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May 16, 2013

The Myth of a Perfect Orderly Liquidation Authority for Big Banks

On Tuesday, with some fanfare, the Bipartisan Policy Center in Washington rolled out a report, “Too Big to Fail: The Path to a Solution.” Focused on how to “resolve” big financial companies — a technical term for the details of handling the failure of such institutions — the report is elegantly written and nicely laid out. You can either read the very short version, the short version or the long version of the same material. Unfortunately, in all three the authors fail to persuade that the problem of too-big-to-fail is fixed or can be brought under control if only we follow their recommendations.

Their argument has three elements. First, big financial companies can be resolved either in bankruptcy or, more likely, through using the orderly liquidation authority, or O.L.A., created by the Dodd-Frank Act of 2010. Second, the key to making O.L.A. workable is sufficient “loss-absorbing” long-term debt and equity at the holding-company level. Third, the implication is that most or all of the big banks already have sufficient “loss-absorbing” debt and equity at the holding company level to make this work.

As a result, the authors contend, we (or perhaps financial-sector executives) are in luck — no significant structural changes, like simplification or reductions in scale, are needed at megabanks.

All three parts of this argument are unconvincing — and the bottom-line policy implication, “do little, be happy,” is downright dangerous.”

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Read Simon Johnson’s full Economix Blog Post here

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