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Sunday, May 9, 2010

More on Chapter 11F

My column published last Monday May 3 in the Wall Street JournalHow to Avoid a ‘Bailout Bill’” generated a lot of questions about the idea of a "Chapter 11F," which I argued is a needed alternative to bailouts. Chapter 11F is a proposed modification or addition to Chapter 11 of the bankruptcy code. It would allow large non-bank financial firms to go through bankruptcy in an orderly and predictable way and thereby minimize disruptions to the financial markets and the economy. Currently there are several different versions of a Chapter 11F, but they all have the common theme of relying more on the bankruptcy law rather than on a new discretionary liquidation or resolution authority or on bailouts. By relying more on the rule of law, the reorganization or liquidation process would be more predictable.

The proposals differ in four main ways: (1) in the type of financial institutions to be covered—most versions do not apply to depository institutions, which would continue to be resolved by the FDIC, (2) in whether or not a regulatory agency could file an involuntary bankruptcy petition for a financial firm, (3) in whether or not the government would be able to provide debtor-in-possession financing, and (4) in whether or not derivatives and repos continue to be exempt from the automatic stay. The last of these is the trickiest of all.

One version of Chapter 11F was put forth by Tom Jackson, the bankruptcy expert from the University of Rochester, in a chapter of the book Ending Government Bailouts As We Know Them. Another version is already in legislative language as a possible amendment to the Dodd Bill filed by Senator Sessions, ranking member of the Judiciary Committee; this version would add another chapter (Chapter 14) to the bankruptcy code, analogous to Chapter 9 for municipalities. Yet another version has been put forth by the Pew Task Force on Financial Reform; it tries to combine resolution authority and bankruptcy. The most recent version is being developed by the Resolution Project, which is part of the Working Group on Economic Policy at Stanford’s Hoover Institution, in which Tom Jackson is a key participant along with other authors (including me) of Ending Government Bailouts As We Know Them.

It is very promising that so many people are now working on these important ideas. I hope that the financial reform legislation now moving through Congress incorporates at least some of the ideas before it becomes law.