What Happens if A Big Bank Fails under Dodd-Frank Rules – Analysis

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Just imagine if a global financial giant, such as the Bank of America Corp (NYSE:BAC), failed under Dodd-Frank. What would happen and who would come to the rescue?

According to Seton Hall University law professor Stephen J. Lubben, things would be a mess. In his new paper, “Resolution, Orderly and Otherwise: B of A in OLA,” he looks at how Dodd Frank’s Orderly Liquidation Authority (OLA), a new insolvency group that addresses bankruptcy law limitations, would “resolve” say, the Bank of America Corp (NYSE:BAC).

Now remember, the paper is fiction but it looks at some serious concerns about whether this new group could really step in and resolve an institution that is the size of Bank of America Corp (NYSE:BAC) with its $2.3 trillion in assets. For now, the standard has been Lehman Brothers with its $713 billion of assets, which sits as the greatest bankruptcy in history.

That resolution didn’t go so well.

What is OLA?

Through OLA, it gives the Federal Deposit Insurance Corp. receivership powers for “systemically important financial institutions” according to The Wall Street Journal. It has utilized this to oversee failed depository banks but Bank of America is more than this type of bank. It is a global giant.

In his paper, Lubben uses Bank of America Corp as an example with its global 600 subsidiaries as opposed to a domestic bank, which he believes the new authority doesn’t address this type of entity.

So who is looking out for the Bank of Americas?

In a recent interview, Michael Krimminger, general counsel of the FDIC, criticized Lubben’s paper and said, “He has something of a misconception of what the Orderly Liquidation Authority is designed to do.”

He explains that OLA doesn’t immediately liquidate the institution but it is intended to maintain the “systemically important operations” of the troubled company to prevent the spread of financial disorder.  It sounds like a regulatory role that really just keeps business humming along.

But there may be more of a story here with his remarks: there’s a little bad blood between the two.

The Old Way vs. The New Way

Lubben and Krimminger have a history through dueling New York Times Dealbook pieces (here and here). Their disagreement came from two opposing points of view: reformers from the banking industry against bankruptcy professionals.

In addition, Lubben’s paper explains that he does not believe in “tweaking” the current Bankruptcy Code for the resolution of an essential financial institution, under a proposal to be named Chapter 14. He finds it doesn’t work.

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

He brings up a good point: people don’t like what he’s saying and there’s no blueprint to address this problem. Until or if OLA is embraced, it will come with critics who (a) don’t want to see change, (b) don’t want to see flaws in the current system exposed and (c) at the end of the day, no one wants to believe an institution as large as Bank of America and with so many tentacles could fail.

It’s perhaps a case of an ostrich keeping his head in the sand and Lubben thinks its time to change this.

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