WASHINGTON (Reuters Breakingviews) - The U.S. Treasury’s view on what happens when big financial companies fail is about right. A long-awaited report recommends beefing up the bankruptcy code in case a large financial institution needs to be resolved, while keeping the door open to government intervention. It’s possible to quibble with the details, but the big-picture proposals strike a sensible balance.
President Donald Trump’s administration has set out to roll back bits of the Dodd-Frank Act, passed in 2010 under his Democratic predecessor. Part of that involved the Orderly Liquidation Authority, which sets out a process for regulators to wind down ailing financial institutions by temporarily borrowing funds from the Treasury.
Republican lawmakers say those powers effectively institutionalize government bailouts. Some, such as House Financial Services Committee Chairman Jeb Hensarling, have pushed to eliminate them altogether. Instead, conservatives would like to see an expansion of the bankruptcy code – so-called “Chapter 14” – designed specifically to resolve complex companies without endangering the broader financial system. Banks, for their part, mostly want to keep the Orderly Liquidation Authority intact.
What’s now being proposed is somewhere in the middle. It includes the idea of a Chapter 14, where bankruptcy would be the option of first resort for failing financial institutions. But retaining extraordinary powers makes sense. Bankruptcy courts might struggle to cleanly resolve a complicated financial institution; there’s also a risk that private liquidity to the firm might run dry. If handled shoddily, contagion could spread.
Throwing the baby out with the bathwater wouldn’t be practical, in any case. Without the clear process for a government rescue of last resort, foreign officials might impose new regulatory requirements on the overseas affiliates of American banks and other companies.
Congress and regulators now get to chew over the proposals – which will mean debating a slew of other tweaks, such as making it harder for officials to treat similar creditors differently, or repealing the tax-exempt status of bridge companies created during the resolution process. Overall, however, the Treasury’s plan strikes a smart balance: mitigating moral hazard and protecting taxpayers, while also allowing officials to put a floor under a potential disaster. The U.S. economy is likely to be better off for it.
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