What Would Happen if a Big Bank Failed?

Ever wonder what the failure of a too-big-to-fail global financial firm, say Bank of America, for example, would look liked under Dodd-Frank?

It could be a mess, according to Seton Hall University Professor Stephen J. Lubben in a new paper, which you can read here. Lubben, a law professor, looks at how Dodd Frank’s Orderly Liquidation Authority, a new insolvency regime created to address the limitations of bankruptcy law, would resolve—that is take over, sell off and wind down—Bank of America.

It’s all hypothetical, of course, and Bank of America declined to comment. But Lubben’s paper raises some serious questions about whether the new regime will be up to the task of resolving an institution like Bank of America, whose $2.3 trillion in assets dwarfs Lehman’s $713 billion, which still ranks as the biggest bankruptcy in history.

The OLA gives the Federal Deposit Insurance Corp. the type of receivership powers for “systemically important financial institutions” it has long exercised to manage failed depository banks, but Lubben says a financial colossus like Bank of America, with more than 600 subsidiaries sprinkled around the globe, looks far different than a domestic bank. The lack of a “global focus” is one of the key drawbacks of the old bankruptcy law and isn’t adequately addressed by the new authority, according to the paper.

Michael Krimminger, general counsel of the FDIC, which would do much of the heavy lifting under the OLA, says Lubben is missing the point.

“He has something of a misconception of what the Orderly Liquidation Authority is designed to do,” said Krimminger in an interview Thursday.

Krimminger says the OLA isn’t designed to create an immediate liquidation but to maintain the systemically important operations of the company in order to prevent the financial contagion from spreading. You can read the latest on the FDIC’s resolution strategy here. You can view how the FDIC would handle the cross-border conflicts  here.

Lubben, a well-respected academic who also writes a column for the New York Time’s DealBook blog, and Krimminger have a bit of a history. Their tussle was part of a broader split between those reformers with experience in banking versus bankruptcy practitioners.

The paper also makes clear that Lubben isn’t a proponent of “tweaking” the Bankruptcy Code to resolve a systemically important financial institution. That position, dubbed Chapter 14 and proposed by the free-market-oriented Resolution Project at Stanford University’s Hoover Institution, is unworkable, he says.

“Part of the problem is I’m the skunk at the garden party, no one likes what I’m saying on either side,” said Lubben in an interview. “You have to acknowledge the pure bankruptcy, free-market solution doesn’t work with respect to a large financial institution.”