Republicans target failing banks

New bankruptcy laws would be one of the many changes to the 2010 Dodd-Frank financial reform law favored by Republicans. Along with Obamacare, Dodd-Frank is one of President Obama’s biggest first-term initiatives and one of the GOP’s biggest targets. But Republicans had no chance to make even minor reforms to the financial law with Democrats holding the Senate.

Under Dodd-Frank, the Federal Deposit Insurance Corporation has the authority to seize a failing firm that threatens to drag down the financial system and close it in an orderly fashion, sorting out the claims of its creditors.

In December, the GOP-led House set the stage for a push next year on a bankruptcy alternative by passing a measure adding a subchapter specifically for financial companies to Chapter 11 of the U.S. Bankruptcy Code.

That bill, the result of a multiyear process overseen by House Judiciary Committee Chairman Bob Goodlatte, R-Va., and other members of the panel, wouldn’t have undone Dodd-Frank. Instead it would have made bankruptcy a more realistic option for failing firms such as Lehman Brothers, which worsened the financial crisis with its uncontrolled collapse in September 2008. The bill is meant to work by altering provisions of the code to allow banks to undergo bankruptcy more quickly while providing greater certainty regarding their subsidiaries.

That bill, which passed on a voice vote, has a Republican counterpart in the Senate, co-authored by John Cornyn of Texas and Pat Toomey of Pennsylvania.

With the GOP having 54 members in the Senate in January, banks and regulators will be watching to see where bankruptcy falls on the new Republican majority’s to-do list.

“The question is one of priorities,” said Wayne Abernathy, an executive vice president at the American Bankers Association.

Abernathy said bankruptcy is preferable to the Dodd-Frank mechanism because it could better preserve the value left in troubled banks and keep decisions about claims on the company away from regulators.

“What we’re seeing is that Congress, in a very careful, reasoned and bipartisan way, wants to make sure there’s an end to too-big-to-fail that doesn’t cripple institutions’ ability to stay alive,” Abernathy said.

Yet many issues would need to be resolved before a bankruptcy bill could advance in Congress.

One notable hurdle: The Cornyn-Toomey bill included repeal of the part of Dodd-Frank that gives the FDIC the power to take over and shutter banks, one of the provisions most criticized by conservatives. The House bill did not include repeal. An aide to Goodlatte said a decision about whether and how to proceed would be made in the new year.

Nevertheless, a financial firm bankruptcy bill could supplement Dodd-Frank, said David Skeel, a University of Pennsylvania law professor and the author of a book criticizing Dodd-Frank.

“My goal would be to make Dodd-Frank resolution and use of those tools safe, legal and extremely rare, as Bill Clinton once said about abortion,” Skeel told the Washington Examiner. In particular, regulators may need to step in and safely shutter banks in case of a systemwide panic.

But strengthening bank bankruptcy, Skeel said, would make regulators less likely to get get involved in all but the most dire cases. It also “tends to be a lot more consistent with rule-of-law values” by being more transparent and less arbitrary, Skeel said.

In particular, he said, it would have been better for Bear Stearns to go bankrupt rather than be bailed out by the federal government in March 2008.

The investment bank was one of the first companies to fail in the wake of the housing collapse. Its downfall came months before the financial crisis peaked that fall. By that time, other banks, including Lehman, could reasonably expect to be bailed out as well.