In defense of bailouts

Georgetown Law Journal

Volumn 99, Issue 2, 2011, Pages 435-514

  Levitin, Adam J ^a  

^a GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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EID: 79956127904     PISSN: 00168092     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (467)

1. E.g., Lehman Brothers, New Century Financial, CIT Group, and the holding companies for IndyMac andWashington Mutual.
2. E.g., General Motors and Chrysler.
3. E.g., IndyMac Federal Savings Bank and Washington Mutual Federal Savings Bank. The FDIC utilizes three separate methods to resolve failed depositary institutions. See, e.g., David A. Skeel, Jr., The Law and Finance of Bank and Insurance Insolvency Regulation, 76 TEX. L. REV. 723, 767-68 (1998) (discussing liquidations, third-party sales, and reorganizations).
4. E.g., Countrywide Financial,Wachovia, and Morgan Stanley.
5. E.g., Bear Stearns.
6. E.g., American Insurance Group (AIG).
7. Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, § 1117, 122 Stat. 2654 (codified at 12 U.S.C. § 1719(g)); Press Release, U.S. Dep't of the Treasury, Treasury Issues Update on Status of Support for Housing Programs (Dec. 24, 2009) (updated Jan. 5, 2010), available at http://www.financialstability.gov/latest/pr-1052010b.html.
8. Bailout Recipients, PROPUBLICA, http://bailout.propublica.org/main/list/ index (last visited Aug. 21, 2010). The TARP was created under the Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, §§ 101-102, 122 Stat. 3765 (2008).
9. See, e.g., DAVID E. LEWIS, PRESIDENTS AND THE POLITICS OF AGENCY DESIGN: POLITICAL INSULATION IN THE UNITED STATES GOVERNMENT BUREAUCRACY, 1946-1997, at 188 (2003).
10. See, e.g., Adam Nagourney, Bracing for a Bailout Backlash, N.Y. TIMES, Mar. 16, 2009, at A1 (discussing Obama administration concern about a bailout backlash);
11. Mary Williams Walsh, Drawing Fire, Geithner Backs Rescue of A.I.G., N.Y. TIMES, Jan. 28, 2010, at A3 (detailing congressional flaying of Treasury Secretary Timothy Geithner for his role in the AIG bailout).
12. See Emre Deliveli, How Far Will Greek Contagion Spread?, FORBES.COM (Feb. 25, 2010), http://www.forbes.com/2010/02/25/balkans-greece-turkey-opinion- contributors-emre-deliveli-print. html (noting potential for Greece's economic distress to spread throughout Europe);
13. Paul Krugman, Op-Ed., The Big Squander, N.Y. TIMES, Nov. 19, 2009, at A35.
14. U.S. TREASURY DEP'T, FINANCIAL REGULATORY REFORM: A NEW FOUNDATION 21-27 (2009) [hereinafter TREASURY WHITE PAPER];
15. see also Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376, Tit. I & II (2010).
16. Witness the European Union effectively flouting its anti-bailout law, Consolidated Version of the Treaty on the Functioning of the European Union art. 125, Mar. 30, 2010, 2010 O.J. (C 83) 99, by structuring the bailout of Greece through bilateral loans coordinated by the EU, rather than made by the EU.
17. See generally JON ELSTER, ULYSSES AND THE SIRENS: STUDIES IN RATIONALITY AND IRRATIONALITY 36-111 (1988);
18. JON ELSTER, ULYSSES UNBOUND: STUDIES IN RATIONALITY, PRECOMMITMENTS AND CONSTRAINTS 88-174 (2000).
19. See, e.g., Kenneth Ayotte & David A. Skeel, Jr., Bankruptcy or Bailouts?, 35 J. CORP. L. 469 (2010) (considering bankruptcy versus bailouts solely for companies that are currently eligible to file for bankruptcy);
20. Cheryl D. Block, Overt and Covert Bailouts: Developing a Public Bailout Policy, 67 IND. L.J. 951, 968-72 (1992) (distinguishing between overt bailouts that take the form of direct assistance via loans and guarantees and covert bailouts via tax breaks, trade restrictions, tariffs, and quotas, and distinguishing between bailouts and general government subsidies on the basis of bailouts focusing on saving particular firms from collapse, rather than support of industries or economic sectors);
21. Steven M. Davidoff & David T. Zaring, Regulation by Deal: The Government's Response to the Financial Crisis, 61 ADMIN. L. REV. 463 (2009) (discussing the government's response to several pending bankruptcies during the most recent financial crisis);
22. Anna Gelpern, Financial Crisis Containment, 41 CONN. L. REV. 1051 (2009) (arguing that financial crisis containment is distinct from regulation, crisis prevention, and resolution and that it involves a standard set of choices);
23. Erik F. Gerding, The Subprime Crisis and the Link Between Consumer Financial Protection and Systemic Risk, 4 FIU L. REV. 435 (2009) (arguing that consumer protection has a systemic risk prevention role);
24. Ronald J. Mann, A Requiem for Sam's Bank, 83 CHI.-KENT L. REV. 953 (2008) (discussing systemic risk posed by payment systems);
25. Edward R. Morrison, Is the Bankruptcy Code an Adequate Mechanism for Resolving the Distress of Systemically Important Institutions?, 82 TEMP. L. REV. 449, 450 (2009) (arguing that bankruptcy provides inadequate tools for dealing with the resolution of systemically significant financial institutions);
26. Karl S. Okamoto, After the Bailout: Regulating Systemic Moral Hazard, 57 UCLA L. REV. 183 (2009);
27. Steven L. Schwarcz, Systemic Risk, 97 GEO. L.J. 193 (2009) (attempting to define systemic risk and potential regulatory responses). Professor Block's work is notable as the only theoretical work on bailouts that I have been able to identify that predates the current crisis. Unfortunately, it appears to have gone nearly unnoticed despite being an extremely perceptive taxonomic article noting that bailouts are part of the same genus as subsidies and cataloging varieties of bailouts.
28. See, e.g., MILTON FRIEDMAN, A PROGRAM FOR MONETARY STABILITY 37-38 (1960);
29. CHARLES P. KINDLEBERGER & ROBERT ALIBER, MANIAS, PANICS, AND CRASHES: A HISTORY OF FINANCIAL CRISES 231 (2005);
30. Viral V. Acharya, A Theory of Systemic Risk and Design of Prudential Bank Regulation, 5 J. FIN. STABILITY 224 (2009);
31. Stanley Fischer, On the Need for an International Lender of Last Resort, 13 J. ECON. PERSP. 85 (1999);
32. Xavier Freixas et al., The Lender of Last Resort: A Twenty-first Century Approach, 2 J. EUR. ECON. ASS'N 1085 (2004);
33. Xavier Freixas et al., Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank, 32 J. MONEY, CREDIT & BANKING 611 (2000);
34. Guillermo Rosas, Bagehot or Bailout? An Analysis of Government Responses to Banking Crises, 50 AM. J. POL. SCI. 175 (2006);
35. Anna J. Schwartz, The Lender of Last Resort and the Federal Safety Net, 1 J. FIN. SERVS. RES. 77 (1987);
36. Robert M. Solow, On the Lender of Last Resort, in FINANCIAL CRISES: THEORY, HISTORY, AND POLICY (Charles P. Kindleberger & Jean-Pierre Laffargue eds., 1982);
37. Lawrence H. Summers, Planning for the Next Financial Crisis, in THE RISK OF ECONOMIC CRISIS 135 (Martin Feldstein ed., 1991);
38. George G. Kaufman, Lender of Last Resort: A Contemporary Perspective (Fed. Reserve Bank of Dallas, Research Paper No. 9008, 1990).
39. See, e.g., Charles M. Kahn & João A.C. Santos, Allocating Bank Regulatory Powers: Lenders of Last Resort, Deposit Insurance, and Supervision, 49 EUR. ECON. REV. 2107 (2005) (modeling whether a single regulator will handle bank financial distress better than multiple regulators);
40. Rob Nijskens & Sylvester C. W. Eijffinger, The Lender of Last Resort: Liquidity Provision Versus the Possibility of Bail-Out (European Banking Center Discussion Paper No. 2010-02), at 20 (modeling whether a central bank or a fiscal authority is the better entity to handle financial crises);
41. Jorge Ponce, Who Should Decide on Emergency Liquidity Assistance, VOX (Jan. 16, 2010), http://www.voxeu.com/index. php?q=node/4494 (considering the trade-off between central banks and deposit insurers as emergency liquidity providers).
42. See Summers, supra note 16, at 136 (summarizing approaches to defining the lender of last resort).
43. Finance theory sometimes employs the term "systematic risk" to refer to market risk that is not specific to an individual firm and for which an investor will not price a firm-specific risk premium.
44. See, e.g., GROUP OF TEN, REPORT ON CONSOLIDATION IN THE FINANCIAL SECTOR 126 (2001) [hereinafter G-10 REPORT ON FINANCIAL SECTOR CONSOLIDATION] ("Systemic financial risk is the risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is serious enough to quite probably have significant adverse effects on the real economy.");
45. Viral V. Acharya et al., Regulating Systemic Risk, in RESTORING FINANCIAL STABILITY: HOW TO REPAIR A FAILED SYSTEM 174, 174 (Viral V. Acharya & Matthew Richardson eds., 2009) (defining systemic risk as the risk that the failure and distress of a significant part of the financial sector reduces the availability of credit, which in turn may adversely affect the real economy);
46. Matthew L. Beville et al., An Information Market Proposal for Regulating Systemic Risk, 12 U. PA. J. BUS. L. (forthcoming 2010) (systemic risk is the financial risk imposed on firms without the ability to contract away their exposure);
47. James Bullard et al., Systemic Risk and the Financial Crisis: A Primer, 91 FED. RES. BANK ST. LOUIS REV. 403, 403 (2009) (systemic risk is the possibility that an event, such as the failure of an individual firm, will seriously impair other firms or markets and harm the broader economy);
48. Prasanna Gai et al., Systemic Risk in Modern Financial Systems: Analytics and Policy Design, 8 J. RISK FIN. 156, 156 (2007) (defining systemic risk as the risk over and above those naturally priced and managed by financial intermediaries themselves, threatening the effective functioning of the financial system as a whole and the economy more broadly);
49. Jean Helwege, Financial Firm Bankruptcy and Systemic Risk, REGULATION, Summer 2009, 24, 24 ("Systemic risk is the risk that the financial system will fail to function properly because of widespread distress.");
50. George G. Kaufman, Bank Failures, Systemic Risk, and Bank Regulation, 16 CATO J. 17, 20 n.5 (1996) (quoting Alan Greenspan, Remarks at a Conference on Risk Measurement and Systemic Risk, Board of Governors of the Federal Reserve System (Nov. 16, 1995)), available at http://www.cato.org/pubs/journal/ cj16n1/cj16n1-2.pdf;
51. George G. Kaufman & Kenneth E. Scott, What is Systemic Risk, and Do Bank Regulators Retard or Contribute to It, 7 INDEP. REV. 371, 371 (2003) (defining systemic risk as "the risk or probability of breakdowns in an entire system, as opposed to breakdowns in individual parts or components");
52. Paul Kupiec & David Nickerson, Assessing Systemic Risk Exposure from Banks and GSEs Under Alternative Approaches to Capital Regulation, 28 J. REAL EST. FIN. & ECON. 123, 123 (2004) (defining systemic risk as "the potential for a modest economic shock to induce substantial volatility in asset prices, significant reductions in corporate liquidity, potential bankruptcies and efficiency losses");
53. Frederic S. Mishkin, Comment on Systemic Risk, 7 RES. FIN. SERVS. PRIV. & PUB. POL'Y 31, 32 (1995) (systemic risk is "the likelihood of a sudden, usually unexpected, event that disrupts information in financial markets, making them unable to effectively channel funds to those parties with the most productive investment opportunities");
54. Schwarcz, supra note 15, at 204 (defining systemic risk as "the risk that (i) an economic shock such as market or institutional failure triggers (through a panic or otherwise) either (X) the failure of a chain of markets or institutions or (Y) a chain of significant losses to financial institutions, (ii) resulting in increases in the cost of capital or decreases in its availability, often evidenced by substantial financial-market price volatility.");
55. Gianni De Nicoló & Myron L. Kwast, Systemic Risk and Financial Consolidation: Are They Related? 4 (IMF, Working Paper No. WP/02/55, 2002) (systemic risk is "the risk that an event (shock) will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is large enough to, in all probability, have significant adverse effects on the real economy");
56. Darryll Hendricks, Defining Systemic Risk 1-2 (Pew Fin. Reform Project, Briefing Paper No. 1, 2009), available at http://www.pewfr.org/admin/project- reports/files/PTF-Note-1-Defining-Systemic-Risk-TFCorrection. pdf ("The essence of a systemic risk is a risk that something bad happens in the financial system that is a good deal bigger and worse than the failure of any single institution.");
57. Charles Taylor, Managing Systemic Risks 2-3 (Pew Fin. Reform Project, Briefing Paper No. 11, 2009), available at http://www.pewfr.org/admin/project- reports/files/Managing-Systemic-Risks-Final.pdf ("'[A] systemic risk is a risk that an event will trigger a loss of confidence in a substantial portion of the financial system that is serious enough to have adverse consequences for the real economy.'" (quoting Hendricks, supra));
58. Peter J. Wallison, The Argument Against a Government Resolution Authority 6 (Pew Fin. Reform Project, Briefing Paper No. 4, 2009), available at http://www.pewfr.org/admin/task-force-reports/files/Wallison-resolution-final- TF-Correction.pdf ("[T]he term 'systemic risk' (what precedes a systemic breakdown) usually refers to the possibility that the failure of a single large firm will cause the failure of others through a contagion-like process in which a cascade of losses flows through an economy.");
59. Hal S. Scott, The Reduction of Risk in the United States Financial System, 33 HARV. J. L. & PUB. POL'Y 671, 673 (2010) (systemic risk is "the risk that the failure of one significant financial institution can cause or significantly contribute to the failure of other significant financial institutions, through the linkages of financial institutions to each other. Systemic risk can also be defined to include the possibility that one exogenous shock may simultaneously cause or contribute to the failure of multiple significant financial institutions.").
60. Schwarcz, supra note 15, at 204.
61. Hendricks, supra note 20.
62. G-10 REPORT ON FINANCIAL SECTOR CONSOLIDATION, supra note 20, at 125;
63. see also Taylor, supra note 20.
64. E. Gerald Corrigan, The Risk of a Financial Crisis, in THE RISK OF ECONOMIC CRISIS, supra note 16, at 44-45.
65. Kupiec & Nickerson, supra note 20, at 123.
66. Schwarcz, supra note 15, at 204.
67. There have been a number of attempts by economists to devise measures and models for systemic risk. These attempts include, by necessity, a definition or conception of systemic risk, often restricted to financial institutions. Whatever the relative merits of these attempts, they can only succeed to the extent of their definition of systemic risk, and their predictive value is unknown. Indeed, if the financial crisis of 2007-2009 has any lessons, it is that financial modeling is very much an art, rather than a science, and a developing one at that. See, e.g., IMF, GLOBAL FINANCIAL STABILITY REPORT: RESPONDING TO THE FINANCIAL CRISIS AND MEASURING SYSTEMIC RISKS 111-43 (2009), available at http://www.imf.org/external/pubs/ft/gfsr/2009/01/index.htm;
68. Franklin Allen & Douglas Gale, Financial Contagion, 108 J. POL. ECON. 1 (2000);
69. Sylvester C.W. Eijffinger, Defining and Measuring Systemic Risk, BANKING & FIN., Jan. 2010, at 44-49;
70. Alfred Lehar, Measuring Systemic Risk: A Risk Management Approach, 29 J. BANKING & FIN. 2577, 2588-98 (2005);
71. John B. Taylor, Defining Systemic Risk Operationally, in ENDING GOVERNMENT BAILOUTS AS WE KNOW THEM (Kenneth E. Scott et al. eds., 2010);
72. Stefano Battiston et al., Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk (Nat'l Bureau of Econ. Research, Working Paper No. 15611, 2009);
73. Monica Billio et al., Measuring Systemic Risk in the Finance and Insurance Sectors 7-9 (MIT Sloan, Research Paper No. 4774-10, 2010), available at http://ssrn.com/abstract=1571277;
74. Xin Huang et al., Assessing the Systemic Risk of a Heterogeneous Portfolio of Banks During the Recent Financial Crisis (Fed. Reserve Fin. & Econ. Discussion Series, No. 2009-44, 2009) (discussing price insurance against systemic risk using CDS prices and correlations);
75. Xin Huang et al., A Framework for Assessing the Systemic Risk of Major Financial Institutions (BIS Working Paper, No. 281, 2008). References and further reading may be available for this article. To view references and further reading you must purchase this article. Tobias Adrian & Markus Brunnermeier, Fed. Reserve Bank of N.Y. & Princeton University, CoVaR: Measuring Systemic Risk Contribution, Presentation at 3rd Unicredit Conference on Banking and Finance (Dec. 17-18, 2009) (proposing using the change in value at risk in a system conditional on a bank default to measure systemic risk);
76. Viral V. Acharya et al., Measuring Systemic Risk (Mar. 16, 2010) (unpublished manuscript), available at http://ssrn.com/abstract=1573171 (proposing using equity prices to measure joint probability of default).
77. Corrigan, supra note 24, at 44-45.
78. Summers, supra note 16, at 137.
79. See, e.g., RONALD J. MANN, PAYMENT SYSTEMS AND OTHER FINANCIAL TRANSACTIONS 271-72 (2008) (discussing "system-failure" risk for CHIPS, the Clearing House Interbank Payment System used for dollar-denominated international wire-transfers);
80. see also David L. Mengle, Regulatory Solutions to Payment System Risks: Lessons from Privately Negotiated Derivatives, 9 J. FIN. SERVS. RESEARCH 187, 187 (1995) ("Payment system risks were the 'major minor' banking policy issue of the 1980s.").
81. See Paul A. Volcker, Financial Crises and the Macroeconomy, in THE RISK OF ECONOMIC CRISIS, supra note 16, at 174, 177-78.
82. Professors Kenneth Ayotte and David A. Skeel, Jr. argue that bankruptcy is the best method for dealing with a broader range of financial and nonfinancial institutions.
83. See Ayotte & Skeel, supra note 15, at 471, 498.
84. Ayotte and Skeel's approach is based on the "theoretical tools from the corporate finance literature," which leads them to concentrate on aspects of the bankruptcy/bailout trade-off other than the political economy.
85. Id. at 471.
86. Although the efficiency issues highlighted by corporate finance theory are important, this Article argues that the choice between bankruptcy or bailout is not made on efficiency grounds, but is driven by political economy concerns that reflect social valuations of factors like economic stability and employment that are not typically accounted for in corporate finance theory's efficiency calculus.
87. See generally ANTHONY DOWNS, AN ECONOMIC THEORY OF DEMOCRACY (1957) (presenting expanded median voter theory);
88. Duncan Black, On the Rationale of Group Decision-Making, 56 J. POL. ECON. 23 (1948) (originating the median voter theorem). A second justification exists for using the median voter as the metric.
89. Economist Robert M. Solow has argued that financial stability is a public good because it is non-rival and non-excludable.
90. Solow, supra note 16, at 241. If the median voter believes that there is systemic risk, the value of financial stability as a public good is being diminished for more people than not. While they may not value the good equivalently, it is an indication that economic harms outweigh economic benefits.
91. The median voter is likely a woman. Women constitute 51.5% of the U.S. voting age population. U.S. Census Bureau, Current Population Survey, 2008, Table 1, Population by Age and Sex: 2008, available at http://www.census.gov/ population/socdemo/gender/2008gender-table1.xls; Author's Calculations.
92. Regulators, in particular, often have superior information, but better information that is incomplete can result in misdiagnoses of problems and misapplication of solutions.
93. See, e.g., DAVID WESSEL, IN FED WE TRUST: BEN BERNANKE'S WAR ON THE GREAT PANIC 220 (2009) (noting that then-New York Federal Reserve President Timothy Geithner objected to FDIC Chairwoman Sheila Bair's decision to take over Washington Mutual and not guarantee its unsecured debt);
94. Damian Paletta & Deborah Solomon, Geithner Vents as Overhaul Stumbles, WALL ST. J., Aug. 4, 2009, at A1.
95. WESSEL, supra note 36, at 272.
96. Id. at 273-74.
97. Id. at 274.
98. Id. at 188-89.
99. See 1 FDIC, HISTORY OF THE EIGHTIES-LESSONS FOR THE FUTURE 175 n.21 (1997).
100. Id. at 174-75.
101. See PETER J. COUGHLIN, PROBABALISTIC VOTING THEORY 20-23 (1992).
102. The United States electoral system does not facilitate median voter responsiveness in presidential elections because of the Electoral College. Staggered Senate elections mute that body's median voter responsiveness. House elections are more median voter responsive, although gerrymandering reduces this responsiveness. This Article does not attempt to take these very real considerations into account because they are larger questions about the nature of the American political system and the key point in this Article about political responsiveness.
103. See G-10 REPORT ON FINANCIAL SECTOR CONSOLIDATION, supra note 20, at 126;
104. Schwarcz, supra note 15, at 204;
105. Kaufman, Bank Failures, Systemic Risk, and Bank Regulation, supra note 20, at 17 n.1, 20;
106. Larry H. P. Lang & René Stulz, Contagion and Competitive Intra-industry Effects of Bankruptcy Announcements, 32 J. FIN. ECON. 45, 46 (1992) (showing that bankruptcy filings can have both contagion and competitive effects on other firms in the same industry).
107. See, e.g., Schwarcz, supra note 15, at 204.
108. See Christopher Edley, Jr., Op-Ed., Let Treasury Rescue the States, N.Y. TIMES, July 8, 2010, at A25 (arguing that the government's failure to treat states as macroeconomic players contributed to the slow pace of recovery).
109. See Oversight of the Federal Government's Intervention at American International Group: Hearing Before the H. Comm. on Fin. Servs., 111th Cong. 12 (2009) (statement of Ben S. Bernanke, Chairman of the Bd. of Governors of the Fed. Reserve Sys.) ("Conceivably, [AIG's] failure could have resulted in a 1930's-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.").
110. A test case for this is the 1975 bailout of New York City by the federal government. See Last-Minute Bailout of a City on the Brink, TIME, Dec. 8, 1975.
111. Irvine H. Sprauge, Financial Risks & Crises, in THE RISK OF ECONOMIC CRISIS, supra note 16, at 53, 57 ("'It would be a great intellectual exercise [to let Continental Illinois National Bank collapse]. We could finally know whether or not the domino theory is true and whether the collapse of a money-center bank would destroy the economy of the nation.'").
112. To be sure, there are arguably counter-examples where there was no intervention even in situations that reasonably raised systemic risk concerns, such as Long Term Capital Management, Lehman Brothers, the Russian debt crisis, and the Argentine debt crisis. These examples show that TBTF treatment is very much a product of political climates, rather than a quantifiable measure of risk.
113. It is possible to expand the set of default resolution regimes to include large financial firms other than banks. But as Part III explains, doing so does not escape the reality that the applicable regime will be honored only so long as it produces acceptable distributional outcomes.
114. Because the priority system is preset, however, voluntary creditors have some ability to account for bankruptcy risk through their transaction terms.
115. TREASURY WHITE PAPER, supra note 12, at 3.
116. See The Lockheed Bailout Battle, TIME, Aug. 9, 1971.
117. See James Ledbetter, Lockheed Was NOT the First Bailout, THEBIGMONEY.COM (Nov. 10, 2009, 11:24 AM), http://www.thebigmoney.com/articles/history-lesson/ 2009/11/10/lockheed-was-not-firstbailout.
118. Charles W. Calomiris, Is the Discount Window Necessary? A Penn Central Perspective, 76 FED. RESERVE BANK OF ST. L. REV. 31, 37-38 (1994).
119. See Volcker, supra note 31, at 174, 176;
120. see also Dusan Stojanovic & Mark. D. Vaughan, The Commercial Paper Market: Who's Minding the Shop, The Regional Economist, Fed. Reserve Bank of St. L., Apr. 1998.
121. William Poole, Macroeconomic Effects of Financial Crises, in THE RISK OF ECONOMIC CRISIS, supra note 16, at 170, 172-73.
122. See Adam J. Levitin, Payment Wars: The Merchant-Bank Struggle for Control of Payment Systems, 12 STAN. J.L. BUS. & FIN. 425, 453-54 (2007) (discussing the relationship between Target and Target National Bank).
123. See D. B. Humphrey, Payments Finality and Risk of Settlement Failure, in TECHNOLOGY AND THE REGULATION OF FINANCIAL MARKETS: SECURITIES, FUTURES, AND BANKING 97, 97 (Anthony Saunders & Lawrence J. White eds., 1986) (the failure of the banks with the largest settlement obligations would produce a disruptive system-wide effect in the United States). A clearinghouse serves as an exchange for banks submitting payment, securities or options trade claims to each other. The banks maintain accounts at the clearinghouse, which are credited and debited depending on whether they are paying or receiving payment.
124. See MANN, supra note 30, at 55-56.
125. Typically there are numerous payment transactions going both directions between any given pair of clearinghouse member banks. Some clearinghouses will only accept transactions when they are satisfied that the paying institution has sufficient funds in its clearinghouse account to pay. Others, however, allow institutions to overdraw on their accounts, based on the expectation that future transactions will replenish the account or that the institution will do so with its own funds at the end of the business day. Because these overdrafts must be cured by the end of the day, they are called "daylight overdrafts." If a bank were to fail when it had a daylight overdraft, the clearinghouse would be exposed to the loss. While it is unlikely that a single institution's inability to honor a daylight overdraft would result in the failure of a clearinghouse, it is more than a theoretical possibility. The collapse in 1974 of Herstatt, a German bank, nearly brought about the failure of CHIPS, a wire transfer system that does the bulk of international, interbank dollar-denominated transfers.
126. JERRY W. MARKHAM, A FINANCIAL HISTORY OF THE UNITED STATES: FROM THE AGE OF DERIVATIVES INTO THE NEW MILLENNIUM (1970-2001), at 20 (2002). Many clearinghouses restrict daylight overdrafts or penalize them.
127. See MANN, supra note 30, at 240 (describing daylight overdrafts on the FedWire system);
128. id. at 271-72 (discussing system risk in the wire transfer system and noting that one major clearinghouse system, CHIPS, is a private institution without central bank support for "the approximately $1.4 trillion that it transfers each day").
129. Clearinghouses often require members to post some form of collateral or margin account and also generally have a right to call on members for additional capital contributions if necessary. Regarding clearinghouses generally, see Craig Pirrong, OTC Derivatives Clearing and the Prevention of the Next Crisis: A Contrarian View (Feb. 15, 2010) (unpublished paper), available at http://www. law.columbia.edu/null/download?&exclusive=filemgr.download&file-id= 154777.
130. Jean Helwege argues that counterparty contagion is not a major risk for national banks because they are limited by 12 U.S.C. § 84(a) to lending no more than 15% of their capital to any single counterparty. See Jean Helwege, Financial Firm Bankruptcy and Systemic Risk, 32 REG. 24 (2009) (distinguishing between counterparty contagion and information contagion). This analysis ignores the fact that both banks and their counterparties are usually leveraged, which can make even limited losses catastrophic. For example, if a bank has $8 in equity for every $100 in assets, then if the value of those assets declines by more than 8%, the bank will be insolvent. Given that many of those assets are either loans or investments, such a decline in value is quite possible. Similarly, even a delay in repayment can itself be problematic because of liquidity constraints. Moreover, the prerequisite for a bank run is not a bank's actual inability to repay its obligations in a timely fashion, but only a perception that the bank might not be able to repay on time.
131. See MERRILL LYNCH & CO., QUARTERLY REPORT (FORM 10-Q) 6-7 (June 27, 2008), available at http://www.sec.gov/Archives/edgar/data/65100/ 000095012308008850/y64172e10vq.htm#102.
132. Id.
133. Markus Brunnermeier et al., The Fundamental Principles of Financial Regulation, in 11 GENEVA REPORTS ON THE WORLD ECON. 17 (2009). Brunnermeier also notes that "[t]he domino model of contagion has been examined in numerous simulation studies conducted at central banks, but the universal conclusion has been that the impact of the domino model of contagion is very small. It is only with implausibly large shocks that the simulations generate any meaningful contagion."
134. Id. at 16.
135. Jón Steinsson, When All the Banks Failed, 3 ECON. COLUM. (Columbia Univ.), Spring 2009, at 4, 4;
136. Thráinn Eggertsson, Professor of Econ., Ice. Sch. Of Bus., Univ. of Ice., and Global Distinguished Professor of Politics, N.Y.U. & Tryggvi Thor Herbertsson, Professor of Econ., Univ. of Reykjavík, and Member of Parliament, System Failure in Iceland and the 2008 Global Financial Crisis, Paper Presented at the 13th Annual Conference of the International Society for New Institutional Economics 22 (June 18-20, 2009).
137. See FEDERAL FINANCIAL SUPERVISORY AUTHORITY (BUNDESANSTALT FÜR FINANZDIENSTLEISTUNGSAUFSICHT (BAFIN)), 2008 ANNUAL REPORT 117-18, http://www.bafin.de/cln-179/nn-992932/SharedDocs/ Downloads/EN/Service/ Jahresberichte/2008/annualreport-08-kap5.html (last visited Dec. 1, 2010). The collapse of HRE Group also appears to have had an element of obligor contagion. HRE Group's Irish subsidiary, Depfa, had large exposures to Lehman. Germany's KfW, Hypo Real Estate Post Heavy Losses, DEUTSCHEWELLE (Nov. 17, 2008), http://www.dw-world.de/dw/article/0,3799955,00.html.
138. Anna Gelpern & Adam J. Levitin, Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage-Backed Securities, 82 S. CAL. L. REV. 1075, 1081-83 (2009).
139. Often a CDO's contingent obligation on a CDS would be collateralized, so that if the CDO were unable to pay, its counterparty could look to the collateral for a recovery. Not all CDS obligations are collateralized, however. See TARP Accountability: Use of Federal Assistance by the First TARP Recipients: Hearing Before the H. Fin. Servs. Comm., 111th Cong. 47-48 (2009) (testimony of Lloyd C. Blankfein, Chief Executive Officer and Chairman, Goldman Sachs & Co.) ("[W]ith respect to our dealings with AIG, we were always fully collateralized and had de minimis or no credit risk at any given moment because we exchanged collateral. So we had outstanding positions, as did most people, but we had no credit exposure because we had collateral from them and in some cases other kind of credit mitigants . . . . Sometimes the collateral would lag [the exposures], and we would also take out credit insurance against their exposure.").
140. Christine Seib, Banking Contagion Costs Alliance & Leicester £1.2bn, TIMES (London), Sept. 18, 2007.
141. Nouriel Roubini, If Lehman Collapses Expect a Run on All of the Other Broker Dealers and the Collapse of the Shadow Banking System, RGE MONITOR (Sept. 13, 2008), http://www.roubini.com/roubinimonitor/253567/if-lehman-collapses- expect-a-run-on-all-of-the-other-broker-dealers-and-the-collapse-of-the-shadow- banking-system.
142. Ingimundur Fririksson, The Banking Crisis in Iceland in 2008, at 5 (Feb. 26, 2009) (unpublished paper), available at http://www.bis.org/review/r090226d. pdf.
143. Id.
144. Id.
145. see also Iceland Learns a Brutal Lesson, W. MORNING NEWS (Plymouth, U.K.), Oct. 13, 2008, at 11 (£4 billion figure).
146. See Lang & Stulz, supra note 45, at 46-47.
147. Hawaiian Airlines, Midway Airlines, Sun Country Airlines, United Airlines, US Airways, and Vanguard Airlines all filed for bankruptcy within approximately two years of September 11, 2001. U.S. Airline Bankruptcies & Service Cessations, AIR TRANSPORT ASS'N OF AM., http://www.airlines.org/ economics/specialtopics/USAirlineBankruptcies.htm (last visited Fed. 24, 2010).
148. Air Transportation Safety and System Stabilization Act, Pub. L. No. 107-42, 115 Stat. 230, Sept. 22, 2001, codified at 49 U.S.C. § 40101 (2006).
149. Vikas Bajaj, Rate Agencies Move Toward Downgrading Some Mortgage Bonds, N.Y. TIMES, July 11, 2007, at C1;
150. Bonnie Sinnock, S&P Downgrades Thousands of MBS Deals to Default Level, NAT'L MORTG. NEWS, Feb. 16, 2009.
151. See Brunnermeier et al., supra note 66, at 14-19.
152. Press Release, The White House, President Obama Calls for New Restrictions on Size and Scope of Financial Institutions To Rein in Excesses and Protect Taxpayers (Jan. 21, 2010), available at http://www.whitehouse.gov/the- press-office/president-obama-calls-new-restrictions-size-and-scopefinancial- institutions-rein-e. But see Paul Davis, Tax Will Mean Little Change at Big Banks, AM. BANKER, Jan. 15, 2010 (arguing that proposed tax on bigness or leverage will have little impact).
153. Press Release, The White House, supra note 81.
154. See Lucian A. Bebchuk & Holger Spamann, Regulating Bankers' Pay, 98 GEO. L.J. 247, 252 (2010);
155. Sanjai Bhagat & Roberta Romano, Reforming Executive Compensation: Focusing and Committing to the Long-Term, 26 YALE J. ON REG. 359, 361 (2009);
156. Frederick Tung, Pay for Banker Performance: Structuring Executive Compensation for Risk Regulation (Feb. 8, 2010) (unpublished manuscript), available at http://ssrn.com/abstarct=1546229.
157. See infra section III.C.
158. Alice Rivlin, Systemic Risk and the Role of the Federal Reserve (Pew Financial Reform Project, Briefing Paper No. 2, 2009), available at http://www.pewfr.org/admin/project-reports/files/Rivlin-Final-TF-Correction-2. pdf.
159. See infra section II.E.
160. See infra section II.D.
161. KINDLEBERGER & ALIBER, supra note 16, at 1.
162. See William W. Bratton & Michael L. Wachter, The Case Against Shareholder Empowerment, 158 U. PA. L. REV. 653, 675-88 (2010).
163. Id. at 658-59.
164. See Taylor, supra note 20, at 3.
165. See, e.g., Too Big To Fail: The Role for Bankruptcy and Antitrust Law in Financial Regulation Reform: Hearing Before the H. Judiciary Subcomm. on Commercial and Admin. Law, 111th Cong. 105-27 (2009) [hereinafter Too Big To Fail] (statement of Christopher L. Sagers, Associate Professor of Law, Cleveland State University) (antitrust regulation); id. at 140-56 (2009) (statement of Robert Weissman, President, Public Citizen) (antitrust regulation); Brunnermeier et al., supra note 66, at 33 (capital charges and Pigouvian taxation); Davis Wessel, Three Theories on Solving the 'Too Big to Fail' Problem, WALL ST. J., Oct. 28, 2009, at A2 (view of Bank of England Governor Mervyn King and former Treasury Secretary George Schultz on reducing the size of banks); Simon Johnson, Bring In the Antitrust Division (On Banking), BASELINE SCENARIO (Apr. 16, 2009, 6:02 AM), http://baselinescenario. com/2009/04/16/bring-in-the-antitrust- division-on-banking/ (antitrust enforcement to reduce the size of large financial institutions).
166. Brunnermeier et al., supra note 66, at 33.
167. Roger W. Ferguson, Jr., Vice Chairman, Fed. Reserve Bd., Remarks at Vanderbilt University: September 11, the Federal Reserve, and the Financial System (Feb. 5, 2003) (transcript available at http://www.federalreserve.gov/ boarddocs/speeches/2003/20030205/default.htm).
168. See Douglas W. Diamond & Philip H. Dybvig, Bank Runs, Deposit Insurance, and Liquidity, 24 FED. RESERVE BANK OF MINNEAPOLIS Q. REV. 14, 15 (2000). The fall of 2008 did witness a run on traditional banks for uninsured deposits.
169. See Markus K. Brunnermeier, Deciphering the Liquidity and Credit Crunch 2007-2008, J. ECON. PERSP., Winter 2009, at 77, 90.
170. PAUL KRUGMAN, THE RETURN OF DEPRESSION ECONOMICS AND THE CRISIS OF 2008, at 158-59 (2009).
171. The collapse of the asset-backed commercial paper (ABCP) market in 2008 illustrates a similar problem. Commercial paper is a short-term debt obligation. Banks are required to hold specific levels of capital in relation to the loans they make (held as assets on their balance sheets). This means that the more loans a bank makes, the more capital it must hold. Raising capital is expensive because it dilutes equity (and hence return on equity). If a bank can sell the loans it holds for cash, however, it does not need to raise as much capital. In order to reduce capital requirements, many traditional financial institutions entered into structured transactions in which they sold loan assets to off-balance sheet subsidiaries they created. These off-balance sheet subsidiaries are called structured investment vehicles (SIVs), and are not subject to any legal capital requirements whatsoever. The SIVs pay for the loan assets by issuing commercial paper. The commercial paper is called asset-backed because it is collateralized by the specific pool of assets held by the SIV. The SIVs are known as ABCP conduits. Because the SIVs' assets have long-term maturities, but the SIVs' liabilities are short-term commercial paper, this arrangement only works as long as the SIVs are able to constantly refinance their ABCP. If demand for ABCP slumps, the SIVs face a liquidity crisis because they will be unable to pay off existing commercial paper obligations through refinancings, much less purchase additional loan assets from banks. ABCP conduits serve as a shadow banking system, and they too are vulnerable to runs. If ABCP buyers get spooked, then refinancings become difficult, and holders of ABCP scramble to sell their holdings, which causes the price of ABCP to drop, meaning SIVs must issue even more paper to refinance the same amount of debt. The result looks like a run, with the SIVs caught in an asset-liability duration mismatch. It only takes the failure of a couple of SIVs for the entire market to become skittish and fail.
172. KRUGMAN, supra note 96, at 158-61 (describing the failure of auction-rate securities).
173. ROGER LOWENSTEIN, WHEN GENIUS FAILED: THE RISE AND FALL OF LONG-TERM CAPITAL MANAGEMENT (2000) (describing market-wide panic triggered by the failure of Long-Term Capital Management, a hedge fund); Andrei Shleifer & Robert W. Vishny, The Limits of Arbitrage, 52 J. FIN. 35, 37 (1997) (noting the possibility of investor runs on hedge funds and mutual funds); Tom Sullivan, Better Disclosure, Courtesy of Madoff, BARRON'S, Jan. 26, 2009, at 45, 45 (noting the risk of investor runs on hedge funds via redemption requests).
174. Money market mutual funds are a subset of mutual funds that invest in high quality, liquid assets, such as commercial paper, short-term bonds, repo agreements, and shares of other money market mutual funds. See 17 C.F.R. § 270.2a-7 (2010) (regulating money market mutual funds and defining related terms).
175. Gary Gorton & Andrew Metrick, Haircuts 1 (Yale Int'l Ctr. for Fin., Working Paper No. 09-15, 2009), available at http://ssrn.com/abstract=1447438;
176. Gary Gorton & Andrew Metrick, Securitized Banking and the Run on Repo, at 0 (Yale Int'l Center for Fin., Working Paper No. 09-14, 2009), available at http://ssrn.com/abstract=1440752;
177. Gary Gorton, Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007, at 33-34 (Paper for the Federal Reserve Bank of Atlanta's 2009 Financial Markets Conference: Financial Innovation and Crisis, 2009), available at
178. CDS or TRS protection buyers can attempt to sell their coverage at a discount if they are worried about the ability of the protection seller to make good on its obligations. Similarly, they can demand that the protection seller post more collateral to cover the exposure. See Gretchen Morgenson & Louise Story, Testy Conflict With Goldman Helped Push A.I.G. to Precipice, N.Y. TIMES, Feb. 7, 2010, at A1 (detailing Goldman Sachs' demands for its CDS protection seller, AIG, to post additional collateral). Demands for additional collateral are tantamount to a run.
179. See Charles Calomiris, Editorial, In the World of Banks, Bigger Can Be Better, WALL ST. J., Oct. 20, 2009, at A21 (noting that banks benefit from economies of scale resulting in cheaper financial services, globally integrated capital markets, and the ability to supply financial intermediation on the scale needed by global corporations).
180. See generally Ross A. Hammond, Systemic Risk in the Financial System: Insights from Network Science 1 (Pew Fin. Reform Project, Briefing Paper No. 12, 2009), available at http://www.pewfr.org/admin/project-reports/files/EP- HammondNetworks-final-TF-Correction.pdf (discussing the role of networks in the financial crisis).
181. Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 308 (1976).
182. Susan M. Wachter et al., Bad and Good Securitization, 13 WHARTON REAL EST. REV., no. 2, Fall 2009, at 23, 23.
183. See Gretchen Morgenson, Future Bailouts of America, N.Y. TIMES, Feb. 14, 2010, at BU1 (quoting Professor Edward J. Kane saying that, "People talk about systemic risk, but they have no metric of measuring it").
184. See, e.g., Rivlin, supra note 85.
185. A systemic risk regulator would also suffer from the problem that it would be impossible to tell if it were doing its job well until and unless it failed. It would be impossible to determine if the regulator's actions headed off systemic risk or merely quashed innocent economic activity.
186. But see Equipping Financial Regulators with the Tools Necessary to Monitor Systemic Risk: Hearing Before the S. Banking Subcomm. on Sec. and Int'l Trade and Fin., 111th Cong. 4-5 (2010) (statement of Daniel K. Tarullo, member, Bd. of Governors of the Fed. Reserve Sys.).
187. See GROUP OF THIRTY, FINANCIAL REFORM: A FRAMEWORK FOR FINANCIAL STABILITY 28 (2009), available at http://www.group30.org/pubs/reformreport.pdf. Notably, the connection between proprietary trading and deposit-taking was not at the core of this crisis;
188. Paul Volcker, How to Reform Our Financial System, N.Y. TIMES, Jan. 31, 2010, at WK11.
189. See Raj Date, Through the Looking Glass (Steagall): Banks, Broker Dealers, and the Volcker Rule, CAMBRIDGE WINTER CENTER FOR FIN. INST. POL'Y (Jan. 27, 2010), http://www.cambridgewinter.org/Cambridge-Winter/Archives/ Entries/2010/1/27-THROUGH-THE-LOOKING-GLASS-(STEAGALL)-files/ looking-glass-steagall-012710-1.pdf (criticizing focus of Paul Volker's proposals as misplaced for failing to cover shadow banking).
190. Too Big To Fail, supra note 92, at 22 (testimony of Michael S. Barr, Assistant Secretary of the Treasury);
191. Richard Herring & Jacopo Carmassi, The Corporate Structure of International Financial Conglomerates: Complexity and Its Implications for Safety and Soundness, in OXFORD HANDBOOK OF BANKING 195, 226 (Allen N. Berger et al. eds., 2009);
192. Richard J. Herring, The Known, the Unknown, and the Unknowable in Financial Policy: An Application to the Subprime Crisis, 26 YALE J. ON REG. 391, 403-04 (2009);
193. see also Restoring American Financial Stability Act of 2010, S. 3217, 111th Cong. § 115(d)(1) (2010).
194. See Ron Feldman, Forcing Financial Institution Change Through Credible Recovery/ Resolution Plans: An Alternative to Plan-Now/Implement-Later Living Wills 1 (Fed. Reserve Bank of Minneapolis Econ. Pol'y Paper No. 10-2, 2010), available at http://www.minneapolisfed.org/pubs/eppapers/10-2/eppaper10-2-wills. pdf (noting that living wills are unlikely to work unless they are driven by bank supervisors);
195. Daniel K. Tarullo, Member, Bd. of Governors of the Fed. Reserve Sys., Supervising and Resolving Large Financial Institutions, Speech at the Institute of International Bankers Conference on Cross-Border Insolvency Issues (Nov. 10, 2009) (transcript available at http://www.federalreserve.gov/newsevents/speech/ tarullo20091110a.htm).
196. Gelpern & Levitin, supra note 69, at 1118-24 (discussing securitization structures as an example of contractual bankruptcy regimes).
197. Cf. Robert K. Rasmussen, Debtor's Choice: A Menu Approach to Corporate Bankruptcy, 71 TEX. L. REV. 51, 112 (1992) (discussing how in a contractual bankruptcy system, optimal structures may change over time).
198. See David Zaring, A Lack of Resolution, 60 EMORY L.J. 99 (2010).
199. Variously given as "Respica te, hominem te memento" or "Memento mori."
200. Too Big To Fail, supra note 92, at 3, 5 (testimony of Michael S. Barr, Assistant Secretary of the Treasury);
201. Taylor, supra note 20, at 6.
202. DANIEL K. TARULLO, BANKING ON BASEL: THE FUTURE OF INTERNATIONAL FINANCIAL REGULATION 29 (2008).
203. Id. at 19-20.
204. Id. at 21-22.
205. See, e.g., 12 C.F.R. Pt. 3, app. A (2010).
206. See, e.g., New York Financial Guarantee Company Law, NY CLS §§ 6901-6903 (2010). State insurance regulators' ability to regulate insurance companies' derivatives activities was preempted in 2000 by the Commodity Futures Modernization Act of 2000, which did not substitute an alternative system of federal regulation. See Commodity Futures Modernization Act of 2000, §§ 101(12) 105, 117, 407 (excluding covered bank swap agreements from CFTC jurisdiction), codified at 7 U.S.C. §§ (1a)(12) (definitions), 2(g) (exclusion of OTC swaps from federal regulation), 16(e)(2) (preemption of state law).
207. TARULLO, supra note 120, at 225-58 (discussing alternatives to Basel II capital adequacy regime for banks).
208. Schwarcz, supra note 15, at 222-23.
209. Id. at 223-24.
210. Brunnermeier et al., supra note 66, at 39-48;
211. Schwarcz, supra note 15, at 225-30.
212. TARULLO, supra note 120, at 231-45;
213. Douglas D. Evanoff, Preferred Sources of Market Discipline, 10 YALE J. ON REG. 347, 355 (1993); (Pubitemid 24821760)
214. Douglas D. Evanoff & Larry D. Wall, Subordinated Debt as Bank Capital: A Proposal for Regulatory Reform, 24 FED. RESERVE BANK OF CHIC. ECON. PERSP. 40 (2000);
215. Douglas D. Evanoff & Larry D. Wall, Subordinated Debt and Bank Capital Reform (Fed. Reserve Bank of ChicagoWorking Paper No. 2000-07) [hereinafter Bank Capital Reform].
216. Brunnermeier et al., supra note 66, at 36;
217. Squam Lake Working Group on Fin. Stability, An Expedited Resolution Mechanism for Distressed Financial Firms: Regulatory Hybrid Securities (Council on Foreign Relations, Center for Geoeconomic Studies Working Paper, April 2009), available at http://www.cfr.org/content/publications/attachments/Squam-Lake- Working-Paper3.pdf. These proposals have many resemblances to the automated bankruptcy proposal of Barry Adler that would feature "chameleon equity"-debt that automatically converts into equity upon the triggering of various financial conditions.
218. Barry E. Adler, Financial and Political Theories of American Corporate Bankruptcy, 45 STAN L. REV. 311, 312 (1993). A bank-specific variation of this can be found in Evanoff, supra note 129, at 359 (proposing that banks have mandatory subordinated debt in capital structure, which would convert to equity once the bank's capital fell to a trigger level).
219. See, e.g., 12 C.F.R. § 1.3 (2010) (limiting banks' single-firm exposures in investment securities).
220. Uninsured, wholesale depositors do have a monitoring incentive, but the market discipline imposed by depositors is primarily ex post and often comes in the form of a run. An example of this is the case of the 1984 failure of Continental Illinois National Bank, when uninsured depositors transferred out their funds as they became concerned with Continental Illinois's exposure to Mexican sovereign debt and Penn Square Bank participations. See TARULLO, supra note 120, at 37.
221. Evanoff & Wall, Bank Capital Reform, supra note 129, at 5.
222. See supra note 83 and accompanying text.
223. See, e.g., Jeffrey N. Gordon & Christopher Muller, Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management (Columbia Law and Econ. Research Paper No. 369, 2010), available at http://ssrn.com/ abstract=1553880 (proposing a $1 trillion bailout fund).
224. See infra section IV.B.
225. See Adam J. Levitin & Susan M. Wachter, Explaining the Housing Bubble, Aug. 31, 2010, University of Pennsylvania Institute for Law & Economics Research Paper No. 10-15, Georgetown Public Law Research Paper No. 10-60, Georgetown Law and Economics Research Paper No. 10-16, available at http://ssrn.com/abstract=1669401.
226. The form of the regulator is itself critical to its efficacy. Consider the Financial Stability Oversight Council (FSOC) created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. See infra section II.I for a discussion of the FSOC's structure. The FSOC arguably suffers from an organizational structure that dilutes responsibility and accountability while also being vulnerable to inaction. The two most important types of FSOC powers-designation of a nonbank financial company as systemically important, and therefore subject to prudential regulation by the Federal Reserve Board, and actions to mitigate systemic risk-both require a two-thirds majority vote (as well as the affirmative vote of its chairperson, the Secretary of the Treasury, in the first instance).
227. See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 113, 124 Stat. 1376, 1398 (2010) (to be codified at 12 U.S.C. § 5323). This structure means that the FSOC will act as a consensus body (seven of ten votes will be needed if all members are present), but it also means that a minority of regulators or the Treasury Secretary alone can block actions, and sets the stage for vote trading.
228. See Cheyenne Hopkins & Donna Borak, Is Systemic Risk Council "Set Up For Failure"?, AM. BANKER, Aug. 2, 2010, at 1.
229. See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, Titles I-II, 124 Stat. 1376, 1376-520 (2010).
230. See id. § 111 (to be codified at 12 U.S.C. §§ 5321, 5314).
231. See id. § 112 (to be codified at 12 U.S.C. § 5322).
232. See id. §§ 151-156 (to be codified at 12 U.S.C. §§ 5341-5342, 1833b, 5 U.S.C. §§ 3132, 5314, 12 U.S.C. §§ 5343-5344, 5346).
233. See id. § 155(d) (to be codified at 12 U.S.C. § 5345).
234. See id. §§ 112(a)(1)(B), 115, 124 Stat. 1376, 1395, 1403 (2010) (to be codified at 12 U.S.C. §§ 5322, 5325).
235. See id. § 121 (to be codified at 12 U.S.C. § 5331).
236. 12 U.S.C. §§ 1844-1850 (2006).
237. For a nonbank financial company to be covered, two-thirds of the FSOC, including the Treasury Secretary, must concur with a determination that "material financial distress" to the firm or "the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the U.S. nonbank financial company, could pose a threat to the financial stability of the United States." See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 113(a)(1), 124 Stat. 1376, 1410 (2010) (to be codified at 12 U.S.C. § 5331).
238. See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 165(b)(1)(A), (d)(6), 124 Stat. 1376, 1423 (2010) (to be codified at 12 U.S.C. § 5365) (nonbinding resolution plan).
239. See id. § 165(b)(1)(B) (to be codified at 12 U.S.C. § 5331).
240. See id. § 165(h)(1)-(2) (to be codified at 12 U.S.C. § 5365).
241. See id. § 165(i) (to be codified at 12 U.S.C. § 5365).
242. See id. § 166 (to be codified at 12 U.S.C. § 5366).
243. Dodd-Frank also imposes concentration limits on financial firms. See id. § 622 (to be codified at 12 U.S.C. § 1852) (imposing 10% concentration limit).
244. See id. § 619 (to be codified at 12 U.S.C. § 1851).
245. See id. § 165(b)(1)(A), (D)(6) (to be codified at 12 U.S.C. § 1851) (nonbinding resolution plan).
246. See id. § 952 (to be codified at 15 U.S.C. § 78j-3).
247. See id. §§ 953, 956 (to be codified at 15 U.S.C. §§ 78n, 791 Note, 5641).
248. See id. § 951 (to be codified at 15 U.S.C. § 78n-1).
249. See id. §§ 155(d), 210(n)-(o), 214 (to be codified at 12 U.S.C. §§ 5345, 5390, 5394).
250. See N. Gregory Mankiw, The Allocation of Credit and Financial Collapse, 101 Q. J. ECON. 455, 469 (1986) ("Historical examinations of financial markets . . . emphasize their propensity for instability and collapse.").
251. See generally Douglas G. Baird, The Uneasy Case for Corporate Reorganization, 15 J. LEG. STUDIES 127 (1986);
252. Thomas H. Jackson, Bankruptcy, Non-bankruptcy Entitlement, and the Creditors' Bargain, 91 YALE L.J. 857 (1982).
253. See Gelpern, supra note 15, at 1051.
254. Id. at 1055.
255. Id. at 1067-68.
256. See Ben S. Bernanke, Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression, 73 AM. ECON. REV. 257, 263 (1983).
257. Simon Johnson, The Quiet Coup, ATLANTIC, May 2009, at 46, 48.
258. Gelpern, supra note 15, at 1076-78.
259. Consider for example, the failure of AIG. When it became clear that AIG was unable to pay all of its obligations as they came due, creditors faced losses under the relevant default resolution systems (state insurance company resolution or bankruptcy depending on the entity within the AIG structure). Under the applicable default regime, some of the losses would have been allocated to Goldman Sachs and to Société Générale, among many others. AIG needed to post $4.1 billion in CDS collateral to Société Générale and $2.5 billion to Goldman Sachs, as well as make CDS payments of $6.9 billion and $5.6 billion, respectively. See AIG, Attachment A-Collateral Postings Under AIGFP CDS and Attachment B-Maiden Lane III Payments to AIGFP CDS Counterparties (2010), http://www.aig.com/ aigweb/internet/en/files/CounterpartyAttachments031809- tcm385-155645.pdf. If AIG had not been bailed out and losses had been imposed on Goldman and Générale, it could have set off another round of crises. This new round would not have been because of AIG, but because of the uncertainty as to Goldman and Générale's soundness; the market would have had to gauge whether Goldman and Générale could absorb the losses from AIG without themselves defaulting, and, if Goldman or Générale were to default, who would end up bearing the losses. Alternatively, if the method for resolution of AIG were not clear, it is uncertain how the losses at AIG would be allocated. In such a situation, not just Goldman or Générale, but also many other firms that dealt with or were suspected of dealing with AIG, would be anathema to the market, and this, in turn, could have second-order effects on their trading partners. The first situation is uncertainty from certainty, the later is uncertainty from uncertainty or panic. The first situation can ultimately be tamed but not the latter. Resolution systems enable the movement from the second situation to the first.
260. 11 U.S.C. §§ 701-06, 721-27, 741-53, 761-63, 765-67, 781-82, 784 (2006 & Supp. I 2007), 11 U.S.C.A. §§ 707, 764, 783 (West 2004 & Supp. 2010). The Securities Investor Protection Corporation (SIPC) has a right of intervention in stockbroker liquidations under Chapter 7. § 742.
261. See generally Daniel J. Morse, When a Securities Brokerage Goes Broke, 25 AM. BANKR. INST. J. 34 (2006).
262. §§ 1101-16, 1121-29, 1141-46, 1161-74 (2006 & Supp. I 2007). Small firms are sometimes also eligible for Chapter 13 bankruptcy or for state law assignments for the benefit of creditors or compositions.
263. 12 U.S.C. §§ 1811-12, 1814-16, 1819, 1820A, 1821A, 1825-27, 1828A-31n, 1831 p-1-31t, 1831v-33c, 1833f-35A (2006, Supp. I 2007 & Supp. II 2008); 12 U.S.C.A. §§ 1813, 1817-18, 1820, 1821, 1822-24, 1828, 1831o, 1831u, 1833e (West 2004 & Supp. 2010).
264. § 4617.
265. Because the priority system is preset, however, voluntary creditors have some ability to account for bankruptcy risk through their transaction terms.
266. There are occasional 100-cent bankruptcy cases, but they are by far the exception, and often the payment in full to creditors is due to changed circumstances (such as a leap in commodity prices). Even in 100-cent cases, however, creditors are not paid on time.
267. Additionally, a firm can be resolved through private ordering not involving government funds, including using state assignment for the benefit of creditor (ABC) laws. The leading example of this is the resolution of Long-Term Capital Management in 1998, which was a federally orchestrated, but entirely private, resolution. See LOWENSTEIN, supra note 99. The bailout of Chrysler in 1979 also has some aspects of a private ordering. Although the government authorized loan guarantees, they did not kick in until a private ordering of creditors was achieved. See Chrysler Corporation Loan Guarantee Act of 1979, Pub. L. 96-185 (1979) (decodified). On a different level, securitization using bankruptcyremote entities creates its own self-executing resolution scheme with senior-subordinate structures and (almost) no noncontractual creditors.
268. See Gelpern & Levitin, supra note 69, at 1121-24.
269. See Gelpern, supra note 15, at 1056 (identifying common patterns of crisis response).
270. 11 U.S.C. §§ 507, 725-726, 1129 (2006).
271. § 507.
272. 12 U.S.C. §§ 1815(e)(2)(C), 1821(d)(11) (2006).
273. Gelpern & Levitin, supra note 69, at 1121-24 (discussing bankruptcy as transparent political distribution in contrast to the private ordering of securitization).
274. See JOHN RAWLS, A THEORY OF JUSTICE 118-23 (1999) (explaining the concept of a veil of ignorance).
275. This is in no way to minimize the influence of interest groups in the routine creation of public policy.
276. See generally Rodgin Cohen & Morris Goldstein, The Case for an Orderly Resolution Regime for Systemically-Important Financial Institutions, THE PEW ECONOMIC POLICY GROUP: PROJECT REPORTS (Oct. 21, 2009), http://www.pewfr.org/admin/project-reports/files/Cohen-Goldstein-FINAL- TFCorrection.pdf;
277. see also Morrison, supra note 15, at 450 ("A systemic risk regulator is needed because a judicially administered process cannot move with sufficient speed and expertise in response to rapidly changing economic conditions.").
278. Sometimes lesser steps, such as moral suasion to encourage privately ordered resolutions, are attempted first. See supra note 175 and accompanying text.
279. Paul Krugman, Summary of Discussion, in THE RISK OF ECONOMIC CRISIS, supra note 16, at 179, 181.
280. But see Ayotte & Skeel, supra note 15 (arguing that there is a choice between bankruptcy and bailouts).
281. See, e.g., id.
282. Stephen J. Lubben, Systemic Risk & Chapter 11, 82 TEMP. L. REV. 433, 447 (2009) (arguing that Chapter 11 can be used to resolve systemically important firms and that "the fear of [C]hapter 11 is largely misguided and too often reflective of outdated notions of [C]hapter 11"); Mark J. Roe, The Derivative Market's Payment Priorities as Financial Crisis Accelerator, 63 STAN. L. REV. (forthcoming Mar. 2011), available at http://ssrn.com/abstract= 1567075 (arguing that derivatives safe harbors from bankruptcy automatic stay should be limited).
283. 11 U.S.C. § 362(b)(6) (commodity contracts, forward contracts, and securities contracts), (7) (repurchase agreements), (17) (swap agreements), (27) (master netting agreements) (2006).
284. See, e.g., George W. Kuney & Michael St. James, A Proposal for Chapter 10: Reorganization for "Too Big To Fail" Companies, 28 AM. BANKR. INSTIT. J., Mar. 2009, at 1 (proposing a new Chapter 10 process for TBTF nonfinancial firms that would generally not affect ordinary course vendors).
285. See, e.g., Harvey R. Miller, Luncheon Keynote Address at the American Bankruptcy Institute 2009 Legislative Symposium, Chapter 11 at the Crossroads: Does Reorganization Need Reform? (Nov. 16, 2009).
286. See, e.g., Stephen J. Lubben, The Bankruptcy Code Without Safe Harbors, 84 AM. BANKR. L.J. 123 (2010) (suggesting that Bankruptcy Code safe harbors for derivates should be narrowed rather than repealed);
287. Stephen J. Lubben, Derivatives and Bankruptcy: The Flawed Case for Special Treatment, 12 U. PA. J. BUS. L. 61 (2009) (arguing for the need to distinguish the bankruptcy treatment of derivatives based on whether they are used for speculation and for hedging).
288. Although Chrysler is much smaller than GM, many key suppliers of GM are also dependent upon Chrysler business, so if Chrysler were liquidated, GM could have lost suppliers that could not easily be resourced.
289. Press Release, White House Office of the Press Secretary, Fact Sheet: Financing Assistance To Facilitate the Restructuring of Auto Manufacturers To Attain Financial Viability (Dec. 19, 2008), available at http://www.cfr.org/ publication/18070/fact-sheet.html.
290. CONG. OVERSIGHT PANEL, SEPTEMBER OVERSIGHT REPORT: THE USE OF TARP FUNDS IN THE SUPPORT AND REORGANIZATION OF THE DOMESTIC AUTOMOTIVE INDUSTRY 8-9 (2009), available at http://cop.senate.gov/documents/cop-090909-report.pdf.
291. Id. at 14, 20-21.
292. 11 U.S.C. § 363(b) (2006) (providing that the trustee or debtor in possession, "after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate").
293. CONG. OVERSIGHT PANEL, supra note 194, at 14-15, 19-20.
294. See Stephen J. Lubben, No Big Deal: The GM and Chrysler Cases in Context, 83 AM. BANKR. L.J. 531 (2009) (arguing that the GM and Chrysler bankruptcies were not exceptional and that, in the absence of realistic alternative bidders for the companies, the 363 sales must be accepted as maximizing value); cf. BFP v. Resolution Trust Corp., 511 U.S. 531, 545 (1994) (upholding a nonjudicial foreclosure sale as establishing reasonably equivalent value to defeat a fraudulent conveyance action).
295. CONG. OVERSIGHT PANEL, supra note 194, at 27-28, 31.
296. See Lubben, supra note 198, at 532;
297. Mark J. Roe & David Skeel, Assessing the Chrysler Bankruptcy, 108 MICH. L. REV. 727, 728 (2010);
298. Edward R. Morrison, Chrysler, GM and the Future of Chapter 11 (Colum. Law and Econ. Research Paper No. 365, Dec. 30, 2009), available at http://papers.ssrn.com/abstract-id=1529734.
299. The Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. Preamble (2010).
300. Id. § 716.
301. Id. § 214.
302. See id. tit. II.
303. Id.
304. (requiring liquidation). If a buyer cannot be found, however, the entity cannot be reorganized to maintain its going concern value or guarantee its future provision of services to counterparties and communities.
305. Id. § 203(a).
306. Id. § 203(b).
307. Id. § 203(c).
308. Id. § 202(a)(1)(A).
309. Id. § 202(a)(1)(A)(v).
310. Id. § 202(d) (three-year receivership, extendable for up to two additional years).
311. Id. § 210(a)(8).
312. Id. § 210(a)(3)-(4) (FDIC adjudication of claims, subject to judicial review).
313. Id. § 210(a)(1)(F).
314. Id. § 210(a)(11) (avoidance powers), (a)(12) (setoff), (a)(6) (D'Oench Duhme avoidance powers, D'oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942)), (a)(1)(I) (incorporating general noninsolvency law, which include fraudulent transfer statutes).
315. § 210(b)(2).
316. Id. § 210(b).
317. Id. §§ 206, 210(b).
318. Id. § 210(b)(4).
319. Id. § 210(b)(4)(A).
320. Id. § 210(s)(1).
321. Id. § 210(n)-(o).
322. Id. § 214(c).
323. KINDLEBERGER & ALIBER, supra note 16, at 204 ("The moral hazard argument is that intervention skews the risk and reward trade-off in the minds of many investors by reducing both the likelihood and the scope of future losses.").
324. DONALD P. MORGAN & KEVIN J. STIROH, TOO BIG TO FAIL AFTER ALL THESE YEARS tbl. 1 (2005), available at http://www.newyorkfed.org/research/staff- reports/sr220.pdf (finding statistically significantly lower spreads on TBTF banks' bonds over Treasury bonds relative to other banks' bonds over Treasury bonds);
325. Brent W. Ambrose & Arthur Warga, Measuring Potential GSE Funding Advantages,
326. J. REAL ESTATE FIN. & ECON. 129, 146 (2002) (finding GSE to Treasury bond spread was 25-29 basis points less than for AA-rated banking sector bonds);
327. Frank Nothaft et al., Debt Spreads Between GSEs and Other Corporations, 25 J. REAL ESTATE FIN. & ECON. 151, 167, tbl. 9 (2002) (finding 22-30 basis point funding advantage relative to AA-rated bonds).
328. See Summers, supra note 16, at 136.
329. Substantial literature exists on LOLR in the international context, and a smaller one on the domestic context. This Article addresses bailout mechanisms only in the U.S. domestic context, although the principles elucidated generally apply to any domestic bailout. Internationally, the choice between ad hoc and institutionalized bailouts is somewhat different. There is an institutional structure that includes the International Monetary Fund, World Bank, and other international financial institutions, but some individual national governments have also contributed to the bailouts of foreign states.
330. It is also possible to have a private LOLR.
331. See, e.g., Michael D. Bordo, The Lender of Last Resort: Alternative Views and Historical Experience, ECON. REV. (FED. RES. BANK RICHMOND). Jan.-Feb. 1990, at 18, 24.
332. The Chrysler and Long Term Capital Management bailouts saw private capital act as LOLRs, and historically, private clearinghouses have served a LOLR function, at least for their members, enabling their members to provide liquidity to nonmember firms. It is questionable, however, whether a private LOLR is truly the lender of last resort or whether it is merely the lender of next-to-last resort. If a private bailout fails, the severity of the crisis is likely to be such that government will step in as LOLR.
333. Paul Krugman, Op-Ed. The Big Squander, N.Y. TIMES, Nov. 20, 2009, at A35 ("Government officials . . . forgot that if you want to govern effectively you have [to] retain the trust of the people. And by treating the financial industry . . . with kid gloves, they have squandered that trust.").
334. KINDLEBERGER & ALIBER, supra note 16, at 231. Throughout the nineteenth century, there were repeated instances when the Treasury provided liquidity assistance to the banking sector by accepting less sound collateral, by early payment on government debt, or by providing a market for specie.
335. Id. at 231-32.
336. The sole exception I have been able to identify is a bailout of New York City in 1914 by the United States Treasury.
337. See generally WILLIAM L. SILBER, WHEN WASHINGTON SHUT DOWN WALL STREET: THE GREAT FINANCIAL CRISIS OF 1914 AND THE ORIGINS OF AMERICA'S MONETARY SUPREMACY 123-25 (2007).
338. KINDLEBERGER & ALIBER, supra note 16, at 232.
339. See SILBER, supra note 231, at 116-30.
340. KINDLEBERGER & ALIBER, supra note 16, at 236.
341. James H. Street, Can Mexico Break the Vicious Circle of "Stop-Go" Policy?: An Institutional Overview, 20 J. ECON. ISSUES 601, 605 (1986). Treasury has, at times, used other funds for bailout purposes, arguably acting illegally.
342. See Russell Dean Covey, Note, Adventures in the Zone of Twilight: Separation of Powers and National Economic Security in the Mexican Bailout, 105 YALE L.J. 1311, 1311-15 (1996) (arguing that the Clinton administration's use of the Exchange Stabilization Fund in 1995 to bail out Mexico was illegal).
343. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 101(a)(1), 122 Stat. 3765, 3767 (2008). The Act defines a financial institution as any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State, territory, or possession of the United States . . . and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government. Id. § 3(5). The Treasury interpreted the TARP's restriction to asset purchases from "financial institutions" liberally to include auto manufacturers GM and Chrysler, and not just their financing arms. CONG. OVERSIGHT PANEL, supra note 194, at 70-79 (discussing whether the Treasury was acting within the scope of its legal authority when it assisted GM and Chrysler). Similarly, Congress arguably expected that once TARP funds were repaid, they would be retired. The Treasury, however, has indicated that it believes that TARP can be used as a revolving fund with repaid TARP funds being relent rather than being retired.
344. See id. at 170.
345. The War Finance Corporation (1918-1939), the Emergency Fleet Corporation (1917-1936), and the U.S. Housing Corporation, Federal Home Loan Banks, Fannie Mae (itself an outgrowth of RFC) and various federal farm loan programs have at various times offered targeted support to particular industries, but have never functioned as generic LOLRs.
346. Reconstruction Finance Corporation Act, Pub. L. No. 72-2, 47 Stat. 5 (1932).
347. Id. § 5.
348. Emergency Relief and Construction Act, Pub. L. No. 302, § 210, 47 Stat. 709, 715 (1932).
349. Two studies of the political economy of the RFC have adduced little evidence of congressional influence over its activities.
350. See Joseph R. Mason, The Political Economy of Reconstruction Finance Corporation Assistance During the Great Depression, 40 EXPLORATIONS IN ECON. HIST. 101, 109 (2003) (finding little evidence of congressional influence on RFC assistance between 1932 and 1933);
351. Randall S. Kroszner, The Political-Economy of the Reconstruction Finance Corporation's Bail-out of the U.S. Banking System During the Great Depression, (Apr. 1994) (unpublished working paper) (on file with author) (finding no evidence of direct political influence from Congress on RFC assistance between 1933 and 1935, but suggesting possible executive branch and Senate Banking Committee influence). This is not surprising;
352. The primary influence on RFC activities would presumably be the executive branch. Neither study claims that the RFC was in any way immune from executive branch political considerations. To the contrary, it was very much a tool of Roosevelt administration policy.
353. Federal Reserve Act, Pub. L. No. 63-43, § 13, 38 Stat. 251, 263 (1913).
354. James C. Dolley, The Industrial Advance Program of the Federal Reserve System, 50 Q.J. ECON. 229, 230 (1936).
355. In addition to the ability to rediscount, the Fed had other emergency lending powers. First, the Federal Reserve Board was permitted to suspend the gold reserve requirement of reserve banks. This removed an important limitation on reserve bank lending to member banks.
356. Id. at 231-32. Second, during 1930-1931, the Board was permitted to suspend the single-borrower lending limitation of 20% when the collateral posted were government securities.
357. Id. at 232.
358. Emergency Relief and Construction Act, § 210. This expansion of discounting authority occurred as part of legislation that authorized the Reconstruction Finance Corporation, which was previously authorized only to lend to financial firms, to make industrial loans.
359. Id. The original draft bills envisioned the Fed as playing this industrial lending role, with the RFC as backup lender, but the final legislation reversed the roles, making the RFC the primary lender and authorizing the Fed to make loans only when no other source of credit could be found. David Fettig, Fed. Res. Bank of Minneapolis, Lender of More Than Last Resort: Recalling Section 13(b) and the Years When the Federal Reserve Opened Its Discount Window to Business, REGION: BANKING & POL'Y ISSUESMAG., Dec. 2002, at 14, 44, available at http://www.minneapolisfed.org/pubs/region/02-12/ lender.pdf. The reason for the shift is not clear.
360. Industrial Advances Act of June 19, 1934, Pub. L. No. 73-417, 48 Stat. 1105. In 1933, the Fed's lending authority was further expanded to allow the Fed to make ninety-day advances to nonbanks if secured by direct obligations of the United States government.
361. See Emergency Banking Relief Act of March 9, 1933, Pub. L. No. 73-1, 48 Stat. 1 (1933).
362. Small Business Investment Act of 1958, Pub. L. No. 85-699, 72 Stat. 689.
363. Federal Deposit Insurance Corporation Improvement Act of 1991, Pub. L. No. 102-242, § 473, 105 Stat. 2236, 2386. The removal of the "merely investments" language proved crucial, as it would have greatly impeded the Fed's efforts to support investment banks in 2008.
364. WESSEL, supra note 36, at 161. Section 13(3) now reads that "[i]n unusual and exigent circumstances" the Fed may "discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange that are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions."
365. 12 U.S.C. § 343 (2006).
366. See Factors Affecting Efforts To Limit Payments to AIG Counterparties: Hearing Before the H. Comm. on Gov't Oversight & Reform, 111th Cong. 8 (2010) (statement of Thomas C. Baxter, Jr., Executive Vice President and General Counsel, Federal Reserve Bank of New York) (noting that the Fed does not have legal authority to guarantee obligations).
367. Federal Deposit Insurance Corporation Improvement Act of 1991, Pub. L. No. 102-242, § 473, 105 Stat. 2386.
368. Fettig, supra note 245, at 18.
369. 12 C.F.R. § 217 (1966);
370. 12 C.F.R. § 217 (1969).
371. WESSEL, supra note 36, at 160.
372. Stephen J. Friedman & Connie M. Friesen, A New Paradigm for Financial Regulation: Getting from Here to There, 3 MD. L. REV. 413, 427 n.99 (1984);
373. Henry T.C. Hu, Faith and Magic: Investor Beliefs and Government Neutrality, 78 TEX. L. REV. 777, 874 (2000);
374. Sidney Posel, Factoring Accounts Receivable in France: Some Legal Aspects and American Comparisons, 57 TUL. L. REV. 292, 298 n.17 (1982);
375. Arthur E. Wilmarth, Jr., The Transformation of the U.S. Financial Services Industry, 1975-2000: Competition, Consolidation, and Increased Risks, 2002 U. ILL. L. REV. 215, 304.
376. Wilmarth, supra note 254, at 303-10.
377. FED. RESERVE BD., PERIODIC REPORT PURSUANT TO SECTION 129(B) OF THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008: UPDATE ON OUTSTANDING LENDING FACILITIES AUTHORIZED BY THE BOARD UNDER SECTION 13(3) OF THE FEDERAL RESERVE ACT: December 29, 2008, PERIODIC REPORT, at 2-3 [hereinafter FRB], available at http://www.federalreserve.gov/monetarypolicy/files/129periodic update08252009.pdf. Notably, the invocation of section 13(3) was not announced when the TSLF was unveiled.
378. WESSEL, supra note 36, at 161-62.
379. Minutes of the Board of Governors of the Federal Reserve System, FEDERAL RESERVE BOARD: NEWS & EVENTS (Mar. 14, 2008), http://www.federalreserve.gov/ newsevents/press/other/other 20080627a1.pdf (authorizing extension of nonrecourse credit to JPMorgan Chase Bank to provide financing to Bear Stearns under section 13(3) powers). Ultimately, the deal involved the Fed making a bridge loan to Bear Stearns directly, as well as making a senior secured nonrecourse loan to a new company, Maiden Lane LLC, a special purpose vehicle (SPV) formed (and owned) by the Federal Reserve Bank of New York.
380. FRB, PERIODIC REPORT, supra note 256. The shift in transaction structure from the originally authorized direct loan to JPMorgan Chase to a loan to an SPV reflected concern that the deal would be seen as the Fed purchasing Bear Stearn's securities outright, which section 13(3) did not authorize. Therefore, the Fed took a page from the structured finance transactions that marked the housing bubble and loaned on a nonrecourse basis to an SPV that held the securities and pledged them as collateral.
381. WESSEL, supra note 36, at 168-69. Maiden Lane LLC acquired $28.8 billion of the less liquid assets of Bear Stearns in order to facilitate JPMorgan Chase's purchase of Bear Stearns.
382. FRB, PERIODIC REPORT, supra note 256, at 3-4.
383. Minutes of the Board of Governors of the Federal Reserve System, FEDERAL RESERVE BOARD: NEWS & EVENTS (Mar. 16, 2008), http://www.federalreserve.gov/ newsevents/press/other/other20080627a2.pdf (authorizing creation of Primary Dealer Credit Facility).
384. The Primary Dealer Credit Facility, created March 17, 2008, permits the Federal Reserve to enter into repurchase (repo) agreements) with the investment banks that serve as the primary dealers for U.S. government securities. Primary Dealer Credit Facility, FEDERAL RESERVE BOARD: MONETARY POLICY, http://www.federalreserve.gov/ monetarypolicy/pdcf.htm (last visited Aug. 22, 2010). Under the repo agreements, the investment banks sell the Fed securities, and the Fed agrees to sell them back later, but at a markup. Economically, the transaction is equivalent to a secured loan made by the Fed to the investment banks, with the markup being the interest and the securities serving as collateral. The Fed thus served as the repo investor of last resort.
385. WESSEL, supra note 36, at 170-71. The facility was terminated February 1, 2010.
386. See Credit and Liquidity Programs and the Balance Sheet: Lending to Primary Dealers, FEDERAL RESERVE BOARD: MONETARY POLICY, www.federalreserve.gov/ monetarypolicy/bst-lendingprimary.htm (last visited Oct. 13, 2010).
387. FRB, PERIODIC REPORT, supra note 256, at 5. Unlike the Fed's 13(3) authority, which is theoretically limitless in dollar amounts given the Fed's ability to print currency, Treasury's TARP authority is limited to the $800 billion appropriated by Congress; nevertheless, Treasury has indicated that it believes repaid TARP funds can be relented rather than be retired.
388. Id.
389. FRB, PERIODIC REPORT, supra note 256, at 6. The CPFF created an LLC authorized to purchase commercial paper (unsecured and asset-backed) directly from commercial paper issuers.
390. The MMIFF authorized senior secured funding to a series of LLCs established with private sector capital to enable the purchase from money market mutual funds of short-term CDs and commercial paper issued by highly rated financial institutions. The program enhanced money market liquidity, enabling money markets to honor redemption requests without selling assets at fire-sale prices. Credit and Liquidity Programs and the Balance Sheet: Other Lending Facilities, FEDERAL RESERVE BOARD: MONETARY POLICY, http://www.federalreserve. gov/monetarypolicy/bst-lendingother. htm (last visited Oct. 13, 2010).
391. The TALF issued nonrecourse loans against asset-backed securities.
392. Id.
393. FRB, PERIODIC REPORT, supra note 256, at 7-10 (detailing support to AIG). Support for AIG included: an $85 billion line of credit from the Federal Reserve Bank of New York (FRBNY);
394. The purchase by Maiden Lane II, LLC, a special purpose subsidiary of the FRBNY, of MBS from AIG insurance subsidiaries to provide liquidity to their investment securities lending programs; and the purchase at market value of $62.1 billion by Maiden Lane III, LLC, another special purpose subsidiary of the FRBNY, of various CDOs on which AIG had underwritten CDS protection, in exchange for termination of the CDS by the CDO sellers, which were permitted to keep the collateral AIG had posted to date.
395. WESSEL, supra note 36, at 170-71.
396. The Dodd-Frank Wall Street Reform and Consumer Protection Act amends section 13(3) of the Federal Reserve Act to clarify that the Fed's section 13(3) power may only be used to provide broad-based liquidity support programs for the market, rather than support for individual firms, and that section 13(3) may not be used to support insolvent firms. Pub. L. No. 111-203, § 1101, 124 Stat. 1376, 2114 (2010).
397. My thinking on the liquidity-solvency divide has been greatly influenced by Professor Anna Gelpern and her blog posts on "illinquency."
398. See, e.g., Anna Gelpern, . . . and Another Thing: Illiquency, THE CONGLOMERATE (Oct. 14, 2008), http://www.theconglomerate.org/2008/10/anna- gelpern-an.html;
399. Anna Gelpern, T.A.R.P. R.I.P.: Illiquency Watch, CREDIT SLIPS (Nov. 14, 2008, 12:31 AM), http://www.creditslips. org/creditslips/2008/11/tarp-rip- illiqu.html.
400. See Covey, supra note 235.
401. See supra note 13.
402. Wallison, supra note 20, at 7.
403. Summers, supra note 16, at 179, 182.
404. See supra section I.A.
405. Comparisons between agency and congressional accountability often reference comparative transparency and deliberativeness of the bodies. These analyses are almost always conducted with the assumption of agency action through notice-and-comment rulemaking. Bailout authorization, however, is generally done on an expedited, urgent, or even emergency basis.
406. See, e.g., Elena Kagan, Presidential Administration, 114 HARV. L. REV. 2245, 2331-37 (2001);
407. Lawrence Lessig & Cass R. Sunstein, The President and the Administration, 94 COLUM. L. REV. 1, 102-03 (1994);
408. Richard J. Pierce, Jr., The Role of the Judiciary in Implementing an Agency Theory of Government, 64 N.Y.U. L. REV. 1239, 1280-85 (1989).
409. Steven G. Calabresi, Some Normative Arguments for the Unitary Executive, 48 ARK. L. REV. 23, 58-70 (1995);
410. Jerry L. Mashaw, Prodelegation: Why Administrators Should Make Political Decisions, 1 J.L. ECON. & ORG. 81, 95-96 (1985);
411. see also Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 865-66 (1984) ("While agencies are not directly accountable to the people, the Chief Executive is, and it is entirely appropriate for this political branch of government to make such policy choices.").
412. Brian Galle & Mark Seidenfeld, Administrative Law's Federalism: Preemption, Delegation, and Agencies at the Edge of Federal Power, 57 DUKE L.J. 1933, 1983 (2008) ("Because of legislative inertia, Congress passes statutes infrequently . . . . Agencies, through both congressional and presidential influences, are more apt to be influenced by current political pressures because political influences on agencies are ongoing and flexible.").
413. 12 U.S.C. § 241 (2006).
414. Peter M. Shane, Political Accountability in a System of Checks and Balances: The Case of Presidential Review of Rulemaking, 48 ARK. L. REV. 161, 200 (1995);
415. see David W. Brady et al., Differences in Legislative Voting Behavior Between Winning and Losing House Incumbents, in CONTINUITY AND CHANGE IN HOUSE ELECTIONS 178, 181-89 (David W. Brady et al. eds., 2000) (claiming that representatives who take more extreme positions than their constituents increase their probability of electoral defeat);
416. Robert S. Erkson & Gerald C. Wright, Representation of Constituency Ideology in Congress, in CONTINUITY AND CHANGE IN HOUSE ELECTIONS 149, 177 (David W. Brady et al. eds., 2000) (asserting that members of Congress "lose votes-and sometimes elections-if they stray too far ideologically [from their constituents' positions]").
417. David M. Halbfinger, Ire at Wall St. Is Now Factor in House Race, N.Y. TIMES, Mar. 28, 2009, at A1; Raymond Hernandez & Thomas Kaplan, Connecticut Senator Draws Voters' Ire for Payout Role, N.Y. TIMES, Mar. 20, 2009, at A1; Adam Nagourney, Dodd Is Said To Decide Against Re-election Bid, N.Y. TIMES, Jan. 6, 2010, at A1.
418. Galle & Seidenfeld, supra note 275, at 1979-80.
419. See, e.g., Ronald A. Cass, Money, Power, and Politics: Governance Models and Campaign Finance Regulation, 6 SUP. CT. ECON. REV. 1, 46-47 (1998);
420. Linda Cohen & Matthew Spitzer, Term Limits, 80 GEO. L.J. 477, 479-80 (1992);
421. Einer Elhauge, Are Term Limits Undemocratic?, 64 U. CHI. L. REV. 83, 154-55 (1997). (Pubitemid 127445760)
422. See Davidoff & Zaring, supra note 15, at 468.
423. See Press Release, Board of Governors of the Federal Reserve (June 27, 2008), available at http://www.federalreserve.gov/newsevent/press/others/ 20080627a.htm (announcing the release of the minutes from March 14 and 16, 2008 Board meetings).
424. OFFICE OF THE SPECIAL INSPECTOR GENERAL FOR THE TROUBLED ASSET RELIEF PROGRAM, FACTORS AFFECTING EFFORTS TO LIMIT PAYMENTS TO AIG COUNTERPARTIES 21 (2009) [hereinafter SPECIAL INSPECTOR GENERAL FOR TARP], available at http://www.sigtarp.gov/reports/audit/2009/Factors-Affecting-Efforts-to-Limit- Payments-to-AIG-Counterparties.pdf.
425. Oversight of the Federal Government's Intervention at American International Group: Hearing Before the H. Comm. on Fin. Servs., 111th Cong. 70-77 (2009) (statement of Ben S. Bernanke, Chairman, Bd. of Governors of the Fed. Reserve Sys.).
426. See SPECIAL INSPECTOR GENERAL FOR TARP, supra note 283, at 25.
427. CONG. OVERSIGHT PANEL, THE AIG RESCUE, ITS IMPACT ON MARKETS, AND THE GOVERNMENT'S EXIT STRATEGY 42 (2010), available at http://cop.senate.gov/ documents/cop-061010-report.pdf.
428. Id. at 41.
429. See id.
430. Morrison, supra note 15, at 462.
431. H. FIN. SERVS. COMM., REPUBLICAN PLAN FOR REFORMING THE FINANCIAL REGULATORY SYSTEM 5 (2009), available at http://republican.financialservice. house.gov/images/stories/fscrepregreformplan.pdf (proposing that Treasury be required to sign off on Federal Reserve actions taken under section 13(3)).
432. Id. (proposing to allow Congress alone to override Federal Reserve actions taken under section 13(3) within ninety days, after which the Fed would be required to unwind all transactions within an additional ninety days).
433. See Eric A. Posner & Adrian Vermeule, Crisis Governance in the Administrative State: 9/11 and the Financial Meltdown of 2008, 76 U. CHI. L. REV. 1613, 1623-33 (2010) (noting nondelegation doctrine issues with the Emergency Economic Stabilization Act of 2008).
434. FRIEDMAN, supra note 16, at 38 (arguing against discount window lending by LOLR in favor of open-market operations);
435. Marvin Goodfriend & Robert G. King, Financial Deregulation, Monetary Policy, and Central Banking, FED. RESERVE BANK OF RICH. ECON. REV. 1, 10-13 (1988) (arguing that discount window lending by LOLR is redundant and incapable of affecting the monetary supply);
436. see also H. FIN. SERVS. COMM., supra note 290, at 5 (proposing restricting section 13(3) to allow support only for market sectors, not specific firms).
437. H. FIN. SERVS. COMM., supra note 290, at 5 (proposing that all expenditures under section 13(3) go on Treasury's balance sheet, rather than on the Fed's).
438. See Posner & Vermeule, supra note 292, at 1633 (noting the limitation on judicial review of the Emergency Economic Stabilization Act of 2008).
439. It should be noted that I served as Special Counsel to the Congressional Oversight Panel from December 2008-May 2010.
440. Wallison, supra note 20, at 7-8.
441. See 12 U.S.C. § 241 (2006) (fourteen-year term for governors);
442. id. § 242 (2006) (removal only for cause).
443. See id. § 1812(c), amended by Pub. L. No. 111-203, 124 Stat. 1376 (2010) (six-year term for FDIC board members).
444. See, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 202, 124 Stat. 1376, 1444 (2010). Dodd-Frank provides for the Treasury Secretary to petition the District Court for the District of Columbia to appoint the FDIC as receiver for a failed covered financial company. The court must grant the petition unless it finds that the Treasury Secretary's determination that a covered financial company is in default or danger of default was arbitrary and capricious.
445. Id. The review must be concluded within twenty-four hours or the Treasury Secretary's petition for the appointment of a receiver shall be automatically granted.
446. Id. § 202(a)(1)(A)(v).
447. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, 122 Stat. 3765.
448. See supra section IV.A.2.
449. Both ad hoc and LOLR regimes can be combined with haircut mechanisms. Mandating haircuts in a congressionally authorized bailout could raise potential Fifth Amendment takings issues, at least if applied to preexisting secured creditors.
450. See United States v. Sec. Indus. Bank, 459 U.S. 70, 81-82 (1982) (holding that liens that existed prior to enactment of the 1978 Bankruptcy Code could not be avoided under a subsequently enacted statute);
451. Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 594-602 (1935) (striking down the Frazier-Lemke Act of 1934 as a taking because of the interference with rights of secured creditors).
452. See supra Part III.
453. AIG received three subsequent rounds of bailouts: a $40 billion TARP investment in preferred shares, part of which was used to repay the Federal Reserve Bank of New York; liquidity support for its securities lending program from Maiden Lane II, LLC, a special purpose subsidiary of the Federal Reserve Bank of New York;
454. And the purchase at market value of CDOs on which AIG had sold CDS protection in exchange for the CDS being terminated and the counterparties keeping all collateral that had been posted by AIG for the decline in the CDOs' value from face value. The negotiations regarding haircuts for AIG counterparties occurred in the context of this fourth round of bailout, but the issue existed starting with the first round of the AIG bailout.
455. See generally SPECIAL INSPECTOR GENERAL FOR TARP, supra note 283 (giving a timeline of the AIG bailout and detailing the actions of Congress, the Federal Reserve, and the Treasury during that time).
456. There is a subsidiary question of how to price for the government's credit risk in recoupment as well as whether penalty rates should apply to what is essentially a government loan to the critical counterparties.
457. These critical counterparties would almost always be business entities, rather than individuals; a firm's employees would not be forced to accept government loans.
458. Ex post taxation of specific firms could raise concerns about the tax being an unconstitutional bill of attainder. Ex post bailout taxes have made their appearance in this current crisis, with a proposed bank tax.
459. See Jackie Calmes, Taxing Banks for the Bailout, N.Y. TIMES, Jan. 15, 2010, at B1;
460. Press Release, White House Office of the Press Secretary, President Obama Proposes Financial Crisis Responsibility Fee To Recoup Every Last Penny for American Taxpayers (Jan. 14, 2010), available at http://www. whitehouse.gov/the-press-office/president-obama-proposes-financial-crisis- responsibility-fee-recoup-everylast-penn. A bailout recoupment tax would ensure that taxpayers do not directly bear the fiscal burden of a bailout. Of course, if the tax is imposed on a less-than-perfectly-competitive industry, such as financially services, some of the cost will eventually be borne by taxpayers in the form of higher prices.
461. Mark Landler & Eric Dash, Drama Behind a $250 Billion Banking Deal, N.Y. TIMES, Oct. 15, 2008, atA1 (describing Treasury's offer to purchase shares of major banks as "a take it or take it offer").
462. There is a critical issue of pricing, but that is well beyond the scope of this Article. The LOLR literature features a debate about whether pricing should be at penalty rates or not in order to discourage use of LOLR facilities.
463. See WALTER BAGEHOT, LOMBARD STREET: A DESCRIPTION OF THE MONEY MARKET 56 (Batoche Books 2001) (1873) ("Very large loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain."). For force-placed investment, another justification must be found for penalty pricing because there is no choice in whether to accept the funding.
464. For example, would the government slash jobs if necessary? Would the government demand particular corporate policies? Would the government want management to take a hard-line position about unionization or collective bargaining agreement negotiation?
465. Recognizing this economic reality might also avoid lurking Takings Clause issues, as the government would be taking the call option, but would have given equivalent value via the bailout.
466. See, e.g., 11 U.S.C. §§ 365(c), 541(c)(1) (2006).
467. KINDLEBERGER & ALIBER, supra note 16, at 1.