely in the future that creditors would run before a Chapter 11 proceeding 

and that policymakers would therefore resort to Title II or a bailout. In the case 

of Lehman, losses were allocated to short-term unsecured creditors that had continued to fund Lehman because they expected its treatment to be similar to Bear 

Stearns’ bailout. Even if these concerns are unwarranted, they lead market participants to expect that Chapter 11 will not be used. 

Bankruptcy Reform for More Credible Resolutions Through Bankruptcy 

Law 

To deal with these shortcomings, a reform of the bankruptcy code is needed with 

a new chapter or subchapters along the lines of the Chapter 14 proposal in the TaxVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00070 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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3 After first using the term Chapter 11F in Scott, Shultz, and Taylor (2010), the Resolution 

Project at Stanford’s Hoover Institution adopted the term Chapter 14 in Scott and Taylor (2012) 

because there is currently no such numbered chapter in the code. Here I use the term Chapter 

14 to refer to this type of bankruptcy reform. 

payer Protection and Responsible Resolution Act 3 or the Subchapter V of Chapter 

11 proposal in the Financial Institution Bankruptcy Act of 2015. Under such a reform the procedures to determine asset values, liabilities, sales of some lines of business, write-downs of claims, and recapitalization would be based on the rule of law, 

as under Chapter 11, and the strict priority rules of bankruptcy would govern. Thus, 

the resolution regime under bankruptcy would ensure that any failing institution 

would be resolved through the same known set of processes. One of the biggest problems in the 2008 panic was a lack of predictability, with the Government applying 

widely varying policies. 

Unlike reorganization under Chapter 11, however, the Chapter 14 proceedings 

would be overseen by a specialized panel of Article III judges and special masters 

with financial expertise. The bankruptcy would involve only a single proceeding, unlike current law where a parent company must go through one proceeding and insurance and brokerage subsidiaries through another, adding considerable complexity. 

Chapter 14 would operate faster—ideally over a weekend—and with no less precision than Chapter 11. Unlike Chapter 11, it would leave all operating subsidiaries 

outside of bankruptcy entirely. It would do this by moving the original financial 

firm’s operations to a new bridge company that is not in bankruptcy. This bridge 

company would be recapitalized by leaving behind long-term unsecured debt—called 

the ‘‘capital structure debt.’’ The firm’s long-term unsecured debt would bear the 

losses due to the firm’s insolvency and any other costs associated with bankruptcy. 

If the amount of long-term debt and subordinated debt were sufficient, short-term 

lenders would not have an incentive to run, and the expectation of Chapter 14’s use 

will reduce ex ante uncertainty about runs. 

The goal of these provisions is to let a failing financial firm go into bankruptcy 

in a predictable, rules-based manner without causing disruptive spillovers in the 

economy while permitting people to continue to use its financial services without 

running. The net effect is similar to well-known bankruptcy cases for nonfinancial 

firms in which people could continue to fly on American Airlines planes, buy Kmart 

sundries and try on Hartmax suits. The provisions make it possible to create a new 

fully capitalized entity which would credibly provide most of the financial services 

the failed firm was providing before it got into trouble. Modularization of the firm, 

which is in principle made easier by the living wills, would expedite the process. 

The new Chapter 14 would also allow the primary Federal regulator of the firm 

to file a bankruptcy petition in addition to creditors and management. This would 

expedite the process, especially in cases where management, fearing a loss of equity 

or employment, has incentives to put off a filing. The examiner’s report on Lehman 

makes it very clear there was no preparation for bankruptcy proceedings before the 

bankruptcy filing, which increased the size of the disruption. 

To understand how such a reformed bankruptcy code would resolve a large and 

complex financial institution, it is very useful to consider how Chapter 14 would 

have worked in the case of Lehman Brothers in 2008. Emily Kapur (2015) has carefully researched such a scenario using balance sheet and financial data that has 

been made public through Lehman’s court proceedings, and has prepared a brief 

and illustrative summary which appears at the end of this testimony. 

Bankruptcy Reform and More Robust Resolution Planning Under the 

Dodd-Frank Act 

The Dodd-Frank Act requires that resolution plans—living wills—be submitted by 

the large and complex financial firms to show how these firms can be resolved in 

cases of distress or failure in a rapid and orderly resolution without systemic 

spillovers under existing law. Of course, existing law includes Chapter 11 of the 

bankruptcy code. 

Thus far the plans submitted by the large financial firms have been rejected by 

the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). The 

reasons for the rejections are not fully known, but clearly the requirement that the 

firms would have to go through a Chapter 11 bankruptcy is an impediment as I explained in the first section of this testimony: it is very difficult, if not impossible, 

at this time to bring one of these large firms through a conventional Chapter 11 

bankruptcy. 

William Kroener (2015) points out, however, that a Chapter 14 reform would 

greatly facilitate the resolutions plans’ ability to meet the statutory requirements. 

68 

4This section is based on Taylor (2013). 

Unlike Chapter 11, it would leave all operating subsidiaries outside of bankruptcy 

entirely as these subsidiaries move to the new firm that is not in bankruptcy. In 

other words, bankruptcy reform would help greatly in the resolution planning process required in the Dodd-Frank Act. 

Shortcomings of the FDIC Resolution Mechanism Under Title II of the 

Dodd-Frank Act 

While full liquidation with wiped-out shareholders was a major selling point of 

the Dodd-Frank Act, 4 in the years since the Act was passed the focus of the FDIC 

has been on how to resolve and reorganize the failing firm into an ongoing concern, 

rather than on how to liquidate it. To achieve such a re-organization under this new 

authority the FDIC would transfer part of a failing firm’s balance sheet and its operations to a new bridge institution. 

In order to carry out this task, the FDIC would have to exercise considerable discretion. The degree of discretion would be especially large in comparison with more 

transparent and less uncertain bankruptcy proceedings through which nonfinancial 

firms are regularly resolved and reorganized through the rules of the bankruptcy 

laws. As a result there is confusion about how the reorganization process would operate under Title II, especially in the case of international firms. Indeed, this uncertainty about the Title II process would likely lead policymakers to ignore it in the 

heat of a crisis and resort to massive taxpayer bailouts as in the past. Hence, the 

concern about bailouts remains. 

But even if the Title II process were used, bailouts would be likely. As the FDIC 

exercised its discretion to form a bridge bank, it would likely give some creditors 

more funds than they would have expected or been entitled to under bankruptcy 

law. They might wish to hold some creditors harmless, or nearly harmless, in order 

to prevent a perceived contagion of the firm’s failure to other parts of the financial 

system. This action would violate the priority rules that underlie everyday decisions 

about borrowing and lending. Under the reasonable definition that bailout means 

that some creditors get more than they would under bankruptcy laws or under the 

normal workings of the market, such action would, by definition, be a bailout of the 

favored creditors. 

This expectation of bailout of some creditors increases the risk of financial instability. Government regulation through capital or liquidity requirements and supervision is not the only way a financial firm’s risk-taking decisions are constrained. 

Discipline is also imposed on the firm by its counterparties, so long as they perceive 

a need to monitor the firm and protect themselves from losses by demanding collateral or simply cutting off credit. Creditors have significant advantages over Government regulators, in terms of current knowledge, ability to act quickly, and financial 

stakes. And they are not subject to regulatory capture. 

The expectation of bailouts of creditors weakens the incentives for them to monitor their loans and thereby provide this constraint on risk taking. Because the bailout reduces the risk incurred by large creditors expecting to be favored, they charge 

a lower interest rate, creating the subsidy of large and complex financial firms. 

It is important to recognize that the perverse effects of such bailouts occur whether or not the source of the extra payment comes from the Treasury financed by taxpayers, from an assessment fund financed by financial institutions and their customers, or from smaller payments for less favored creditors. 

Contrasting the resolution of a failing financial firm under Title II with resolution 

under a reformed bankruptcy procedure reveals additional concerns with Title II. 

Under bankruptcy reorganization, private parties, motivated and incentivized by 

profit and loss considerations, make key decisions about the direction of the new 

firm, perhaps subject to bankruptcy court oversight. But under Title II a Government agency, the FDIC and its bridge bank, would make the decisions. This creates 

the possibility that the FDIC would be pressured to ask the bridge firm to grant 

special favors to certain creditors as in the case of the Government Sponsored Enterprises. 

In addition, the resolution of a firm through a Government-administered bridge 

company could give the new firm advantages over its competitors in comparison 

with a bankruptcy resolution. The Treasury is authorized to fund the FDIC which 

can fund the bridge firm, creating a subsidy, and under Title II the bridge firm can 

be given lower capital requirements and forgiven tax liabilities. 

One can understand that the FDIC or any Government agency in charge of resolutions would want to use such legal provisions to nurse the bridge firm with special 

advantages for a while before letting it compete on a level playing field. But with 

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cess, there is a concern that the advantages granted by a Government agency could 

become excessive and prolonged. 

Summary 

In this testimony I showed why a reform of the bankruptcy law along the lines 

of the Senate bill, ‘‘The Taxpayer Protection and Responsible Resolution Act’’ 

(TPRRA) or the House bill, ‘‘The Financial Institution Bankruptcy Act of 2015’’ is 

essential for ending Government bailouts as we know them. Such a reform—which 

would make failure feasible even for large and complex financial institutions—would 

play a key role in addressing the problems of excess risk taking, uncertainty, and 

unfair subsidies associated with too big to fail, which persist under the Dodd-Frank 

Act. If accompanied with an increase in capital and capital structure debt, such a 

reform would go a long way toward ending too big too fail. 

If Title II of the Dodd-Frank Act remains in the law, such a reform would likely 

reduce the use of Title II, and thus lead to more rules-based and less discretionary 

resolutions. The reform would also repair the resolution planning process now required under the Dodd-Frank Act. 

70 

71 

72 

73 

74 

75 

76 

1Dodd-Frank Act §165(d)(1). 2Dodd-Frank Act, §165(d)(4) 3Dodd-Frank Act, §165(d)(5)(A) and (B). 

PREPARED STATEMENT OF THOMAS H. JACKSON 

PRESIDENT EMERITUS, UNIVERSITY OF ROCHESTER

JULY 29, 2015 

Thank you for inviting me to testify today. I am Thomas Jackson, Distinguished 

University Professor and President Emeritus at the University of Rochester. Prior 

to moving to the University of Rochester, I was a professor of law, specializing in 

bankruptcy, at Stanford, Harvard, and the University of Virginia schools of law. I 

am the author of a Harvard Press book, The Logic and Limits of Bankruptcy Law, 

a bankruptcy casebook, and numerous articles on bankruptcy law. Recently, my 

work in the field of bankruptcy has focused on the use of bankruptcy in resolving 

systemically important financial institutions (SIFIs). In that capacity, I was cochair 

of a Bipartisan Policy Center working group that produced, in May of 2013, Too Big 

To Fail: The Path to a Solution. I have also been, since 2008, a member of the Hoover Institution’s Resolution Project, which has produced three books discussing how 

bankruptcy can be made more effective in terms of the resolution of SIFIs (the most 

recent one, Making Failure Feasible, is in the final publication process). And, since 

2013, I have been a member of the Federal Deposit Insurance Corporation’s (FDIC’s) 

Systemic Resolution Advisory Committee. I am here today in my individual capacity, and the views I express are my own, not those of any group or organization with 

which I am affiliated. 

I am a firm believer that the Bankruptcy Code, with a few significant changes, 

can be made an important player in the resolution of SIFIs and that both bankruptcy law and the Dodd-Frank Act can be made more effective as a result. Before 

discussing those changes, however, I believe it is important to set out, briefly, (a) 

the relationship envisioned between the Dodd-Frank Act and bankruptcy law, (b) 

the current status of the major alternative to bankruptcy—the Orderly Liquidation 

Authority (OLA) of Title II of the Dodd-Frank Act, (c) why bankruptcy law, without 

statutory changes, is likely to be inadequate in terms of fulfilling what virtually everyone believes should be its role, and (d) why this creates problems both for the 

Dodd-Frank Act’s Title I provisions for resolution plans under Section 165(d)—socalled ‘‘Living Wills’’—as well as for its OLA provisions under Title II. After setting 

out that important backdrop, I will discuss, at a somewhat abstract level, the core 

of changes that I would suggest be implemented in the Bankruptcy Code in order 

to make it the primary resolution mechanism, even in light of the FDIC’s development of ‘‘single-point-of-entry’’ (SPoE) as its presumptive method of implementing 

OLA under Title II of the Dodd-Frank Act, thus fulfilling the intent of both Title 

I and Title II of that Act. A full set of changes I might recommend—including provisions that might be ‘‘nice but not necessary’’—is discussed in my contribution to 

Making Failure Feasible, a copy of which is attached to this Statement as an Appendix. 

The Relationship Envisioned Between the Dodd-Frank Act and Bankruptcy 

Law 

In two key places, the Dodd-Frank Act envisions bankruptcy as the preferred 

mechanism for the resolution of SIFIs. The first occurs in Title I, with the provision 

for resolution plans under Section 165(d). Covered financial institutions are required 

to prepare, for review by the Board of Governors of the Federal Reserve System 

(Federal Reserve Board or FRB), the Financial Stability Oversight Council, and the 

FDIC, ‘‘the plan of such company for rapid and orderly resolution in the event of 

material financial distress or failure . . . .’’ 1 If the Federal Reserve Board and the 

FDIC jointly determine that a submitted resolution plan ‘‘is not credible or would 

not facilitate an orderly resolution of the company under Title 11, United States 

Code’’ (i.e., the Bankruptcy Code), the company needs to resubmit a plan ‘‘with revisions demonstrating that the plan is credible, and would result in an orderly resolution under title 11, United States Code . . . .’’ 2 The failure to submit a plan that 

meets these tests can lead to restrictions, and divestiture, ‘‘in order to facilitate an 

orderly resolution of such company under title 11, United States Code . . . .’’ 3 For 

present purposes, the important point is that effective resolution plans are tested 

against bankruptcy law, not OLA under Title II of the Dodd-Frank Act. It therefore 

goes without saying—but is worth saying nonetheless—that the effectiveness of 

77 

4See William F. Kroener III, Revised Chapter 14 ‘‘2.0 and Living Will Requirements Under 

the Dodd-Frank Act’’, in Kenneth E. Scott, Thomas H. Jackson, and John B. Taylor (eds.), Making Failure Feasible: How Bankruptcy Reform Can End ‘‘Too Big To Fail’’ (Hoover Institution 

Press 2015). 5Dodd-Frank Act, §203(a)(1)(F) and (a)(2)(F); §203(b)(2) and (3). 6Federal Deposit Insurance Corporation, ‘‘The Resolution of Systemically Important Financial 

Institutions: The Single Point of Entry Strategy’’, 78 Fed. Reg. 76614 (Dec. 18, 2013) (hereafter 

‘‘FDIC SPoE’’), at 76615 (‘‘the statute makes clear that bankruptcy is the preferred resolution 

framework in the event of the failure of a SIFI’’); see Statement of Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation on Implementation of the Dodd-Frank Act before 

the Committee on Banking, Housing, and Urban Affairs, United States Senate (December 6, 

2011), available at http://www.fdic.gov/news/news/speeches/chairman/spdec0611.html (‘‘If the 

firms are successful in their resolution planning, then the OLA would only be used in the rare 

instance where resolution under the Bankruptcy Code would have serious adverse effects on 

U.S. financial stability’’). 7See Remarks by Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation, 

in Implementation of the Dodd-Frank Act before the Volcker Alliance Program (October 13, 

2013), available at http://www.fdic/gov/news/news/speeches/spoet1313.html. 8There is a separate question—that I do not address (as it is not my area of expertise)—as 

to whether several financial institutions are simply ‘‘too big.’’ I strongly urge that question be 

addressed directly—and separately. Bankruptcy law should efficiently resolve (through reorganization, recapitalization, sale, or liquidation) the entities, including financial institutions, that 

use it. It should not include a policy—that would be inconsistent with long-standing bankruptcy 

policy—favoring liquidation simply based on size. 9Financial Stability Board, ‘‘Progress and Next Steps Towards Ending ‘Too Big To Fail’,’’ Report of the Financial Stability Board to the G20, available at www.financialstabilityboard.org/ 

publications/rl130902.pdf (Sept. 2013); Thomas Huertas, Vice Chairman, Comm. of European 

Banking Supervisors and Dir., Banking Sector, U.K. Fin. Services Auth., ‘‘The Road to Better 

Resolution: From Bail-Out to Bail-In’’, speech at The Euro and the Financial Crisis Conference 

(Sept. 6, 2010), available at http://www.fsa.gov.uk/library/communication/speeches/2010/ 

0906lth.shtml; Clifford Chance, ‘‘Legal Aspects of Bank Bail-Ins’’ (2011). 

bankruptcy law in being able to resolve SIFIs is critically important to the development of credible resolution plans under Title I. 4

Indeed, first-round resolution plans were uniformly rejected as inadequate. The 

eight U.S. Global Systemically Important Banks (G–SIBs) filed revised plans within 

the past month; most of them propose a SPoE resolution strategy, keyed off of the 

FDIC’s work for resolution under the Dodd-Frank Act’s Title II OLA, and which, in 

my view, would be awkwardly implemented—perhaps not impossible, but difficult— 

under today’s Bankruptcy Code, for reasons I will discuss. 

The second occurs in the context of the ability to initiate the OLA process under 

Title II of the Dodd-Frank Act. Invocation of Title II itself can only occur if the Government regulators find that bankruptcy is wanting. 5 That is, by its own terms, 

bankruptcy is designed by the Dodd-Frank Act to be the preferred resolution mechanism. 6 The FDIC has announced that it supports the idea that bankruptcy, not 

OLA, should be the presumptive resolution procedure. 7 The ability of bankruptcy 

law to fulfill its intended role as the presumptive procedure for resolution, of course, 

turns on the effectiveness of bankruptcy law in rising to the challenge of accomplishing a resolution that meets three important goals: One that (a) both minimizes 

losses and places them on appropriate, pre-identified, parties, (b) minimizes systemic consequences; and (c) does not result in a Government bail-out. (In many 

ways, (c) is actually a direct consequence of (a): If losses are borne by appropriate, 

pre-identified, parties, the Government does not need to absorb losses via a bailout.) The goal should be resolution within these constraints, not necessarily an inefficient liquidation—a goal wholly consistent with that of Chapter 11 of the Bankruptcy Code. 8

The Current Status of the Orderly Liquidation Authority 

Title II of the Dodd-Frank Act, containing the OLA, in many ways adopts many 

of bankruptcy law’s provisions, with a key difference being that the resolution is 

handled by the FDIC, as receiver, retaining significant discretion, as compared to 

a bankruptcy court, subject to statutory rules that can and will be enforced by appellate review through the Article III judicial system. 

But we are not in 2010, when the Dodd-Frank Act was envisioned and enacted. 

Much thinking and work has occurred since then, in terms of how, effectively, to 

resolve a SIFI without jeopardizing the financial system and without a Government 

bailout. Increasingly, attention has turned, in Europe as well as in the United 

States, on a rapid recapitalization. Europe has focused on a ‘‘one-entity’’ recapitalization via bail-in 9 while the FDIC has focused, in its SPoE proposal, on a ‘‘twoVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00081 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
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10FDIC SPoE, supra note 6. See Federal Deposit Insurance Corporation and Bank of England, Joint Paper, ‘‘Resolving Globally Active, Systemically Important, Financial Institutions’’ 

(Dec. 10, 2012), available at http://www.bankofengland.co.uk/publications/Documents/news/ 

2012/nr156.pdf (jointly proposing the single-point-of-entry approach). 11 Early signs of which were foreshadowed in Randall Guynn, ‘‘Are Bailouts Inevitable?’’ 29 

Yale J. On Regulation 121 (2012). 12 In part, this difference is driven by different organizational structures common to U.S. 

SIFI’s versus European SIFIs—our SIFIs are much more likely to use a holding company structure; in part this difference is driven by Title II’s liquidation ‘‘mandate.’’ Section 214(a) of the 

Dodd-Frank Act explicitly states: ‘‘All financial companies put into receivership under this subchapter shall be liquidated.’’ As a bankruptcy scholar, I view this latter mandate, at least in 

the abstract, as unfortunate. A first-day lesson in a corporate reorganization course is that ‘‘understanding that financial and economic distress are conceptually distinct from each other is 

fundamental to understanding Chapter 11 of the Bankruptcy Code,’’ Barry Adler, Douglas 

Baird, and Thomas Jackson, ‘‘Bankruptcy: Cases, Problems, and Materials’’ 28 (Foundation 

Press 4th ed. 2007). Avoiding a bailout requires that losses be borne by appropriate parties, 

identified in advance, not necessarily by liquidation of the underlying business, which may cause 

an unnecessary destruction of value. The FDIC’s SPoE strategy formally complies with the statutory requirement, by liquidating the SIFI holding company after its assets have been liquidated via the transfer to the bridge company. 13See John Bovenzi, Randall Guynn, and Thomas Jackson, ‘‘Too Big To Fail: The Path to a 

Solution’’ (Bipartisan Policy Center, Failure Resolution Task Force May 2013). 14www.federalreserve.gov/bankinforog/ccar.htm 15See Daniel Tarullo, ‘‘Toward Building a More Effective Resolution Regime: Progress and 

Challenges’’ (Oct. 2013), available at http://www.federalreserve.gov/newsevents/speech/ 

tarullo20131018a.html (‘‘The single-point-of-entry approach offers the best potential for the orderly resolution of a systemic financial firm . . . ’’); William Dudley, President and Chief Executive Officer, Federal Reserve Bank of New York, Remarks at the Federal Reserve Board and 

Federal Reserve Bank of Richmond Conference, ‘‘Planning for the Orderly Resolution of a Globally Systemically Important Bank, p.1 (Wash. DC, Oct. 18, 2013) (‘‘I very much endorse the single-point-of-entry framework for resolution as proposed by the Federal Deposit Insurance Corporation (FDIC).’’); John Bovenzi, Randall Guynn, and Thomas Jackson, supra note 13; David 

Skeel, ‘‘Single Point of Entry and the Bankruptcy Alternative’’, in Martin Neil Baily and John 

B. Taylor (eds.), ‘‘Across the Great Divide: New Perspectives on the Financial Crisis’’ (Hoover 

Press 2014). 

entity’’ recapitalization rather than a formal bail-in. 10 Under the FDIC’s approach, 11 a SIFI holding company (the ‘‘single point of entry’’) is effectively ‘‘recapitalized’’ over a matter of days, if not hours, by the transfer of virtually all its assets 

and liabilities, except for certain long-term unsecured liabilities, to a new bridge institution whose capital structure, because of the absence of those long-term unsecured liabilities, is both different and presumptively ‘‘sound.’’ Because of the splitting off of the long-term unsecured debt, the bridge institution, in the FDIC’s model, 

looks very much like a SIFI following a European-like ‘‘bail in.’’ The major difference 

is that in the ‘‘bail in,’’ the SIFI holding company before and after the recapitalization is the same legal entity (thus, the ‘‘one-entity’’ recapitalization), whereas in the 

FDIC’s SPoE proposal, the ‘‘recapitalized’’ bridge institution, a different legal entity, 

is formed first and effectively receives a ‘‘new’’ capital structure by virtue of having 

long-term unsecured debt left behind in the transfer to it and the bridge institution, 

in turn, recapitalizes (where necessary) its operating subsidiaries (thus, the ‘‘twoentity’’ recapitalization) 12 In both cases, the resulting holding company then forgives intercompany liabilities or contributes assets to recapitalize its operating subsidiaries. 

There are preconditions for making this work. Important among them are legal 

rules, known in advance, setting forth a required amount of long-term debt (or subordinate or bail-in debt) to be held by the SIFI that would be legally subordinate 

to other unsecured debt—in the sense of its debt-holders knowing that this debt 

would be ‘‘bailed-in’’ (in a one-entity recapitalization) or left behind (in a two-entity 

recapitalization). 13 Much work has been done on this dimension, both under Basel 

III and through the Federal Reserve Board’s Comprehensive Capital Analysis and 

Review (CCAR). 14 And the effective use of a two-entity recapitalization in Title II 

of the Dodd-Frank Act needs to straddle the tension between Title II’s liquidation 

mandate (literally met because, following the transfer to the bridge company, the 

assets of the original holding company will have been removed from the SIFI holding company, which will subsequently itself be liquidated) and the notion of limiting 

financial contagion and using Title II only when its invocation is required because 

of serious doubts about the effectiveness of the use of the bankruptcy process. That 

said, many recognize that the FDIC’s SPoE proposal for Title II of the Dodd-Frank 

Act, consistent with parallel work in Europe, is a significant development in terms 

of advancing the goals of avoiding ‘‘too big to fail’’—a resolution process that (a) allocates losses among the appropriate parties, (b) limits systemic consequences, and (c) 

avoids a Government-funded bail-out. 15

79 

16See FDIC SPoE, supra note 6, 76616–18. 17Dodd-Frank Act, section 210(h)(1) (‘‘a bridge financial company . . . shall be exempt from 

all taxation now or hereafter imposed by the United States, by any territory, dependency, or 

possession thereof, or by any State, county, municipality, or local taxing authority’’). 18FDIC SPoE, supra note 6, 76617. 19FDIC SPoE, supra note 6, 76618. 20FDIC SPoE, supra note 6, 76619. 21Kenneth Scott, ‘‘The Context for Bankruptcy Resolutions’’, in Kenneth E. Scott, Thomas H. 

Jackson, and John B. Taylor (eds.), supra note 4, at 5–6. 22David Skeel, ‘‘Debt’s Dominion: A History of Bankruptcy Law in America’’ 227 (Princeton 

2001); Barry Adler, Douglas Baird, and Thomas Jackson, supra note 12, at 466–467 (‘‘between 

[1983 and 2003] a sea change occurred through which an auction of the debtor’s assets has become a commonplace alternative to a traditional corporate reorganization’’). 23See text accompanying notes 8–15, supra. 

Title II’s OLA provisions, however, also come with certain defects. The FDIC retains discretion to prefer some creditors over others of equal rank, without limiting 

it to occasions where there is background legal authority (which will rarely occur 

at the holding company level), and at important points the FDIC, rather than the 

market, is making critical determinations regarding the bridge financial company 

and its equity. 16 Thus, the FDIC proposes that the bridge financial institution created in the SPoE process (treated as a Government entity for tax purposes 17) is effectively run, for a while at least, by the FDIC. 18 In addition, the FDIC’s SPoE proposal relies on expert (and FDIC) valuations of the new securities that will form 

the basis of the distribution to the long-term creditors and old equity interests ‘‘left 

behind,’’ 19 and the FDIC retains the authority to distribute them other than according to the absolute priority rule so well known in bankruptcy law. 20

In addition, the FDIC’s SPoE proposal is, itself, potentially limited in scope: 

The FDIC’s SPoE bridge proposal seemingly applies only to domestic financial companies posing systemic risk (currently, eight bank and three or four 

nonbank holding companies are so regarded, although more may be added, 

even at the last minute), not to the next hundred or so bank holding companies with more than $10 billion in consolidated assets, or to all the (potentially over one thousand) ‘‘financial companies’’ covered by Dodd-Frank’s 

Title I definition (at least 85 percent of assets or revenues from financial 

activities). 21

The Inadequacies of Current Bankruptcy Law Seen in Light of SPoE 

I believe the ‘‘bones’’ for a comparably successful resolution of a SIFI under the 

Bankruptcy Code are already in place. But, without statutory revisions, such as I 

will be addressing in this Statement, those ‘‘bones’’ are unlikely to translate to a 

competitive resolution procedure to SPoE, as developed by the FDIC, under Title II 

of the Dodd-Frank Act. 

While it is probably the case that the original ‘‘intent’’ of Section 363 of the Bankruptcy Code—a provision providing for the use, sale, and lease of property of the 

estate—at the time of its enactment in 1978 was to permit piecemeal sales of unwanted property, Chapter 11 practice began, over time, to move in the direction of 

both (a) pre-packaged plans of reorganization and (b) procedures whose essential device was a going-concern sale of some or all of the business (whether prior to or in 

connection with a plan of reorganization), leaving the original equity and much of 

the debt behind and with the proceeds of the sale forming the basis of the distribution to them according to the plan of reorganization and bankruptcy’s priority 

rules. 22 While these going-concern sales don’t fit perfectly with the original vision, 

which assumed the Chapter 11 company would be reorganized, not sold, such sales 

have been used, repeatedly, as a way of continuing a business outside of bankruptcy 

while the claimants and equity interests, left behind, wind up as the owners of 

whatever was received by the bankruptcy estate in connection with the sale. And 

it, at least in rough contours, has structural features in common with the two-step 

recapitalization that is envisioned under the FDIC’s SPoE procedure. 

That said, a Section 363 sale is an imperfect competitor to SPoE in its current 

form. While both will require identification of long-term debt (or capital structure 

debt) that will be left behind—again, work that is well underway 23—a successful 

two-entity recapitalization essentially requires the bridge company to be able to acquire all of the remaining assets, contracts, permits, rights, and liabilities of the 

SIFI holding company, while preserving the businesses of the transferred, nonbankrupt, operating subsidiaries. 

That seems to me very difficult to accomplish under the current Bankruptcy Code. 

First, because of a series of amendments designed to insulate qualified financial 

contracts—swaps, derivatives, and repos—from many of bankruptcy’s provisions, 

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24 Bankruptcy Code §§362(b)(6), (7), (17), (27), 546(e), (f), (g), (j), 555, 556, 559, 560, 561. (The 

FDIC SPoE proposal, consistent with statutory authorization, Dodd-Frank Act §210(c)(8), (9), 

(10), (16), will override any such provisions in counterparty contracts (and subsidiary cross-default provisions); bankruptcy, being a judicial proceeding, cannot (and should not) do that without comparable statutory authorization which currently not only is missing but is expressly contradicted by provisions that exist.) While my statement today focuses on changes that are necessary in these existing protective provisions for counterparties on qualified financial contracts 

in the Bankruptcy Code in order to permit an effective two-step recapitalization of a SIFI holding company, I believe these existing Bankruptcy Code provisions, and their relationship to 

bankruptcy law more generally, needs to be rethought. See David Skeel and Thomas Jackson, 

‘‘Transaction Consistency and the New Finance in Bankruptcy’’, 112 Colum. L. Rev. 152 (2012). 25See ISDA, ‘‘Resolution Stay Protocol—Background’’, October 11, 2014; see also Tom 

Braithwaite and Tracy Allway, ‘‘Banks Rewrite Derivative Rules To Cope With Future Crisis’’, 

Financial Times, October 7, 2014. 26Many of these will not be executory contracts, subject to the assumption and assignment 

provisions of §365 of the Bankruptcy Code. Nor does the current Bankruptcy Code directly deal, 

apart from those provisions, with change-of-control triggers in licenses and the like. 27 Bankruptcy Code §102(1) provides that ‘‘after notice and a hearing’’ includes (B) 

‘‘authoriz[ing] an act without an actual hearing if such notice is given properly and if . . . (ii) 

there is insufficient time for a hearing to be commenced before such act must be done, and the 

court authorizes such act . . . .’’ 28See sources cited, supra note 15. 

most notably the automatic stay and the unenforceability of ipso facto clauses, there 

is no effective mechanism in the current Bankruptcy Code to preclude counterparties on qualified financial contracts from running upon the commencement of a 

bankruptcy case. 24 Importantly, even if most such contracts reside in nonbankrupt 

operating subsidiaries of the bridge company, such creditors may have cross-default 

or change-of-control provisions triggered by the Chapter 11 filing of their former 

holding company. (As a result of a dialogue with regulators sensitive to this problem 

in resolution proposals outside of bankruptcy, a major step in ‘‘solving’’ this concern—at least for adhering parties (initially, the 18 largest dealer banks)—occurred 

with the International Swaps and Derivatives Association’s (ISDA’s) 2014 Resolution Stay Protocol. 25) Nor would it be clear under existing bankruptcy law that operating licenses, permits, and the like could be transferred to the bridge company, 

either because it legally is a new company or because there has been a change of 

control of the holding company and its operating subsidiaries in derogation of 

change-of-control provisions or requirements applicable to individual entities. 26

Moreover, while the Bankruptcy Code clearly contemplates an ability to move 

with necessary speed, including when a provision calls for a notice and hearing before any decision (such as under Section 363(b)), 27 the lack of clear statutory authority for a very rapid transfer to a bridge company may leave too much—for the 

comfort of a SIFI or a regulatory body—up to the discretion of a particular judge 

who first gets a SIFI holding company requesting such a transfer. Nor is there a 

clear necessity for notice to, or hearing by, a Government regulator—whether the 

FDIC or Federal Reserve Board, in the case of the holding company, or a foreign 

regulator, in the case of a foreign subsidiary that is proposed to be transferred to 

a bridge company. These uncertainties, even with a robust resolution plan, may inspire enough lack of confidence by the FDIC and the Federal Reserve Board so as 

to view the commencement of an OLA proceeding under Title II of the Dodd-Frank 

Act to be the preferable course—or, alternatively, lack of sufficient confidence by foreign regulators so as to acquiesce in allowing the bankruptcy process to unfold without the regulator intervening at the foreign subsidiary level. 

The Problems These Inadequacies Create for the Dodd-Frank Act 

As noted above, resolution plans under Title I of the Dodd-Frank Act focus on 

bankruptcy, and Title II of the Dodd-Frank Act is, explicitly, designed to be a fallback solution to be invoked when bankruptcy is determined to be inadequate to 

avoid serious financial consequences on the U.S. financial system. But if the ‘‘best’’ 

resolution process we currently envision—one that, as noted above, (a) both minimizes losses and places them on appropriate, pre-identified, parties, (b) minimizes 

systemic consequences, and (c) does not result in a Government bail-out—involves, 

indeed, a recapitalization such as proposed by the FDIC with its SPoE procedure 

under Title II, 28 then there is a disconnect between design and implementation. As 

a result, the resolution plans will fail to do what they are supposed to do—prepare 

a SIFI for the most successful possible resolution—leading to OLA under Title II 

assuming primacy in terms of the resolution process. Moreover, the resolution plans, 

relentlessly focused on a bankruptcy process under Title I’s own standards, will be 

addressing a different set of issues and will provide little guidance to the FDIC in 

its OLA proceeding. To have the statutory pieces ‘‘fit’’ together—to have resolution 

81 

29 Again, the Dodd-Frank Act is explicit that Title II cannot be invoked without a determination that bankruptcy resolution would be inadequate. See notes 5 and 6, supra. 30 In addition to the proposal contained in the Appendix, both the Senate and the House had 

introduced in the last session focused bankruptcy bills that largely incorporated the features I 

discuss next. See S. 1861, 113th Congress, 1st Sess. (‘‘The Taxpayer Protection and Responsible 

Resolution Act’’) (December 2013); H. 5421, 113th Congress, 1st Session (‘‘The Financial Institution Bankruptcy Act’’) (approved by the House via a voice vote on December 1, 2014). 31There is a third, important, question of access to liquidity by the bridge company that, formally is not a part of the bankruptcy process. While a potentially contentious issue, I believe 

there is a great deal of wisdom in David Skeel’s analysis of this in Financing Systemically Important Financial Institutions, Chapter 3 of Kenneth E. Scott, Thomas H. Jackson, and John 

B. Taylor, supra note 4. In summary: I argue in this chapter that the widespread pessimism 

about a SIFI’s ability to borrow sufficient funds—sufficiently quickly—to finance resolution in 

Chapter 11 is substantially overstated. The criticism appears to be based on the assumption 

that the largest banks have essentially the same structure as they had prior to the 2008 panic, 

thus ignoring the effects of the regulatory changes that have taken place as a result of the 

Dodd-Frank Act. Critics also do not seem to have fully considered the likelihood that the quick 

sale resolution of a SIFI—like prepackaged bankruptcies of other firms should require less new 

liquidity than the traditional bankruptcy process. (pp. 63–64) Recognizing, however, that there 

is still some residual concern, Professor Skeel ‘‘conclude[s] that lawmakers should give SIFI’s 

limited, explicit access to Fed funding, preferably by expanding the Fed’s emergency lending authority under section 13(3) of the Federal Reserve Act,’’ p. 65—where ‘‘the Fed [is] constrained 

under 13(3) by the requirement that it lend on a fully secured basis’’ as well as by the requirement that ‘‘the Fed must also determine that the loan is needed to prevent systemic or other 

harm.’’ (p. 85). In general, I think the Bankruptcy Code amendments outlined here should be 

made irrespective of the availability of Government-based liquidity. That discussion can be held 

separately, and should include whether an inability of the bridge company to access Government-based liquidity under some circumstances will make more likely use of OLA under Title 

II of the Dodd-Frank Act, where access to the orderly liquidation fund (OLF) is clear. 

plans effectively prepare a firm for resolution, to have bankruptcy serve as its intended role as the primary resolution device, and (beneficially) to have the resolution plans be relevant to a proceeding under Title II of the Dodd-Frank Act ‘‘just 

in case’’—it makes sense to move, through limited but important changes to the 

Bankruptcy Code, from the ‘‘bones’’ of a successful two-step recapitalization process 

in the current Bankruptcy Code to a process that can deliver what it can only incompletely promise today. 

Proposed Amendments to the Bankruptcy Code 

Bankruptcy can be an effective resolution mechanism, tracking major features of 

the FDIC’s SPoE proposal (but run through a bankruptcy process, with bankruptcy 

rules and market-based controls) that will usually, if not virtually always, obviate 

the need to invoke OLA under Title II of Dodd-Frank. 29 But to do so, it needs some 

focused amendments. 

What are these changes? While any resulting bill will necessarily be complicated, 30 at the center of effectuating a bankruptcy-based two-entity recapitalization of a SIFI holding company, are two principles. First, that there is sufficient 

long-term unsecured debt (or ‘‘capital structure debt’’) at the holding company level 

to be ‘‘left behind’’ in the transfer to a bridge company so as to effectuate the recapitalization. (This is—or should be—largely an issue outside of bankruptcy law itself— 

and, indeed, as noted earlier, is central to a basically rule-based application of the 

FDIC’s SPoE proposal under Title II of the Dodd-Frank Act. The precise level of 

those mandated capital requirements are being worked on, and already are significantly above those of 2008.) Second, that the bridge company otherwise be able to 

acquire all the assets, rights, and liabilities of the former holding company, including ownership of the former holding company’s operating subsidiaries. 31

Thus, the ‘‘guts’’ of the proposed amendments I believe are necessary to place 

bankruptcy law where the Dodd-Frank Act—in both Title I and Title II—envisions 

it should be, center on a provision that substantially sharpens the nature and focus 

of a sale of assets under Section 363 of the Bankruptcy Code. This provision contemplates a rapid transfer to and, in effect, recapitalization of, a bridge company 

(e.g., within the first 48 hours of a bankruptcy case) by a SIFI holding company (the 

debtor), after which the bridge company can recapitalize, where necessary, its operating subsidiaries. If the court approves the transfer, then the SIFI holding company’s operations (and ownership of subsidiaries) shift to a new bridge company 

that is not in bankruptcy—and will be perceived as solvent by market-participants, 

including liquidity providers because it will be (effectively) recapitalized, as compared to the original SIFI, by leaving behind in the bankruptcy proceeding previously identified long-term unsecured (capital structure) debt of the original SIFI. 

After the transfer, the debtor (i.e., the SIFI holding company) remains in bankruptcy but is effectively a shell, whose assets usually will consist only of its beneVerDate Nov 24 2008 11:48 Jan 27, 2016 Jkt 046629 PO 00000 Frm 00085 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-29 THE ROLE OF BANKRUPTCY REFORM IN ADDRESSING TOO-
82 

32While these provisions would affect the contracts, permits, liabilities, and the like of entities (e.g., affiliates such as operating subsidiaries) not themselves in bankruptcy, I believe they 

are fully authorized (at least for domestic subsidiaries), if not by Congress’ Article I bankruptcy 

power, then by application of the independent (albeit related) Congressional power pursuant to 

the ‘‘necessary and proper’’ clause of Article I, as interpreted since McCulloch v. Maryland, 4 

Wheat. 316 (1819), see also United States v. Comstock, 560 U.S. (2010), since the bankruptcy 

of the SIFI cannot successfully be concluded without these provisions that permit the unimpeded 

transfer of the operating subsidiary’s ownership to the bridge company. (The question of foreign 

subsidiaries, while complex, is being actively discussion by U.S. and foreign regulators, and legislation is being discussed in Europe and elsewhere that is designed to help assure these results 

extend to non-U.S. operations in the case involving the resolution of a U.S.-based SIFI holding 

company.) 33See David Skeel and Thomas Jackson, supra note 24. 

ficial interest in a trust that would hold the equity interests in the bridge company 

until they are sold or distributed pursuant to a Chapter 11 plan, and whose claimants consist of the holders of the long-term debt that is not transferred to the bridge 

company and the old equity interests of the SIFI holding company. This debtor in 

Chapter 11 has no real business to conduct, and essentially waits for an event (such 

as the sale or public distribution of equity securities of the bridge company by the 

trust) that will value or generate proceeds from its assets (all equity interests in 

the new, recapitalized entity) and permit a distribution of those equity interests or 

proceeds, pursuant to bankruptcy’s normal distribution rules, to the holders of the 

long-term debt and original equity interests of the debtor (the original SIFI holding 

company). 

The details of accomplishing this are somewhat intricate and, of course, can vary, 

but it is useful, I believe, to trace the general ideas of how I envision this two-step 

recapitalization might be implemented in bankruptcy. The transfer motion would be 

heard by the court no sooner than 24-hours after the filing (so as to permit 24-hour 

notification—I would propose—to the 20 largest holders of unsecured claims, the 

Federal Reserve Board, the FDIC, and the Secretary of the Treasury, and the primary financial regulatory authority—whether U.S. or foreign—with respect to any 

subsidiary whose ownership is proposed to be transferred to the bridge company). 

And, because the provisions must stay qualified financial contract termination (and 

related) rights (including those based on cross-defaults in nonbankruptcy subsidiaries) for a period to allow the transfer to the bridge company to be effective in a 

seamless fashion, the transfer decision essentially must be made within a designated period (e.g., 48 hours) after the filing. There should be conditions on the 

ability of the court to authorize the transfer to the bridge company—but conditions 

that can be satisfied by advanced planning (e.g., resolution plans) or otherwise determined within a very short timeframe. 

Many of the remaining provisions that I believe would need to be adopted as well 

would be designed to permit the successful transfer of assets, contracts, liabilities, 

rights, licenses, and permits—of both the holding company and of the subsidiaries— 

to the bridge company. 

First, there are provisions applicable to debts, executory contracts, and unexpired 

leases, including qualified financial contracts. Conceptually, the goal of these provisions would be to keep operating assets and liabilities ‘‘in place’’ so that they can 

be transferred to the bridge company (within a 48-hour window) and, thereafter, remain ‘‘in place’’ so that ‘‘business as usual’’ can be picked up the bridge company 

and its operating subsidiaries once it assumes the assets and liabilities. This requires overriding ‘‘ipso facto’’ clauses (of the type that would otherwise permit termination or modification based on the commencement of a bankruptcy case or similar 

circumstance, including credit-rating agency ratings, whether in the holding company or in its operating subsidiaries), 32 and it requires overriding similar provisions 

allowing for termination or modification based on a change of control, again whether 

in the holding company or in its operating subsidiaries, since the ownership of the 

bridge company will be different than the ownership of the debtor prior to the bankruptcy filing. These provisions need to be broader than Section 365 of the Bankruptcy Code, for at least two reasons. First, perhaps because of the limited scope 

of the original ‘‘purpose’’ of Section 363, bankruptcy doesn’t have a provision expressly allowing for the ‘‘transfer’’ of debt (although many debts are in fact transferred as a matter of existing practice under Chapter 11 ‘‘going concern sales’’). Unlike executory contracts, which might be viewed as net assets (and thus something 

to ‘‘assume’’) or as net liabilities (and thus something to ‘‘reject’’), debt is generally 

considered breached and accelerated (think ‘‘rejected’’) upon the filing of a petition 

in bankruptcy. 33 But, if there is going to be a two-step recapitalization, the bridge 

company needs to take the liabilities it would assume ‘‘as if nothing happened.’’ 

Thus, provisions designed to accomplish that need to be included. Second, Section 

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34 Although ex post damage remedies should then be available for what was judicially determined to be an improper filing. See Kenneth Scott, supra note 24, at 9–10. 35See, e.g., FDIC SPoE, supra note 6, p. 76617 (‘‘The FDIC would retain control over certain 

high-level key matters of the bridge financial company’s governance, including approval rights 

for . . . capital transactions in excess of established thresholds; asset transfers or sales in excess 

of established thresholds; merger, consolidation or reorganization of the bridge financial company; any changes in directors of the bridge financial company (with the FDIC retaining the 

right to remove, at its discretion, any or all directors); any distribution of dividends; any equity 

based compensation plans . . . . Additional controls may be imposed by the FDIC as appropriate.’’). 

365 doesn’t deal with change-of-control provisions; amendments need to add that 

and extend it to debt agreements as well. 

With respect to qualified financial contracts, there should be provisions in addition to those just mentioned. The stay on termination, offset, and net out rights 

should apply for the period from the filing until the transfer occurs, it is clear it 

won’t occur, or 48 hours have passed. Because of this interregnum, when there is 

a likelihood that the transfer will be approved, and all of these qualified financial 

contracts (and related guarantees, if any) go over ‘‘in their original form’’ to the 

bridge company, there is a requirement that the debtor and its subsidiaries shall 

continue to perform payment and delivery obligations. Conversely, because the 

counterparty may not know for sure what the outcome will be during this interregnum, there is a provision that the counterparty may promptly ‘‘cure’’ any 

unperformed payment or delivery obligations after the transfer. 

Just as the principle of having the bridge company have the same rights, assets, 

and liabilities drive the provisions regarding debts, executory contracts, and unexpired leases just discussed (including qualified financial contracts), a similar provision is necessary to keep licenses, permits, and registrations in place, and does not 

allow a Government to terminate or modify them based on an ‘‘ipso facto’’ clause 

or a transfer to a bridge company. 

There are many other considerations. For example, in addition to voluntary bankruptcy proceedings initiated by the SIFI holding company, should Government regulators (such as the FDIC or FRB) have the power, under specified conditions, to initiate a bankruptcy case, and should it doing so be contestable? I believe Government 

regulators should be able to commence such proceedings, and (because of the very 

narrow time window between the filing and the transfer to a bridge company) such 

commencements should not be contestable in advance. 34 But I can imagine a system 

in which the Government regulators could not place a SIFI holding company in 

bankruptcy, as they retain enormous powers, either to ‘‘induce’’ a so-called voluntary 

filing (as was the case in Lehman Brothers(, or to go directly to the initiation of 

an OLA proceeding under Title II of Dodd-Frank. While the issue needs to be decided, in my view, which way it is resolved is not integral to the integrity of the 

Bankruptcy Code or the proposed amendments I have discussed. Similarly, whether 

the proceedings should be in front of district judges, or bankruptcy judges, and 

whether the judges are from a pre-designated panel, are details that may be important in ensuring the effectiveness of a 24 hour transfer, but are not at the heart 

of the needed amendments. 

Conclusion 

While the details are many, the concept is simple. Through modest amendments 

to the Bankruptcy Code, expressly enabling it to effectuate a rapid two-step recapitalization from a SIFI holding company to a bridge company (by leaving long-term 

unsecured debt behind), it indeed can be considered the primary resolution vehicle 

for SIFIs, as envisioned by the Dodd-Frank Act, limiting the role of Title II—and 

therefore administrative-based resolution—to the cases, that almost inevitably may 

occur, where we cannot contemplate today the causes or contours of the next crisis, 

so that the FDIC’s inevitable discretion, compared to a judicial proceeding, becomes 

a virtue rather than a concern. 

Absent that (hopefully rare) need, however, I view the virtues of bankruptcy resolution over agency resolution to be several. First, the new company formed in the 

Section 363-like recapitalization sale (or transfer) is neither (a) subject to the jurisdiction of a bankruptcy court nor (b) subject to ‘‘control’’ by a Government agency, 

such as the FDIC, whereas the bridge company created in the SPoE process is effectively run, for a while at least, by the FDIC. 35 In this bankruptcy process, the 

bridge company, appropriately, faces market-discipline first and foremost; in Title 

II, there inevitably is a heavier layer of regulatory overlay and control. Second, and 

related, a bankruptcy process envisions at least the possibility that the market can 

determine the equity value of the new company (and thus the amount to be distributed to the creditors and old equity interests ‘‘left behind’’), whereas the FDIC’s 

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36FDIC SPoE, supra note 6, p. 76618 (‘‘the SPoE strategy provides for the payment of creditors’ claims in the receivership through the issuance of securities in a securities-for-claims exchange. This exchange involves the issuance and distribution of new debt, equity and, possibly, 

contingent securities . . . to the receiver. The receiver would then exchange the new debt and 

equity for the creditors’ claims . . . . Prior to the exchange of securities for claims, the FDIC 

would approve the value of the bridge financial company. The valuation would be performed by 

independent experts . . . selected by the board of directors of the bridge financial company. Selection of the bridge financial company’s independent experts would require the approval of the 

FDIC, and the FDIC would engage its own experts to review the work of these firms and to 

provide a fairness opinion.’’). 37Dodd-Frank Act §206(4) (the FDIC shall ‘‘ensure that management responsible for the 

failed condition of the covered financial company is removed’’); see also Dodd-Frank Act §206(5) 

(similar provision for members of a board of directors). 38See FDIC SPoE, supra note 6, p. 76617 (‘‘As required by the statute, the FDIC would identify and remove management of the covered financial company who were responsible for its 

failed condition’’). 39See, e.g., FDIC SPoE, supra note 6, p. 76618 (in addition to identified categories, the FDIC 

retains ‘‘a limited ability to treat similarly situated creditors differently’’). 40Dodd-Frank Act §210(h)(10) (‘‘Notwithstanding any other provision of Federal or State law, 

a bridge financial company, its franchise, property, and income shall be exempt from all taxation 

now or hereafter imposed by the United States, by any territory, dependency, or possession 

thereof, or by any State, county, municipality, or local taxing authority’’). 

SPoE proposal relies on expert valuations for those distributions. 36 Third, because 

of language in the Dodd-Frank Act, 37 the FDIC may push on its own initiative for 

the replacement of management (i.e., not permit management of the former SIFI 

holding company take similar positions in the bridge company). 38 In the bankruptcy 

process, the Board of Directors, and management, of the newly created bridge-company, ideally, would be identified with the input both of the SIFI’s primary regulators as well as the beneficiaries of the transfer and, importantly, would be subject 

to the approval of the district court in an open and transparent process at the time 

of the transfer of the holding company’s assets and liabilities to the bridge company. 

Fourth, at various points, the FDIC has discretion that can amount to ex post priority determinations (such as whether liabilities other than predefined long-term 

unsecured debt gets transferred to the bridge company)—discretion that may be useful in extraordinary cases, but that is potentially a cause for undermining market 

confidence in the rule of law in other circumstances. 39 Fifth, Title II treats the 

bridge company created in an OLA under Title II as a Government entity, exempt 

from taxes; 40 I think that provision is a mistake, preferring the bridge company to 

its nonprotected competitors, and should not be replicated in any bankruptcy 

amendments, whose goal is to have the bridge company treated ‘‘just as’’ the holding 

company was before the two-entity recapitalization. Sixth, and (perhaps) finally, I 

am concerned—as I suspect the FDIC is as well—that the actual use of SPoE under 

Title II of the Dodd-Frank Act will be subject to ex post criticism and investigation. 

Bankruptcy, with appropriate amendments—and its underlying judicial process subject to the rule of law, is in a more robust position to ‘‘do the right thing’’ in terms 

of fairly addressing the consequences of financial failure without having it necessarily lead to economic failure. 

I want to thank the Subcommittee for allowing me this opportunity to present my 

views. It is an honor to appear before you today. I would of course be delighted to 

answer any questions you may have about my testimony. 

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1 Also a member of the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory 

Committee, the Office of Financial Research’s Research Advisory Committee, and the Systemic 

Risk Council (created and chaired by Sheila Bair). All the views expressed here are mine alone. 

Underlined text indicates links to supplementary material; to see this, please access an electronic version of this document, e.g., at http://BaselineScenario.com. For important disclosures, 

see http://baselinescenario.com/about/. 

2See Gary Stern and Ron Feldman, ‘‘Too Big To Fail: The Hazards of Bank Bailouts’’, Brookings Institution Press, 2004. 3See Andrew Ross Sorkin, ‘‘Too Big To Fail: The Inside Story of How Wall Street and Washington Fought To Save the Financial System—And Themselves’’, Viking, 2009. The assets and 

liabilities of Lehman Brothers were just over $600 billion, about 4 percent of U.S. GDP. 4For a recent comprehensive and accurate assessment, see ‘‘The Cost of the Crisis: $20 Trillion and Counting’’, a report by Better Markets, July 2015. Massive Government assistance was 

provided to big banks and some other parts of the financial sector but not generally to the nonfinancial sector—and hardly at all to families who owed more on their mortgages than their 

homes were worth. 5See Section 204, creating the Orderly Liquidation Authority, and all related parts of Title 

II. 

PREPARED STATEMENT OF SIMON JOHNSON 

RONALD A. KURTZ PROFESSOR OF ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF

MANAGEMENT

JULY 29, 2015 

Main Points 

1. Some financial sector firms have become so large and so complex that handling 

any potential insolvency through standard bankruptcy procedures is difficult 

and costly. The precise distribution of losses across creditors and counterparties is hard to predict, often with unforeseen consequences around the globe. 

Such bankruptcy events can therefore have major destabilizing effects on financial markets and the real economy in the U.S. and internationally. 1

2. The systemic risks posed by the failure of large complex financial institutions 

have been understood for several decades—and use of the term ‘‘too big to fail’’ 

in this context dates back at least to the 1980s. 2 But in mid-September 2008 

the U.S. authorities took the view that the failure of Lehman Brothers could 

be handled through the bankruptcy courts and might even have a cathartic effect on the financial system. Within 24 hours of Lehman’s bankruptcy, the 

leadership at the Treasury Department and the Federal Reserve Board of Governors realized that this was most definitely not the case—the negative spillover effects of Lehman’s bankruptcy on the U.S. and global economies were 

huge. 3

3. Lehman’s bankruptcy led directly to the U.S. Government’s bailout of AIG, a 

large insurance company, and to the unprecedented support provided to money 

market mutual funds. When this failed to stabilize the system, Goldman Sachs 

and Morgan Stanley were allowed to become bank holding companies, which 

increased their access to Federal Reserve support. The Troubled Asset Relief 

Program (TARP) was rushed through Congress and quickly became the largest 

injection of capital into private financial firms in the history of the United 

States. Additional unprecedented bailouts were provided to Citigroup in November 2008 and to Bank of America in January 2009. Further statements of 

guarantee were provided by top officials in February 2009, and a stress test 

process—assuring market participants that the Government believed leading 

banks had enough loss-absorbing equity—was conducted in spring 2009. 

4. These and related enormous forms of selective Government support were not 

sufficient to prevent the most serious recession since the 1930s from which, 

after 7 years, the U.S. economy is still struggling to recover. 4

5. There has long been a ‘‘resolution’’ process, run by the Federal Deposit Insurance Corporation (FDIC), that handles the insolvency of banks that have insured retail (i.e., small-scale) deposits. For over 70 years, the FDIC has protected insured depositors and not incurred any liability for taxpayers. Shareholders are often wiped out and bondholders face losses in FDIC resolution, in 

accordance with well-defined and transparent criteria. However, prior to 2010, 

this FDIC procedure could only be applied to banks with insured deposits. 

6. In July 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Title II of this Act created an Orderly Liquidation Authority that essentially broadened the mandate and powers of the FDIC to include the resolution of nonbank financial companies. 5

7. However, this power is intended only as a back-up, in case bankruptcy is determined—by the Secretary of the Treasury, with the Federal Reserve and the 

130 

6See ‘‘A Progress Report on the Resolution of Systemically Important Financial Institutions’’, 

speech by Martin J. Gruenberg, chairman of the FDIC; May 12, 2015. Mr. Gruenberg makes 

it clear that the single point of entry is only one option for the FDIC’s approach to resolution. 7See ‘‘A Dialogue on the Costs and Benefits of Automatic Stays for Derivatives and Repurchase Agreements’’, by Darrell Duffie and David A. Skeel, University of Pennsylvania Law 

School, January 2012. 8This stay is supported by the International Swaps and Derivatives Association (ISDA) Resolution Stay Protocol, but the coverage of this is still incomplete—it currently only includes major 

banks, not ‘‘buy side’’ investors. 9The FDIC and the Bank of England have a memorandum of understanding on resolutionrelated issues; this would likely not apply if a large complex financial institution were to file 

for bankruptcy. 10This push is being led by the Financial Stability Board but it almost certainly represents 

a European attitude towards how to handle financial distress. Given that the European authorities are much more comfortable with continuing some version of Too Big To Fail—and providing 

bailouts to creditors under a wide variety of circumstances—it is most unwise to follow their 

lead on this matter. 11See the December 2014 edition of The Global Capital Index, produced by Thomas Hoenig, 

vice chairman of the FDIC. Mr. Hoenig converts U.S. GAAP accounts to their International Financial Reporting Standards (IFRS) equivalent, as this better reflects the risks inherent in derivative positions. The new reporting of risk exposures to the Fed (on FR Y-15) produces numbers that are similar to those of Mr. Hoenig. For example, in Mr. Hoenig’s index, the largest 

bank in the world at the end of 2014 was JPMorgan Chase, with a balance sheet of $3.827 trillion (under IFRS); on its FR Y-15, JPMorgan Chase states its total risk exposure as $3.743 trillion. 

FDIC—to be infeasible or likely to cause unacceptable levels of collateral damage. Titles I and II of Dodd-Frank make it clear that all firms should be able 

to go bankrupt—and the point of the ‘‘living wills’’ process is to force firms to 

change in order to become resolvable through bankruptcy. (More on the difficulties of bankruptcy is in Section B below.) 

8. Since 2010, the FDIC has developed a resolution strategy for large complex financial institutions in which there is likely to be single point of entry in the 

resolution of any group of firms under a bank holding company. 6 In this strategy, shareholders in the holding company would be wiped out (if the losses are 

large enough) and debt would be converted to equity—in order to recapitalize 

a new enterprise as a going concern, presumably without the activities that incurred the devastating losses. There would be a one day stay on creditors of 

all kinds. 7 There are also moves to end the automatic termination of derivative 

contracts in the event of resolution. 8 This is intended to give the FDIC time 

to complete the resolution process—and to allow operating subsidiaries to continue in business. 

9. Repealing Title II of Dodd-Frank would be a mistake. Title II is a backstop, 

in case bankruptcy proves infeasible (see Section C below). Title II creates a 

clear mandate for advance planning for private sector firms and for officials, 

and makes it possible to create a structure for cross-border cooperation on resolution. 9

10. At the same time, we should recognize that: 

a. Title I of Dodd-Frank requires credible living wills, in which firms would be 

able to fail through bankruptcy. We are a long way from having satisfactory 

living wills. Officials need to press harder on this front; more on this in Section C below. 

b. The largest and most complex financial firms need to become much simpler 

and, most likely, smaller in order for either bankruptcy to work (as required 

under Title I) or for the FDIC’s single point of entry strategy to work (if Title 

II powers are used). 

c. The FDIC’s primary resolution strategy relies on there being enough ‘‘lossabsorbing capital’’ at the holding company level. But only equity is really 

loss-absorbing. ‘‘Loss-absorbing debt’’ is an oxymoron—when creditors suffer 

major losses on a mark-to-market basis, there is real potential for a systemic 

panic, particularly as other related assets will be immediately reduced in 

value. 

d. We should be very concerned about the current international push towards 

a Total Loss Absorbing Capacity (TLAC) approach for bank holding companies. 10 We currently have only 4–5 percent equity (and 95–96 percent debt) 

in our largest bank holding companies. 11 Resolution as designed by the 

FDIC will likely not work in this scenario—the losses imposed on creditors 

will have serious systemic effects. Bankruptcy would be even more of a disaster. The result could easily be some new form of Government-sponsored 

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12The Federal Reserve is moving capital requirements in the right direction, including with 

a higher requirement for loss-absorbing equity in the largest firms. But, as Mr. Hoenig’s Global 

Capital Index shows, these buffers against losses remain very small relative to true risk exposures. For the integrated and persuasive case for higher capital requirements, see Anat Admati 

and Martin Hellwig, ‘‘The Bankers’ New Clothes: What’s Wrong With Banking and What To Do 

About It’’, Princeton University Press, 2013. 

bailout, through the Federal Reserve or through new powers granted by Congress (as happened in September 2008). It is imperative that officials move 

to greatly increase loss-absorbing equity in the largest, most complex financial firms (see Section D below). 12

The Problem With Bankruptcy 

There are two variants of the ‘‘bankruptcy-only’’ proposal. In both approaches, 

Title II of Dodd-Frank would be repealed—so the FDIC could not be involved in the 

failure of any bank holding company (or any financial firm, other than a bank with 

retail deposits). 

In the first variant, the bankruptcy code would be modified, for example to grant 

the kind of automatic stay now available only under FDIC resolution, but there 

would be no debtor-in-possession financing provided by the Government. 

The problem with this scenario is that it would be very difficult for a bankruptcy 

judge to enable any part of the financial firm to continue in business. The bankruptcy would be akin to complete liquidation or winding down, as was the case with 

Lehman Brothers. The losses to creditors in this scenario are large while the precise 

incidence of losses would take many years to determine fully. Under such an approach, the failure of a large complex financial institution would most likely result 

in chaos, along the lines experienced in September 2008. 

In the second bankruptcy-only variant, proponents argue that debtor-in-possession 

financing should be provided by the Government—precisely because the private sector is highly unlikely to provide the scale of funding needed. To make this more palatable, this kind of funding is sometimes referred as a ‘‘liquidity’’ loan. 

But providing large scale funding from the Government to a bankruptcy judge is 

both a bad idea economically and politically infeasible. Judges lack the experience 

necessary to administer such loans. In all likelihood, this would become a form of 

bailout that keeps existing management in place. To support a large complex financial institution, the scale of loans involved—from the Treasury or the Federal Reserve—would be in the tens of billions of dollars (in today’s prices) and there would 

be a very real possibility of taxpayer losses. The extent of executive branch engagement and congressional oversight would be limited. Most likely there would be both 

scope for both genuine concern and a dangerous broader collapse of legitimacy. 

It makes sense to examine ways to improve the bankruptcy code to make it easier 

for financial firms fail through bankruptcy—and this is completely consistent with 

making Title I of Dodd-Frank more effective. But any threats to rely solely on bankruptcy for the largest, most complex, and massively global firms are simply not credible. This would be the same kind of tactics that the Treasury resorted to under 

Hank Paulson in 2008—until the policy was dramatically reversed after the bankruptcy of Lehman Brothers. It was that reversal under President George W. Bush 

and President Barack Obama that created the modern expansive version of Too Big 

To Fail that haunts us still. 

Bankruptcy cannot work for the largest and most complex banks at their current 

scale and level of complexity. This is not a viable option under current law for the 

largest bank holding companies with their current scale and structure, even if the 

law is tweaked to allow for a longer stay on creditors. And changing the law more 

dramatically to add a bailout component (or ‘‘Government-backed liquidity loans’’) 

to bankruptcy procedures—but only for very large complex financial institutions— 

would not lead to good outcomes. 

Bankruptcy and Living Wills 

Under current law—and as a matter of common sense—the Federal Reserve now 

needs to take the lead in forcing large complex financial institutions to become 

smaller and simpler. 

The legal authority for such action is clear. Under section 165 of the 2010 DoddFrank financial reform legislation, large nonbank financial companies and big banks 

are required to create and update ‘‘the plan of such company for rapid and orderly 

resolution in the event of material financial distress or failure.’’ The intent is that 

this plan—known as a ‘‘living will’’—should explain how the company could go 

through bankruptcy (i.e., reorganization of its debts under Chapter 11 or liquidation 

under Chapter 7 of the Bankruptcy Code), without causing the kind of collateral 

damage that occurred after the failure of Lehman Brothers. 

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13Public portions of living wills are available on the FDIC Web site. Plans filed on July 1, 

2015, show some progress towards more disclosure. But there is nothing in the latest published 

living wills that suggests bankruptcy is currently a plausible approach to the potential failure 

of the largest bank holding companies. 14For a glimpse into the complexity of corporate structures across borders within individual 

large complex global financial firms, see the corporate network visualizations available at 

https://opencorporates.com (e.g., for Goldman Sachs). As one global regulator reportedly has 

said, large banks live globally but die locally—so any bankruptcy (or resolution) has to sort out 

a myriad of intertwined obligations across multiple jurisdictions. 15 Although it must be pointed out that Citigroup’s total risk exposure at the end of 2014 was 

$2.766 trillion, substantially larger than the number mentioned by the official, who must have 

been thinking only about on-balance sheet assets. One lesson from the experience of 2007–08 

and from the data now reported in FR Y-15 (Banking Organization Systemic Risk Reports, required by Dodd-Frank) is that we should think more in terms of total risk exposure. 16For a discussion of what would happen if global banks fail post-Dodd-Frank, see Marc 

Jarsulic and Simon Johnson, ‘‘How a Big Bank Failure Could Unfold’’, NYT.com, Economix blog, 

May 23, 2013. 

This bankruptcy should not involve any Government support. It is supposed to 

work for these large financial companies just like it works for any company, with 

a bankruptcy judge supervising the treatment of creditors. Existing equity holders 

are typically ‘‘wiped out’’—meaning the value of their claims is reduced to zero. 

The full details of these living wills are secret—known only to the companies and 

to the regulators. 13 But based on the publicly available information these living 

wills are not currently credible because the big banks remain incredibly complex, 

with cross-border operations, and a web of interlocking activities. 14 When one piece 

fails, this triggers cross-defaults, the seizure of assets around the world by various 

authorities, and enormous confusion regarding who will be paid what. All of these 

effects are exacerbated by the fact that these firms are also highly leveraged, with 

much of this debt structured in a complex fashion (including through derivatives). 

What then are the implications? The Dodd-Frank Act has some specific language 

about what happens if ‘‘the resolution plan of a nonbank financial company supervised by the Board of Governors or a bank holding company described in subsection 

(a) is not credible or would not facilitate an orderly resolution of the company’’. 

Not unreasonably, under section 165 of Dodd-Frank, the Fed and the FDIC, ‘‘may 

jointly impose more stringent capital, leverage, or liquidity requirements, or restrictions on the growth, activities, or operations of the company, or any subsidiary 

thereof, until such time as the company resubmits a plan that remedies the deficiencies.’’ 

The company may also be required, ‘‘to divest certain assets or operations identified by the Board of Governors and the Corporation, to facilitate an orderly resolution.’’ 

Some supporters of the big banks argue in favor of skipping bankruptcy and go 

directly to Title II resolution. But this Title II (of Dodd-Frank) authority is intended 

as a back-up—only to be used if, contrary to expectations, bankruptcy does not work 

or chaos threatens. 

As it is currently obvious that bankruptcy cannot work, the legislative intent is 

clear. The Fed and the FDIC must require significant remedial action, meaning that 

something about the size, structure, and strategy of the megabanks must change 

and these changes must be sufficient to allow bankruptcy (without massive systemic 

damage) to become a real possibility. 

Global Issues and the Need for Additional Capital Requirements 

Writing in the March 29, 2011, edition of the National Journal, Michael Hirsch 

quotes a ‘‘senior Federal Reserve Board regulator’’ as saying: 

‘‘Citibank is a $1.8 trillion company, in 171 countries with 550 clearance 

and settlement systems,’’ and, ‘‘We think we’re going to effectively resolve 

that using Dodd-Frank? Good luck!’’ 

This regulator has a point. 15 The FDIC can close small- and medium-sized banks 

in an orderly manner, protecting depositors while imposing losses on shareholders 

and even senior creditors. But it is a stretch to argue that such a resolution authority will definitely ‘‘work’’—i.e., prevent spillover systemic damage and negative impact on the real economy—for any failing large bank with significant cross-border 

operations. 

The resolution authority granted under Dodd-Frank is purely domestic, i.e., it applies only within the United States. 16 The U.S. Congress cannot make laws that 

apply in other countries—a cross-border resolution authority would require either 

a treaty-level agreement between the various Governments involved or some sort of 

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17The Memorandum of Understanding between the FDIC and the Bank of England is helpful 

in this regard but unlikely to prove sufficient to eliminate significant cross-border difficulties 

in the event of the failure of a large complex financial institution. This understanding also only 

applies in the case of FDIC resolution; it would not apply in the event of bankruptcy (i.e., without FDIC involvement). 18Senators Sherrod Brown and David Vitter have proposed a scale for capital requirements, 

with greater focus on the leverage ratio (i.e., less value attached to the importance of riskweights), that would increase steeply for the largest and most complex financial institutions. 

This is a promising approach that deserves further legislative and regulatory attention. Given 

the issues with bankruptcy and resolution, discouraging scale and complexity makes sense. For 

further discussion, see Simon Johnson and James Kwak, 13 Bankers, Pantheon, 2010. 

synchronization for the relevant parts of commercial bankruptcy codes and procedures. 

There are no indications that such treaties will be negotiated—or that there are 

serious inter-governmental efforts underway to create any kind of cross-border resolution authority, for example, within the G20. 17

The best approach for the United States today would be to make all financial institutions small enough and simple enough so they can fail—i.e., go bankrupt—without adversely affecting the rest of the financial sector. The failures of CIT Group 

in fall 2009 and MF Global towards the end of 2011 are, in this sense, encouraging 

examples. But the balance sheets of these institutions were much smaller—about 

$80 billion and $40 billion, respectively—than those of the financial firms currently 

regarded as Too Big To Fail. 

To the extent that the authorities are unwilling or unable to make some banks 

smaller and simpler, they should substantially increase the required amount of lossabsorbing equity for those firms. 18 Concerns about complexities associated with the 

failure of cross-border operations also strengthen the case for higher capital requirements (in the form of loss-absorbing equity, not an illusory TLAC requirement). 

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ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

LETTER FROM THE NATIONAL BANKRUPTCY CONFERENCE 

SUBMITTED BY SENATOR MERKLEY 

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