The South Bay Law Firm Law Blog highlights developing trends in bankruptcy law and practice. Our aim is to provide general commentary on this evolving practice specialty.
 





 
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • March 2014
  • September 2013
  • July 2013
  • June 2013
  • February 2012
  • January 2012
  • December 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • November 2010
  • October 2010
  • September 2010
  • August 2010
  • July 2010
  • June 2010
  • May 2010
  • April 2010
  • March 2010
  • February 2010
  • January 2010
  • December 2009
  • November 2009
  • October 2009
  • September 2009
  • August 2009
  • July 2009
  • June 2009
  • May 2009
  • April 2009
  • March 2009
  • February 2009
  • January 2009
  • December 2008
  • November 2008
  •  
      RSS
    Comments RSS
    Log in
       
      Insolvency News and Analysis - Week Ending November 21, 2014
    Auto Draft
    Auto Draft
    Auto Draft
       

    Why Banks Aren’t In Bankruptcy

    Recent federal assistance to the banking sector has focused attention on how failing banks are regulated – and why.  From the University of Virginia School of Law, professors Richard M. Hynes and Steven D. Walt visit this issue in their recent article entitled “Why Banks Are Not Allowed in Bankruptcy.”

    Here’s the article – and the authors’ abstract:

    Unlike most other countries, the United States uses different procedures to resolve insolvent banks and non-bank firms. When non-bank firms file for bankruptcy, the Bankruptcy Code divides control among the various claimants and a judge supervises the resolution process. By contrast, the FDIC acts as the receiver for an insolvent bank and has almost complete control. Other claimants can sue the FDIC, but they cannot obtain injunctive relief, and their damages are limited to the amount that they would have received in liquidation. The FDIC has acted as the receiver of insolvent banks since the Great Depression, and the concentration of power in the FDIC is traditionally justified by two arguments: i) the need for a timely disposition of the bank’s assets to maintain the liquidity of deposits and encourage faith in the banking system, and ii) the FDIC’s role as the largest creditor gives it an incentive to maximize the recovery from the assets. We revisit these arguments in light of the dramatic changes that have occurred in banking and ask whether they still (or ever did) justify FDIC control. We suggest that the first argument fails because it conflates the need for a timely satisfaction of the claims of insured depositors by the FDIC with the need to quickly dispose of the failed bank’s assets. As stated, the second argument does not justify FDIC control as one must generally ask whether the largest creditor will take actions that are harmful to the other claimants on the failed firm’s assets. However, if modified the second argument is much more persuasive. A detailed survey of the capital structure of failed banks reveals that the FDIC is usually the only major creditor and that the value of the FDIC’s claim nearly always exceeds the value of a failed bank’s assets. The FDIC is therefore the residual claimant and has the incentive to make the right decisions in disposing of the bank’s assets. We question whether this principle can justify recent proposals to extend FDIC control over the resolution of large bank holding companies. We further note that this principle limits the circumstances in which the FDIC should retain control over the resolution of the banks themselves. Four limits are considered: i) capital structure is endogenous – the absence of claims junior to the FDIC may reflect the lack of voice given to these claimants in a bank resolution process, ii) agency costs internal to the FDIC may prevent the FDIC from maximizing the recovery from the failed bank’s assets, iii) the FDIC may not be the residual claimant of extremely large banks with complex liability structures, and iv) debt conversion schemes which allow for automatic financial restructuring of a failed bank may render bank resolution procedures less necessary. The Article argues that these limits do not justify removing the FDIC from control in resolving most bank failures.

    Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

    Leave a Reply