[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]



 
                          BANKRUPTCY CODE AND 
                   FINANCIAL INSTITUTION INSOLVENCIES 

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                           REGULATORY REFORM,
                      COMMERCIAL AND ANTITRUST LAW

                                 OF THE

                       COMMITTEE ON THE JUDICIARY
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                               __________

                            DECEMBER 3, 2013

                               __________

                           Serial No. 113-59

                               __________

         Printed for the use of the Committee on the Judiciary

      Available via the World Wide Web: http://judiciary.house.gov

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                       COMMITTEE ON THE JUDICIARY

                   BOB GOODLATTE, Virginia, Chairman
F. JAMES SENSENBRENNER, Jr.,         JOHN CONYERS, Jr., Michigan
    Wisconsin                        JERROLD NADLER, New York
HOWARD COBLE, North Carolina         ROBERT C. ``BOBBY'' SCOTT, 
LAMAR SMITH, Texas                       Virginia
STEVE CHABOT, Ohio                   MELVIN L. WATT, North Carolina
SPENCER BACHUS, Alabama              ZOE LOFGREN, California
DARRELL E. ISSA, California          SHEILA JACKSON LEE, Texas
J. RANDY FORBES, Virginia            STEVE COHEN, Tennessee
STEVE KING, Iowa                     HENRY C. ``HANK'' JOHNSON, Jr.,
TRENT FRANKS, Arizona                  Georgia
LOUIE GOHMERT, Texas                 PEDRO R. PIERLUISI, Puerto Rico
JIM JORDAN, Ohio                     JUDY CHU, California
TED POE, Texas                       TED DEUTCH, Florida
JASON CHAFFETZ, Utah                 LUIS V. GUTIERREZ, Illinois
TOM MARINO, Pennsylvania             KAREN BASS, California
TREY GOWDY, South Carolina           CEDRIC RICHMOND, Louisiana
MARK AMODEI, Nevada                  SUZAN DelBENE, Washington
RAUL LABRADOR, Idaho                 JOE GARCIA, Florida
BLAKE FARENTHOLD, Texas              HAKEEM JEFFRIES, New York
GEORGE HOLDING, North Carolina
DOUG COLLINS, Georgia
RON DeSANTIS, FLORIDA
JASON T. SMITH, Missouri

           Shelley Husband, Chief of Staff & General Counsel
        Perry Apelbaum, Minority Staff Director & Chief Counsel
                                 ------                                

    Subcommittee on Regulatory Reform, Commercial and Antitrust Law

                   SPENCER BACHUS, Alabama, Chairman

                 BLAKE FARENTHOLD, Texas, Vice-Chairman

DARRELL E. ISSA, California          STEVE COHEN, Tennessee
TOM MARINO, Pennsylvania             HENRY C. ``HANK'' JOHNSON, Jr.,
GEORGE HOLDING, North Carolina         Georgia
DOUG COLLINS, Georgia                SUZAN DelBENE, Washington
JASON T. SMITH, Missouri             JOE GARCIA, Florida
                                     HAKEEM JEFFRIES, New York

                      Daniel Flores, Chief Counsel

                      James Park, Minority Counsel



                            C O N T E N T S

                              ----------                              

                            DECEMBER 3, 2013

                                                                   Page

                           OPENING STATEMENTS

The Honorable Spencer Bachus, a Representative in Congress from 
  the State of Alabama, and Chairman, Subcommittee on Regulatory 
  Reform, Commercial and Antitrust Law...........................     1
The Honorable Steve Cohen, a Representative in Congress from the 
  State of Tennessee, and Ranking Member, Subcommittee on 
  Regulatory Reform, Commercial and Antitrust Law................     6
The Honorable Bob Goodlatte, a Representative in Congress from 
  the State of Virginia, and Chairman, Committee on the Judiciary     8

                               WITNESSES

Jeffrey M. Lacker, President, Federal Reserve Bank of Richmond
  Oral Testimony.................................................    10
  Prepared Statement.............................................    13
Donald S. Bernstein, Co-Chair, Insolvency and Restructuring 
  Group, Davis Polk and Wardell L.L.P.
  Oral Testimony.................................................    67
  Prepared Statement.............................................    72
Mark J. Roe, Professor of Law, Harvard Law School
  Oral Testimony.................................................    91
  Prepared Statement.............................................    94

          LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING

Material submitted by the Honorable Spencer Bachus, a 
  Representative in Congress from the State of Alabama, and 
  Chairman, Subcommittee on Regulatory Reform, Commercial and 
  Antitrust Law..................................................     2

                                APPENDIX
               Material Submitted for the Hearing Record

Prepared Statement of the Honorable Spencer Bachus, a 
  Representative in Congress from the State of Alabama, and 
  Chairman, Subcommittee on Regulatory Reform, Commercial and 
  Antitrust Law..................................................   116
Prepared Statement of the Honorable Steve Cohen, a Representative 
  in Congress from the State of Tennessee, and Ranking Member, 
  Subcommittee on Regulatory Reform, Commercial and Antitrust Law   119
Prepared Statement of the Honorable Bob Goodlatte, a 
  Representative in Congress from the State of Virginia, and 
  Chairman, Committee on the Judiciary...........................   119
Prepared Statement of the Honorable John Conyers, Jr., a 
  Representative in Congress from the State of Michigan, and 
  Ranking Member, Committee on the Judiciary.....................   120
Response to Questions for the Record from Jeffrey M. Lacker, 
  President, Federal Reserve Bank of Richmond....................   121
Response to Questions for the Record from Mark J. Roe, Professor 
  of Law, Harvard Law School.....................................   123


         BANKRUPTCY CODE AND FINANCIAL INSTITUTION INSOLVENCIES

                              ----------                              


                       TUESDAY, DECEMBER 3, 2013

                       House of Representatives,

                  Subcommittee on Regulatory Reform, 
                      Commercial and Antitrust Law

                      Committee on the Judiciary,

                            Washington, DC.

    The Subcommittee met, pursuant to call, at 1:54 p.m., in 
room 2141, Rayburn Office Building, the Honorable Spencer 
Bachus (Chairman of the Subcommittee) presiding.
    Present: Representatives Bachus, Goodlatte, Marino, 
Holding, Collins, Smith of Missouri, Cohen, DelBene, and 
Garcia.
    Staff present: (Majority) Anthony Grossi, Counsel; Ashley 
Lewis, Clerk; and (Minority) James Park, Minority Counsel.
    Mr. Bachus. Well, good afternoon.
    The Subcommittee on Regulatory Reform, Commercial and 
Antitrust Law hearing will come to order.
    Without objection, the Chair is authorized to declare 
recesses of the Committee at any time. And, if we have votes, 
we will recess for those votes.
    Now, I will recognize myself for an opening statement.
    I would like to enter into the record the Committee memo 
that was prepared for this hearing. In my view, it is an 
excellent overview of the issues involved with improving the 
Bankruptcy Code in its role as a primary mechanism for dealing 
with distressed or insolvent financial institutions.
    [The information referred to follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
                               __________

    Mr. Bachus. One of our witnesses today is the president of 
the Federal Reserve Bank of Richmond, Jeffrey Lacker. And let 
me say that there are statistics in an essay prepared by the 
Richmond Fed that underscore the importance of what we are 
talking about. And let me read from the essay directly.
    And I quote, this was I think 2011 essay and it was on 
``too big to fail.'' According to--and I quote, ``according to 
Richmond Fed estimates, the proportion of total U.S. financial 
firms liabilities covered by the Federal financial safety net 
has increased by 27 percent during the past 12 years. The 
safety net covered $25 trillion in liabilities at the end of 
2011 or 57.1 percent of the entire financial sector. Nearly two 
thirds of the support is implicit and ambiguous.''
    And I think you see that two-thirds portion when we talk 
about Lehman and Bear Stearns. Where Bear Stearns received 
financial support from the government several months later. 
People are thinking, maybe that it is implied, that they will 
do the same thing with Lehman. And it didn't happen. And one of 
the results was people didn't prepare for it. It surprised 
people. And the uncertainty that ensuring--the government, the 
taxpayer ensuring that large portion of the financial assets of 
our country, the great majority, and then two thirds of that 
support being iffy is, I think, is a condition that all of us, 
in a bipartisan way, ought to be concerned about.
    Those are very significant financial liabilities to place 
on the Federal Government and ultimately on taxpayers. It is a 
structure that can tilt the field toward government 
intervention and bailouts. In my view, statistics like this 
strengthen the case for improving the bankruptcy process so 
that risks are borne by private parties and cases are handled 
in a consistent way, based on established precedent and rule of 
law.
    And let me say, this hearing is not about Dodd-Frank. But 
Dodd-Frank actually set up the mechanism for utilization of 
bankruptcy. So this hearing is not an attempt to substitute 
something for Dodd-Frank. In fact, Dodd-Frank called for a GAO 
hearing and Fed studies on how to improve bankruptcy. So, 
nothing we are saying today is an indictment of Dodd-Frank. In 
fact, ``living wills'' have been one of the few things that I 
think almost everyone, in a bipartisan way, has said that was a 
good thing. Although there is a--we discussed earlier 
witnesses, you have to be cautious that you don't set up a 
corporation structure as if it is going to bankrupt. But you 
ought to--there ought to be planning of what you are going to 
do in the case there is a bankruptcy.
    With that, let me recognize the Ranking Member of the 
Subcommittee, Mr. Cohen of Tennessee, for his opening 
statement.
    Mr. Cohen. Thank you, Mr. Chair.
    And I couldn't not start this hearing without 
congratulating you on your Auburn victory. What an unbelievable 
game. And you were there. I would like to yield to you. Would 
you tell us--we heard what the Auburn announcer said, when the 
kick was returned. Can you tell us what you said as the kick 
was returned? [Laughter.]
    Mr. Collins. The Alabama perspective was, ``Oh, God.''
    Mr. Cohen. And the Auburn perspective was, ``Thank God?'' 
[Laughter.]
    Mr. Bachus. Well, you know, I am--having represented 
Tuscaloosa County, the home of the University of Alabama for 20 
years, I am not all that vocal sometimes. But, I was thinking 
how lucky Auburn had been two games in a row. And I thought 
that after that immaculate catch against Georgia that we had 
had all the luck we deserved. But, we got some more of it. It 
was something to see.
    Mr. Cohen. But, what did you say? Did you say anything at 
all? I mean----
    Mr. Bachus. No. I sort of had that expression, if you seen 
number 56, that freshman at Auburn that has been on ESPN 
where---- [Laughter.]
    He is trying to put this all together. That's what we did. 
My wife is a University of Alabama graduate too. So----
    Mr. Cohen. That was a smart move on your part.
    Mr. Bachus. So, I was telling her how sorry I was. But she 
knew I wasn't very sincere. [Laughter.]
    Mr. Cohen. You are the kind of the opposite of McKaren and 
his girlfriend.
    Mr. Bachus. Yeah, she is an Auburn brat.
    Mr. Cohen. I know it.
    Mr. Bachus. That is how it is going to be. [Laughter.]
    All right.
    Mr. Cohen. Did you go to Toomer's Corner and throw toilet 
paper?
    Mr. Bachus. No. You know what, an Alabama fan poisoned 
those trees and killed them. That is true, I don't know if you 
knew that.
    Mr. Cohen. They pled guilty and should have gone to jail 
for a long time.
    Mr. Bachus. Yeah.
    Mr. Cohen. Bad guy.
    Mr. Bachus. But the---- [Laughter.]
    That is actually--that is true he went--but, you know, he 
was responding to Auburn students putting an--after the 2010 
victory over Alabama, Cam Newton, they put an Auburn jacket on 
Bear Bryant's statute. So, he felt like that was----
    Mr. Cohen. That was disrespectful.
    Mr. Bachus. Yes.
    Mr. Cohen. But, not worthy of killing trees.
    Mr. Bachus. No, they didn't kill Bear Bryant's statue.
    Mr. Cohen. Innocent there.
    Mr. Bachus. All right. I am sorry.
    Mr. Cohen. Back to Dodd-Frank---- [Laughter.]
    Which I voted for and proudly then, and support to this day 
and continue to.
    Its passage by Congress in 2010 was an acknowledgment that 
insufficient regulation led to the problem of the so-called 
``too big to fail'' financial institutions. Those were 
institutions that became so big and so interconnected that 
their insolvencies threatened to paralyze the entire financial 
system and the economy of the world. This situation in turn 
resulted in extreme pressure for taxpayer bailouts when those 
institutions fell under financial stress. And the bill, I 
think, was somewhat bipartisan, pretty bipartisan to save the 
country and bail out the banks because we had to.
    The bankruptcy filing of Lehman Brothers in 2008, which was 
the largest bankruptcy in our history, involved more than $600 
billion in assets and illustrates this problem. The bankruptcy 
filing greatly exacerbated the financial panic on Wall Street, 
leading to a severe crisis in the greatest economic downturn 
since the Great Depression, now we call it the Great Recession. 
The financial markets' reaction to Lehman Brothers' bankruptcy 
highlighted potential limitations of the Bankruptcy Code in 
handling the resolution of these financially distressed 
institutions and the systemic effect they would have on 
financial institutions in general. Dodd-Frank has certain 
enhancements in it that are strong ways that we have dealt with 
and responded to that problem.
    I support legislation to increase the minimum required 
amount of capital for covered financial institutions under 
Dodd-Frank. We should also consider the potential need for 
other enhancements like adding a representative of the 
Antitrust Division of the Department of Justice to the 
Financial Stability Oversight Council, which was created by 
Dodd-Frank to oversee the stability of the financial system.
    It is in this spirit that I approach today's hearing, which 
will focus on whether current Bankruptcy Code is sufficient to 
allow for the early reorganization or liquidation of 
systemically important financial institutions under title I of 
Dodd-Frank.
    Whether one supports or doesn't support Dodd-Frank, we can 
agree that today's inquiry is an important one to the extent 
that modest revisions to the Bankruptcy Code will help ensure 
that we avoid the need for additional future taxpayer bailouts 
of financially struggling large financial institutions. We 
should be able to work together in crafting such changes.
    Just as the Chairman of the full Committee brought us 
together on patent reform, I feel confident that the Chairman 
of the Subcommittee, that great Auburn war eagle, can bring us 
together on something to solve this problem too.
    With that, I yield back the balance of my time.
    Mr. Bachus. I thank Mr. Cohen for that opening statement.
    And, at this time, I recognize Chairman Goodlatte, the full 
Committee Chairman.
    Mr. Goodlatte. Well, thank you, Mr. Chairman. I appreciate 
your holding this hearing.
    The Bankruptcy Code has existed in this country for well 
over a hundred years. Over this time, our bankruptcy system has 
evolved to become one of the most sophisticated regimes in the 
world. The bedrock principle embedded in the bankruptcy system 
of providing for the efficient resolution and reorganization of 
operating firms, has allowed our economy to grow and flourish. 
Nevertheless, a periodic evaluation of the Bankruptcy Code to 
ensure its adequacy to address the challenges posed by the 
changing nature of operating firms, is one of the fundamental 
responsibilities of this Committee.
    I applaud Chairman Bachus for holding today's hearing to 
examine whether the existing Bankruptcy Code is best equipped 
to address the insolvency of large and small financial 
institutions.
    The bankruptcy process confers a number of benefits to all 
operating companies, including financial firms. The bankruptcy 
court provides transparency and due process to all parties 
involved. Furthermore, bankruptcy case law has been developed 
over decades providing consistency and predictability. 
Additionally, the bankruptcy process has been sufficiently 
dynamic to administer the resolution and restructuring of 
complex operating companies with billions of dollars in assets, 
as well as smaller companies and individuals.
    But, despite the bankruptcy system's ability to accommodate 
complex operating companies, financial firms may possess unique 
characteristics that are not yet optimally accounted for in the 
Bankruptcy Code. For example, efficient and orderly resolution 
of financial firms can require an unusual level of speed. 
Refinements to the code might be considered to provide--to 
better provide that speed, while still assuring due process. 
Additionally, in some circumstances, the failure of financial 
firms can pose unique threats to the broader stability of the 
economy. To account for that, title I of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act requires certain 
firms to prepare ``living wills'' to plan for resolution in 
bankruptcy in the event of failure.
    The Bankruptcy Code is well crafted to maximize the 
recoveries of a debtor's creditors, while providing an 
opportunity for the debtor to either reorganize or liquidate in 
an orderly fashion. It might, however, bear improvements 
designed specifically for the efficient execution of title I 
living wills. There are some of the--these are some of the 
issues that may need to be examined as part of the broader 
evaluation of the existing Bankruptcy Code's adequacy to 
address financial institution insolvencies.
    I look forward to the testimony from today's excellent 
panel of witnesses on these important issues.
    And, Mr. Chairman, I thank you and yield back the balance 
of my time.
    Mr. Bachus. I thank you.
    And without objection, other Members' opening statements 
will be made a part of the record.
    And I do agree with the Chairman when he says that we have 
an excellent panel of witnesses, because we do have three of--
really people that, in a bipartisan nature, we consider experts 
on bankruptcy and how it can be enhanced to address complex 
situations.
    I will first begin by introducing our witnesses.
    Governor Lacker is the current president of the Federal 
Reserve Bank of Richmond, where he began his term on August 
1st, 2004. Prior to serving as the president of the Richmond 
Federal Reserve, he was a research economist with the bank for 
25 years, serving in various capacities including vice 
president, senior vice president and director of research. He 
is the author of numerous articles and professional journals on 
monetary financial and payment economics. And he has presented 
his work at universities and central banks worldwide. He 
received his BA in economics from Franklin and Marshall 
College, and a doctorate in economics from the University of 
Wisconsin.
    Mr. Bernstein, Donald Bernstein, is a partner of Davis Polk 
here in Washington. Is that right or New York? New York, okay. 
Where he heads the firm's insolvency and restructuring 
practice. During his distinguished 35-year career, he has 
represented nearly every major financial institution in 
numerous restructuring, as well as leading a number of 
operating firms through bankruptcy including Ford, LTV Steel, 
and Johns Manville. Mr. Bernstein has earned multiple honors 
for his practice including being elected by his peers as the 
chair of the National Bankruptcy Conference, the most 
prestigious professional organization in the field of 
bankruptcy. Mr. Bernstein received his AB cum laude from 
Princeton University and his JD from the University of Chicago 
Law School. And we welcome you.
    Professor Mark Roe is a professor of law at Harvard Law 
School where he teaches business bankruptcy and corporations 
courses. Professor Roe has authored countless articles and 
opinion pieces that have been published across the globe 
including in the law reviews and--the law reviews of Penn, 
Virginia, Columbia, Michigan, Stanford, Yale, and Harvard. He 
also literally wrote the book on corporate restructuring that 
is used in law schools across the country. Prior to joining 
Harvard's faculty, Professor Roe taught law at Columbia 
University, the University of Pennsylvania and Rutgers 
University. Prior to joining academia, he worked at the law 
firm of Cahill Gordon and at the Federal Reserve. Professor Roe 
received his BA from Columbia University summa cum laude, and 
his JD from Harvard Law School.
    Each of the witnesses' written statements will be entered 
into the record in its entirety. I ask that each of the 
witnesses summarize his testimony or her testimony. I am not 
going to restrict you to 5 minutes, I think it is too 
important. If you go over that, that is fine.
    And so I am not going to read this about the light and all 
that.
    So, we--at this time, Governor Lacker, you are recognized 
for your opening statement.

          TESTIMONY OF JEFFREY M. LACKER, PRESIDENT, 
                FEDERAL RESERVE BANK OF RICHMOND

    Mr. Lacker. Thank you, good morning.
    I am honored to speak to the Subcommittee about why I 
believe it is important to improve our Bankruptcy Code to make 
it easier to resolve failing financial firms in bankruptcy.
    At the outset I should say that my comments reflect my own 
views and do not necessarily reflect those of the Board of 
Governors or my other colleagues at other Federal Reserve 
banks.
    I think the events of 2008 provide strong evidence of 
glaring deficiencies in the way financial institution distress 
and insolvency are handled, particularly at large institutions. 
The problem, widely known as ``too big to fail,'' consists of 
two mutually reinforcing expectations.
    First, many financial institution creditors feel protected 
by an implicit government commitment of support should the 
institution face financial distress. This belief dampens 
creditors' attention to risk and it leads to overuse of types 
of borrowing such as short-term wholesale funding that are more 
fragile, more prone to runs, more prone to volatility.
    The second of these two mutually reinforcing expectations 
is that if a large financial firm is highly dependent on short-
term funding, policymakers are often unwilling to let it file 
for bankruptcy under the U.S. Bankruptcy Code fearing that it 
would result in undesirable effects on counterparties. This 
fear leads policymakers to intervene in ways that allow short-
term creditors to escape losses such as through central bank 
lending or public sector capital injections.
    This behavior just reinforces creditors' expectations of 
support. That in turn reinforces firms' incentives to grow 
large and their incentive to rely on short-term funding which 
in turn reinforces policymakers' proclivity for intervening to 
support creditors. The result is more financial fragility and 
more rescues. The path toward a stable financial system 
requires that policymakers have confidence in the unassisted 
failure of financial firms under the U.S. Bankruptcy Code and 
that investors are thereby convinced that unassisted bankruptcy 
is the norm. This is why I believe it is vitally important to 
ensure that our bankruptcy laws are well crafted to apply to 
large financial institutions.
    In response to the experience of 2008, title I of the Dodd-
Frank Act laid out a planning process for the resolution of 
failed financial institutions. A resolution plan or ``living 
will,'' as they are popularly called, is the description of a 
firm's strategy for rapid and orderly resolution under the U.S. 
Bankruptcy Code without government assistance. It spells out 
the firm's organizational structure, key management information 
systems, critical operations, and a mapping of the relationship 
between core business lines and legal entities. The heart of 
the plan is the specification of the actions the firm would 
take to facilitate rapid and orderly resolution and prevent 
adverse effects of failure, especially the firm's strategy to 
maintain critical operations and funding.
    The Federal Reserve and the Federal Deposit Insurance 
Corporation can jointly determine that a plan is ``not 
credible'' or would not facilitate the orderly resolution--an 
orderly resolution under the Bankruptcy Code. And, in that 
case, the firm would be required to submit a revised plan to 
address deficiencies. If the Fed and the FDIC jointly determine 
that the revised plan does not remedy identified deficiencies, 
they can require more capital, increase liquidity requirements, 
reduce reliance on short-term funding, or restrict the growth, 
activities or operations of the firm. In essence, regulators 
can order changes in the structure and operations of a firm to 
make it resolvable in bankruptcy without government assistance.
    Note the implication here that if a firm would require, the 
way it is running itself now, an unrealistically large amount 
of ``debtor-in-possession'' financing, regulators can require 
ex ante, pre-bankruptcy changes in the firm's funding structure 
so that plans for funding operations in bankruptcy are 
realistic and credible.
    Title II of the Dodd-Frank Act gives the FDIC the ability 
to take a firm into receivership under its so-called ``Orderly 
Liquidation Authority,'' if there is a determination that the 
firm's failure under the U.S. Bankruptcy Code would have 
serious adverse effects on U.S. financial stability. Title II 
receivership differs from the Bankruptcy Code in that the FDIC 
would have the ability to borrow funds from the U.S. Treasury 
to support creditors, and would have broad discretion to treat 
similarly situated creditors differently. This is likely to 
replicate the two mutually reinforcing expectations that define 
``too big to fail.'' And this is why improving the Bankruptcy 
Code to facilitate orderly resolution of large financial firms 
is so important. It would position us to wind down the Orderly 
Liquidation Authority at an appropriate time and to wind down 
other financing mechanisms such as the Federal Reserves' 
remaining 13(3) powers to lend in ``unusual and exigent 
circumstances.''
    Without winding these down, I think that those mutually 
reinforcing conditions are likely to arise again. Expectations 
of support, in the absence of clear guidance as to when and 
where support will be forthcoming, will encourage excessive 
risk taking. That risk taking will trap policymakers. It will 
put them in a box and force them to respond with rescues and 
support, in the event of distress.
    The Dodd-Frank Act itself clearly envisions bankruptcy 
without government support as the first and most preferable 
option in the case of a failing financial institution, and for 
good reason, in my view. The expectation of resolution in 
bankruptcy without government support would result in a much 
better alignment between the incentives of market participants 
and our public policy goal of a financial system that 
effectively allocates capital and risk.
    Thank you very much.
    [The prepared statement of Mr. Lacker follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
                               __________
    Mr. Bachus. Thank you.
    Mr. Bernstein?

  TESTIMONY OF DONALD S. BERNSTEIN, CO-CHAIR, INSOLVENCY AND 
       RESTRUCTURING GROUP, DAVIS POLK AND WARDELL L.L.P.

    Mr. Bernstein. Well, thank you for inviting me to testify.
    I have spent a lot of my practice life dealing with the 
failures of financial institutions, starting with Drexel 
Burnham many years ago. And, in recent years, I have done a lot 
of work on resolution plans, ``living wills.''
    I too am here in my individual capacity, however, and the 
views I express are my own. They are not to be attributed to my 
firm or clients or organizations with which I am affiliated.
    I want to begin with a few observations about the Lehman 
Brothers bankruptcy and its implications for the bankruptcy of 
other large financial institutions. Then I am going to provide 
a bit of an overview of how orderly liquidation authority is 
being contemplated to be used, including the single point of 
entry resolution strategy that has been developed by the FDIC. 
And then, I am going to turn to the Bankruptcy Code and talk a 
bit about how resolution planning has interfaced with the 
Bankruptcy Code in its current form. And I will end with a few 
suggestions as to the way the code might be amended to make it 
easier to resolve financial firms.
    The unplanned failure of Lehman Brothers as we all know had 
an enormously disruptive effect on the U.S. economy. Financial 
firms are very vulnerable to a loss of confidence. Even if 
their economic fundamentals haven't changed once the confidence 
is lost because they are in the business of so-called maturity 
transformation. They incur short-term liabilities like deposits 
and some of the other short-term liabilities that were just 
mentioned and they invest them in long-term assets like 
mortgages and corporate loans and the like. And when short-term 
creditors lose confidence they run. They take their money and 
they run.
    And if a run is prolonged and intense, it can force the 
firm to sell assets at fire-sale prices and distress markets 
and exacerbate any losses that might otherwise exist. And that 
also results in depressing market values generally, which has a 
follow-on effect to other firms. So, if you have this process 
of unwinding of maturity transformation from what it has been 
called, ``contagious panic,'' you end up with a very 
destabilizing situation. And, in fact, that is how Lehman 
Brothers' unplanned failure actually unfolded.
    Now, to avoid this disrupt--this abrupt unraveling of 
maturity transformation, distressed firms need to be able to 
meet sudden liquidity needs without being forced to abruptly 
sell their assets. And, over the longer term, they need to be 
able to either be recapitalized or wound down in an orderly way 
that doesn't create the risk of fire sales of assets. In 2008, 
neither the regulators nor the firms had the tools to 
accomplish these goals without financial support from 
taxpayers. And though the large institutions ended up repaying 
those investments, there was wide recognition that more tools 
were needed to avoid having taxpayer funds put at risk again.
    Many regulators and commentators believe that some of the 
tools that are being developed, under title II of Dodd-Frank, 
actually accomplish this goal. And I am going to describe the 
single point of entry tool, which is the most--the one that is 
most frequently discussed. In a single point of entry 
resolution, only the holding company for the financial 
institution is put into an insolvency or receivership 
proceeding. All of the losses are borne by the holding 
companies, creditors and shareholders. And the operating 
subsidiaries, like the bank or the broker-dealer, wouldn't 
fail. They would be recapitalized using assets that are 
maintained for that purpose at the holding company and they 
would continue in business as a newly created--as subsidiaries 
of a newly created holding company which, under orderly 
liquidation authority, is called a bridge holding company.
    There are a number of reasons why many people think this 
approach has some viability. The first is that the holding 
company structure used by large financial institutions creates 
an additional layer of loss-absorbing debt that is effectively 
subordinated to operating liabilities and especially the short-
term liabilities that were just mentioned that are down in the 
operating subsidiaries. The firms have also substantially 
increased the amount of loss-absorbing capital and debt that 
are in the holding companies and new rules are expected to be 
forthcoming that require them to maintain sufficient loss-
absorbing debt and assets at their holding companies. So 
financially the firms should be in a position to execute the 
type of recapitalization that is being contemplated with all of 
this additional loss absorbency that they have.
    In addition, because the firm's operating subsidiaries keep 
in business, single point of entry eliminates the need for 
multiple insolvency proceedings for different entities, both 
domestically and in foreign countries, which greatly reduces 
the complexity of the resolution process. That was one of the 
big problems in Lehman Brothers. You had a siloing of each 
entity, one from the other, that resulted in the inability to 
effectively resolve because you had too many people, too many 
parties to consult with and the inability to deal with entities 
on a regular-way basis.
    To supplement this, there have been initiatives on a 
multinational level including those at the Financial Stability 
Board and crisis management groups that have been organized by 
key regulators of individual firms that are creating increased 
alignment among the national regulatory authorities regarding 
the benefits of what are called single point of entry and bail-
in approaches to the failure of financial firms. And this is 
evidenced by joint work that has been done by the FDIC and the 
Bank of England on the subject.
    Finally and importantly, orderly liquidation authority does 
include certain special tools that are not currently available 
under the Bankruptcy Code. And that is going to lead me into my 
discussion of bankruptcy. But, those tools really are not 
that--there aren't that many of them. There are three very 
important ones.
    One is the clear path that orderly liquidation authority 
provides to creating a bridge holding company and transferring 
the stock of recapitalized subsidiaries to the bridge holding 
company. That separates them from the debt and the equity of 
the old holding company and effectively creates a recapitalized 
entity.
    The second important feature is the orderly liquidation 
fund which is underwritten by the private sector and provides 
fully secured interim liquidity, if needed, to stabilize the 
recapitalized firm.
    And the third is the preservation of financial contracts by 
briefly staying closeouts and having provisions that override 
cross-defaults and bankruptcy defaults so the contracts can be 
assumed by the ongoing entities. Again, a problem that was 
faced in Lehman Brothers because of the safe harbors in the 
Bankruptcy Code.
    Recognizing that progress is being made in developing the 
single point of entry strategy, just a couple of weeks ago, 
Moody's Investor Service announced that it was removing the two 
notch uplift provided to ratings of debt of the largest bank 
holding companies to account for the possibility of government 
support. Effectively, they have reached the conclusion that 
that government support is going to be unnecessary because of 
the progress that is being made on resolution.
    So, let us turn to the Bankruptcy Code now. I agree 
completely that traditional bankruptcy proceedings do provide a 
path that, despite the Lehman Brothers' experience, can be 
utilized to resolve financial firms provided that there is 
appropriate preplanning. The Bankruptcy Code provides 
transparency. It provides the opportunity for effected parties 
to receive notice and be heard in court and ex ante judicial 
review prior to major actions. All of which serve to inspire 
market confidence. And, if you talk to people who are 
investors, all of them like--uniformly like the Bankruptcy 
Code. They like the transparency.
    In my view, these are clear benefits of the bankruptcy 
process. However, the absence of the special tools available 
under orderly liquidation authority makes it harder for 
financial firms in bankruptcy to utilize a single point of 
entry strategy. As a result, the title resolution--title I 
resolution plans typically adopt a hybrid approach in which 
some operating businesses are contemplated to be sold or 
recapitalized, while others are allowed to wind down in an 
orderly way. First, the resolution plans identify the material 
operating entities that, because of their capital structure or 
the nature of their business, are unlikely either to suffer 
losses or that can be recapitalized as they would be under 
orderly liquidation authority.
    And then, there are tools, such as Section 363 of the 
Bankruptcy Code that can be used to accomplish a speedy sale or 
transfer of the stock of those entities that are not going to 
fail to a debt-free holding company or to a third party. And 
the debt-free holding company might be owned by a trust for the 
creditors of the bankruptcy estate so that the creditors in 
fact are not losing value, but they are actually preserving the 
going concern value and it is being held for their benefit by a 
fiduciary. The new holding company can then be sold in private 
transactions or public transactions, pieces of it can be sold 
or its shares can be distributed to the left-behind creditors 
in a conventional Chapter 11 plan of reorganization.
    This is all possible under the current code. Now, entities 
that can't be sold or recapitalized need to be wound down in an 
orderly way. And the wind downs need to be carefully planned 
taking into account the impact of the different insolvency 
regimes; the reactions of regulators, customers, 
counterparties, financial market utilities, and others that 
need to be anticipated in the resolution plan. Liquidity needs, 
through the wind down, need to be conservatively anticipated 
and the maintenance of shared services and technology, and the 
transition of critical operations to other firms, and the 
distribution of customer assets and property need to be 
provided for.
    Today, liquidity levels at the firms allow them to sustain 
in addition a pre-failure runoff of some of their balance 
sheet. You may recall that in 2008 one of the problems that 
faced Lehman Brothers was----
    Mr. Bachus. Let me----
    Mr. Bernstein. Sorry.
    Mr. Bachus. We have a pending vote series----
    Mr. Bernstein. Okay.
    Mr. Bachus [continuing]. On the House floor. So, we are 
going to stand in recess. We will come back and I will allow 
Mr. Bernstein to complete that very good opening statement.
    And the Committee stands in recess, subject to the call of 
the Chair.
    And we ask Members to return immediately so we may resume 
the hearing as soon as possible. And we anticipate doing that 
fairly soon, but the staff will keep you abreast.
    Thank you.
    [Recess.]
    Mr. Bachus. We will go ahead and commence the hearing so 
that the Committee is called to order.
    And, Mr. Bernstein, you are recognized for your----
    Mr. Bernstein. Thank you, Mr. Chair.
    So, I was just describing how the resolution plans seem to 
be evolving into hybrid strategies involving continuation of 
some entities and wind down of others. And I was giving an 
example of how today, with the liquidity levels that the firms 
have, some of that wind down can actually happen prior to 
failure because they have got the ability to address 
liabilities that are running for a period of time because of 
the liquidity on their balance sheets. And I was mentioning the 
example of prime brokerage accounts, which were one of the 
precipitating liquidity factors in Lehman's bankruptcy. And 
that is something that can be planned for. And it can actually 
make the resolution process less complex and less systemically 
disruptive.
    And I also note in my written statement a number of other 
ways that the plans contemplate taking steps, either well in 
advance or immediately prior to the failure of the firm, to 
reduce the complexity of the wind downs of entities that are 
not being recapitalized or sold.
    So, to summarize, the title I plans rely on a combination 
of approaches to orderly resolution under the code. They adjust 
some current operating practices to simplify resolution. They 
plan for client-driven reductions in the firm's balance sheet, 
prior to resolution. They preplan the marketing and sale of 
some of the firm's businesses. They contemplate 
recapitalization and continuation of others and the wind down 
of still others. Those hybrid approaches can actually be quite 
robust with appropriately detailed planning. And I can't 
emphasize that enough. The plans are extremely detailed and 
they need to be.
    So, part of making these things work is not only the 
planning process, but also appropriate consultation with 
regulators in advance and education of both regulators, market 
participants and those who administer the bankruptcy process so 
they understand how these plans work and are in a better 
position to implement them.
    Now all of that being said, I think the hybrid approaches 
do entail complexity and more risk than the single point of 
entry approach. So, I believe that reforms to the Bankruptcy 
Code that add tools to facilitate the single point of entry 
approach, perhaps in the form of a modified Chapter 14, which I 
know people have been talking about, should be considered.
    These changes would include, among other things, clarifying 
that bank holding companies can indeed recapitalize their 
operating subsidiaries prior to commencement of bankruptcy 
proceedings; clarifying that Section 363 of the Bankruptcy Code 
can be used to create a new bridge holding company, in the 
manner that I described; briefly staying closeouts and allowing 
the assumption and preservation of financial contracts, 
including overriding bankruptcy defaults or cross defaults to 
facilitate resolution; and providing a fully secured resource, 
like the OLF, to be available if DIP financing, debtor-in-
possession financing, is not available in the market.
    Expanding resolution options in bankruptcy will minimize 
systemic risk and better avoid putting taxpayer money at risk. 
But, importantly, even if the Bankruptcy Code is amended, I 
think it is important that we retain all of our options. That 
single point of entry in bankruptcy is not the only option, but 
that the orderly liquidation authority be retained as a backup 
option; not necessarily the first choice, but just to have it 
there in case it is needed.
    We can't know what the contours of the next crisis will be. 
And we should want regulators to have the greatest variety of 
tools in their toolkit. In addition, host country regulators, 
regulators in other countries who are less familiar with our 
bankruptcy system, will take comfort from the fact that, if all 
else fails, U.S. regulators have the power to act.
    I want to thank you for allowing me this opportunity to 
present my views.
    [The prepared statement of Mr. Bernstein follows:]

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                               __________

    Mr. Bachus. Thank you very much.
    And, Professor Roe?
    Now, let me say this, I think that the testimony so far has 
been very substantial and very helpful. And it--a lot of good 
discussion on policy. So, thank you.

          TESTIMONY OF MARK J. ROE, PROFESSOR OF LAW, 
                       HARVARD LAW SCHOOL

    Mr. Roe. I will do my best to maintain that.
    So, Chairman Bachus, thank you for the gracious 
introduction earlier.
    I am Mark Roe. I am a law professor who focuses on 
corporate law, business law, business bankruptcy issues. And I 
do appreciate the opportunity to be here to provide you with my 
views on the Bankruptcy Code's adequacy in dealing with 
failing, failed financial institutions.
    I am going to focus my testimony on the exemptions from 
bankruptcy for derivatives and short-term financing, the so-
called ``bankruptcy safe harbors.'' Simply put, the Bankruptcy 
Code, as it is set up now, cannot effectively deal with most 
large failing financial institutions. And a core reason for 
that is that the safe harbors are far too wide. They exempt too 
much short-term financing and risky investments from the normal 
operation of American bankruptcy law. They thereby make an 
effective resolution in bankruptcy without regulatory support 
harder than it needs to be, quite possibly impossible. They 
undermine market discipline in the prebankruptcy market making 
the financial system riskier and more prone to suffer major 
failures. They subsidize short-term lending over stronger, more 
stable longer-term financing for financial institutions. We get 
more subsidized short-term debt and less stable, but 
unsubsidized, longer-term debt. They also make it harder for 
financial upstarts and regional banks to compete with the big 
money center banks.
    Five years ago Lehman Brothers propelled forward the 
financial crisis, when it filed for bankruptcy. The Lehman 
bankruptcy proved to be chaotic and the country suffered a 
major economic setback from which it is still recovering. Yet, 
if a Lehman-class bankruptcy occurred today, the Bankruptcy 
Code and the bankruptcy system really couldn't do any better 
than it did in 2008. So, if a major financial failure gets by 
the regulators for whatever reason, we still really can't count 
on bankruptcy to catch the ball.
    Complex systems, and our financial world is one very 
complex system, need redundancy in dealing with failure. If one 
stabilizer fails in a complex system, we want another mechanism 
to take over to avoid a catastrophic failure. Engineers know 
that and we should start to make bankruptcy a more viable 
option than it is today.
    Second reason for acting on this is that bankruptcy is the 
first line of defense by statute and regulatory preference. 
Financial regulators say that they will play the Dodd-Frank 
title II card only if bankruptcy fails. But, regulators cannot 
allow a bankruptcy for even a day to see if it works, if we 
have a major, systemically important financial institution with 
significant safe harbored securities, because, under today's 
bankruptcy rules, as soon as the financial institution with 
major safe harbored financing files for bankruptcy, the 
exemption for bankruptcy for much of its short-term debt and 
for its derivatives portfolio will lead its counterparties to 
rip apart the bankrupts portfolio. There will be no chance to 
put Humpty Dumpty back together.
    The third reason to work on bankruptcy as a viable 
alternative: it is possible that title II may not work. It 
hasn't been tried. And we should be wary of untested systems.
    What are the kinds of things we should be thinking about 
doing for the Bankruptcy Code?
    First, the kind of collateral that is allowed for short-
term lending safe harbors that are exempt from normal 
bankruptcy should be narrowed. Yes, for United States Treasury 
securities. No, for mortgage-backed securities.
    Second, the broad exemption from bankruptcy for safe 
harbored counterparties should be curtailed. They should be 
required to stay in bankruptcy for long enough so that the 
court can sell off bundles of the failed firm's derivatives 
book intact. The chaotic closeouts in Lehman Brothers are said 
to have cost Lehman about $50 billion in value. We could do 
better with a better Bankruptcy Code.
    Third, the blanket preference safe harbor needs to be 
better targeted. Preference law has long reduced creditor's 
incentives to grab collateral and force repayment on the eve of 
bankruptcy, driving a weak but possibly survivable firm into 
bankruptcy. Preference law reduces the incentives to grab and 
demand repayment on the eve of bankruptcy.
    So, if John owes Jane $1 billion in normal debt and if she 
holds a gun to John's head and says, ``Repay me,'' when he is 
on the verge of bankruptcy, she would go to jail for extortion 
and the $1 billion will be recovered from Jane as a preference 
in John's bankruptcy for the benefit of all of John's 
creditors. And the $1 billion preference forced out of John 
prior to his bankruptcy, will be recoverable even if Jane 
exerts much less pressure than with a gun. But, if John owes $1 
billion to Jane in derivatives debt and she holds a gun to his 
head to collect, then she will also go to jail for extortion, 
but she won't have to return the $1 billion as a preference. 
The derivative safe harbors will fully protect her from the 
operation of preference law.
    I would submit that this exempting of blatant grabs from 
basic preference law is one of the several overly wide aspects 
of the safe harbors that need correction and narrowing to fit 
markets better. And there is reason to believe that the 
collateral grabs that AIG suffered, as it sank in 2008, would 
have been preferential had the safe harbors not existed. AIG 
might have failed, would probably have failed and quite 
plausibly would have been bailed out anyway, but maybe it 
wouldn't have been done in such dire circumstances and there 
would have been more regulatory options available, if so much 
of AIG's obligations were not safe harbored.
    So, overall, bankruptcy should support financial safety 
better than it does now. Bankruptcy should be capable of 
resolving a non-bank, systemically important financial 
institution with major positions in safe-harbored financing. 
But, as of today, it cannot. Because it cannot, bailouts are 
more likely than otherwise and, perhaps even more importantly, 
system-wide costs to the economy are more likely than they 
would be otherwise. Bankruptcy should not subsidize the 
riskiest forms of financing and investment, the shortest-term 
debts in our financial system. And they shouldn't be 
facilitating riskier, weaker, systemically important financial 
institutions. Today, bankruptcy subsidizes this extra risk and 
short-term finance.
    Bankruptcy should promote market discipline. Today it tends 
to undermine that market discipline via the safe harbors, 
making our financial institutions weaker than they otherwise 
would be. Several of these problems can be fixed. They are not 
that hard to fix. And we should fix them.
    Thank you.
    [The prepared statement of Mr. Roe follows:]

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                               __________

    Mr. Bachus. Thank you very much.
    Mr. Smith, do you have any questions or do you want me to? 
I can go first and then you can. All right thank you.
    Hearing your testimony, I think we are all thinking back to 
2008 in our mind. And we are talking about the failures of what 
is now called SIFIs and there was obviously almost a ``domino 
effect.'' I mean, everyday there was a Merrill Lynch or there 
was a Lehman. For a while there AIG was just--you pick up the 
paper and what is next?
    I do think, as we consider what we are going to do, you 
mentioned redundancy. I think that was your testimony Professor 
Roe, which I think is tremendously important in a case like 
that, because I--when you said, you know, title II might work, 
but it might not work. Or enhanced bankruptcy may work, but it 
may not. But you have two tracts. And I have told people that 
2008 was almost like the economy had a stroke or a heart 
attack. And it was--you know, as with a stroke or heart attack, 
you need to get to the patient, time is of the essence.
    And knowing that, we also add the political theater of 
what, you know, as these companies either begin to--they become 
insolvent--there is probably only going to be maybe two or 
three--it would be unusual to have one, because I think some of 
the regulations we have now on short-term financing and over 
leveraging, hopefully we won't have that. But it may be almost 
a systemic event. And you wonder whether you have to also 
factor in, is Congress going to try to intervene which even 
complicates that.
    I think it is important for us to address this now, not do 
it in the middle of a crisis where we are being pushed around 
by changing sentiment. And I think you have all given us a 
roadmap.
    One thing that I am struck by, that I did not know at the 
time, AIG was credit default swaps. I mean this was all pretty 
risky stuff. It was their insurance business, which was their 
core business, was totally reserved, there was no--but it was 
one of their subsidiaries. And I am just wondering, and I--my 
first question, Mr. Bernstein, in that case you had a 
subsidiary where the liability was overwhelming the whole 
company. That single point of entry, does that work in that 
situation?
    Mr. Bernstein. I am going to answer this one in the 
abstract because we had a major involvement in AIG, so I would 
prefer to keep it to the general.
    I think if you have significant liabilities in one 
subsidiary, first of all, if you made some of the changes that 
permitted you to assume the credit default swaps and other 
types of instruments rather than having them terminate on 
bankruptcy, you would have many more options. You could put 
that subsidiary into bankruptcy and you could preserve those 
contracts as a book which had value. Or you could recapitalize 
that entity or do other things. Whereas, you know, currently, 
with the way bankruptcy works, bankruptcy wasn't an option.
    Mr. Bachus. Right. And, you know, from your testimony, I 
think both of you mentioned that the safe harbor includes 
derivatives. So, it probably included credit default swaps. So, 
which took, in the case of AIG, almost all their liabilities 
were outside of bankruptcy or were in the safe harbor. You 
know, one--there was a lot of discussion back then about good 
bank, bad bank. Though that is not what you are proposing, is 
it?
    Mr. Bernstein. No. It is the single point of entry approach 
is not really so much good bank, bad bank. It is really taking 
a group of stakeholders that are subordinated and imposing the 
losses on them in the private sector, rather than having the 
public sector support the institution.
    Mr. Bachus. Yeah.
    You know, there is. I think Senator Vitter has a bill to 
basically do away with our largest financial institutions. I 
know this isn't the subject of this hearing and there is a lot 
of discussion on that. But, I want to say this, I don't think 
that is the best alternative because we have to compete on a 
global marketplace. And I think one of our strengths is we do 
have some very large companies and financial institutions they 
are, of course, and I know I am not going to ask you all, at 
this point, you know, unless you want to discuss that. Does 
anyone want to volunteer?
    Mr. Lacker?
    Mr. Lacker. I will just comment that there is a relevance. 
There is a connection between bankruptcy reform and strategies 
like Vitter's or my colleague--former colleague Tom Hoenig, who 
have advocated dividing up the institutions either by size or 
activities. You know, what you want to achieve. What those 
strategies are designed to achieve is a situation in which 
those firms are resolvable in bankruptcy without government 
support. I think that is their general objective. And the 
planning work, that Mr. Bernstein described so eloquently and 
in detail, that is the way you would deduce, that is the way to 
figure out exactly what they have to look like now in order for 
us to feel confident in the future, in extremis, that you could 
take them through bankruptcy with a fair amount of confidence 
that it would be orderly enough to be workable.
    At this point in the process of those ``living wills'' we 
have just been through, we have just had a second round of 
submissions, I don't think we know enough now to know exactly 
what changes we need to make. Whether it is--I am not sure size 
is the right criteria and I am not sure activities are. I think 
it is likely to be more--it is more likely to be things like 
what Mr. Bernstein pointed to, having clear plans, having 
detailed plans; organizing your legal entities in conformance 
to your operating activities in a way that makes them 
severable, if need be, in bankruptcy, if you ever feel the need 
to spinoff a foreign subsidiary, for example, or handle a 
foreign subsidiary differently than domestic subsidiaries.
    So I think all those things are well motivated. But, I 
think the ``living will'' and the planning process centered 
around a bankruptcy filing and the fine details of what that 
looks like, I think that is going to be more informative and 
more reliably get us to the right kind of solution.
    Mr. Bachus. You know, AIG, in all of this, is a great 
example to look at because for--on several different angles. 
But you did have a foreign subsidiary in London that really was 
making bets it couldn't afford to lose and in staggering 
percentages.
    You also, if you are dealing with a global financial 
institution headquartered here or even headquartered somewhere 
else, you--and I am sure somewhere in the Bankruptcy Code, I am 
not sure how you would--there would have to be some cooperation 
globally between regulators or between really the court system 
in different countries. And what would you--how would you 
address a company that was operating major subsidiaries and 
business across the globe?
    Mr. Bernstein. This is also an area where resolution 
planning is important because, one, you can't assume that local 
jurisdictions are going to act outside their own self-
interests. So, you have to assume self-interest will be the 
driving force. And you have to design plans that demonstrate 
that the self-interest of the local jurisdiction is going to be 
fulfilled by cooperating with the resolution.
    Many of them do not have a bankruptcy process like we do. 
They have got a purely administrative process. Some countries 
go in the other direction and have processes which are purely 
common law. So, you have to really look at each entity and look 
at how you demonstrate it is in the local interest to 
cooperate.
    Mr. Bachus. All right.
    You know, again, derivatives would have, if there was a 
derivative, if they weren't in a safe harbor, if there were 
some provisions in dealing with those, as opposed to sort of a 
fire sale, both Lehman and AIG, I think, you know, would be 
some benefit if that had been in the code.
    Mr. Roe. Well that--the difficulty with the safe harboring 
that causes problems for financial institutions with a major 
derivatives portfolio is that the portfolio is put together as 
a unit: buy pounds on this side and sell pounds on that side. 
And the best way to be able to reposition the portfolio is to 
sell it intact or to sell obvious units of the portfolio 
intact. The safe harbors make this very difficult because I may 
have packaged selling pounds with buying pounds together, but 
my counterparty will tend to closeout this part of the 
portfolio and my other counterparty might close out that part 
of the portfolio on terms that aren't particularly favorable to 
me and make it impossible for me to sell the portfolio 
somewhere else, if I have a buyer. With some cutback on the 
safe harbors, we have the potential to be able to put the 
portfolio together and reposition it and sell it presumably 
quickly in a bankruptcy. We can't really do that in bankruptcy 
now. It is possible to do that under title II, but it is not 
really viable for a firm that has significant derivatives that 
actually does the filing for bankruptcy.
    Mr. Bachus. Would, under the Bankruptcy Code that you 
envision, would all safe harbors be--would there be no safe 
harbors or would you do it incrementally?
    Mr. Roe. Incrementally.
    And there are several things in the Bankruptcy Code that 
make it difficult or impossible for the good functioning of the 
derivatives market to work. So, one example, when somebody buys 
or sells a derivative, they are basically trying to protect 
themselves against volatility in whatever they are buying or 
selling. The Bankruptcy Code gives the debtor a nearly 
unlimited right to reject or assume that contract without any 
real time limits on that capacity to reject or assume.
    So, if we had a derivatives contract and I went bankrupt, 
you would be very worried, legitimately worried that I just 
might play the market to wait for the moment when the contract 
has turned favorable to me. So there ought to be some fairly 
sharp limits on the debtors' capacity to reject or assume a 
contract. Something along the lines of a few days, a short 
period in which the portfolio could be assumed and sold intact 
to somebody else.
    Mr. Bachus. Okay.
    And, of course you know, to a certain extent, the Fed 
assumes some of those to do that, I think. I mean, their book. 
I mean they assume some of those. I guess they assume some of 
them were derivatives and that the Fed took on there.
    Mr. Lacker. Are you talking about the AIG case? I am not 
familiar with the details of what they assumed----
    Mr. Bachus. Yeah. I guess well they mortgaged----
    Mr. Lacker [continuing]. How much, I am not sure.
    Mr. Bernstein. Yes.
    Mr. Bachus. Mr. Bernstein?
    Mr. Bernstein. One point to make, which I think was being 
made by Professor Roe is that--now I think there are really two 
separate issues here. One, is what it takes to do an effective 
resolution of a financial institution, in terms of changes to 
the safe harbors which might be a limited stay and it might be 
the ability to quickly assume and move the contracts. The 
separate issue and I think it is, you don't necessarily need to 
deal with it in financial institution insolvencies, is the more 
general question of the scope of the safe harbors. And there is 
a lot of good work being done on that by the National 
Bankruptcy Conference, the American Bankruptcy Institute 
Commission and I know Professor Roe is involved in that. But I 
think it is worth separating those two issues for purposes of 
this hearing because it is really the former that we really 
need to focus on for financial firms.
    Mr. Bachus. All right. I appreciate it.
    Now, mortgage-backed security, is that a derivative? Excuse 
my ignorance, but I am just trying to----
    Mr. Lacker. No.
    Mr. Roe. The principal place where mortgage-backed 
securities would come into the safe harbors would be as a repo. 
So, if I lent to you with a mortgage-backed security as my 
collateral, this transaction would be safe harbored under the 
Bankruptcy Code. One of the problems in the financial crisis is 
that there was a lot of dumping of the mortgage-backed 
securities when people realized they weren't worth as much as 
they hoped they were going to be worth in 2005 and 2006. They 
turned out to be worth less in 2008.
    The safe harbors facilitate some of those quick sales in 
that, if you have done a repo on a mortgage-backed security 
with me and I go bankrupt, you can take the mortgage-backed 
security and immediately sell it. In a traditional bankruptcy 
you can't immediately get to the mortgage-backed security and 
sell it. The judge has to promise that you will be adequately 
protected. But, that adequate protection can be realized 
sometime later on.
    Mr. Bachus. All right.
    Mr. Roe. So, that is where----
    Mr. Bachus. And I am not----
    Mr. Roe [continuing]. The mortgage-backed securities----
    Mr. Bachus [continuing]. Thinking that mortgage-backed 
security wouldn't be a derivative because it is just a basket 
of mortgages. So, it doesn't derive its value from anything 
external, I guess, is that correct?
    Governor Lacker?
    Mr. Lacker. It is not traditionally thought of--mortgage-
backed security is not traditionally thought of as a 
derivative.
    Mr. Bachus. Right.
    Mr. Lacker. There are derivatives that are written to 
replicate----
    Mr. Bachus. Right.
    Mr. Lacker [continuing]. The returns on mortgage-backed----
    Mr. Bachus. And that's what----
    Mr. Lacker [continuing]. Securities or to reference those 
returns.
    Mr. Bachus. Well, and I, you know----
    Mr. Lacker. So, that happens.
    Mr. Bachus. Some of those were--bets were made to do just 
that.
    Mr. Lacker. Yeah. There is a lot of that.
    Mr. Bachus. Mr. Jason Smith of Missouri.
    Mr. Smith of Missouri. Thank you, Mister----
    Mr. Bachus. A Missouri Tiger fan.
    Mr. Smith of Missouri. Absolutely. Is there any other?
    Thank you, Mr. Chairman.
    Mr. Bachus. When there is not a miracle on the Auburn side?
    Mr. Smith of Missouri. I hope not. It is a miracle for both 
of us right now. [Laughter.]
    Mr. Smith of Missouri. My question is to Mr. Lacker.
    In your view, what are the benefits of resolving the 
financial firms through the bankruptcy process?
    Mr. Lacker. So, the alternative are worse, essentially. And 
the alternatives that we have utilized involve the 
discretionary deployment of public funds to protect creditors. 
I think that is an unstable and unsustainable approach. And 
that is what concerns me about title II as well.
    The dynamic--the expectation, I talked about that creditors 
view large financial institutions as ``too big to fail'' and 
likely to get government support, arose over several decades 
from the early 70's and it was the accretion of--slow accretion 
of various precedents that led to the expectation that that is 
how we are going to behave. We ended up--those precedents 
resulted from situations in which, faced with a choice between 
rescuing or not and having the ability to do that, policymakers 
erred on the side of caution and protected creditors.
    And this came home, this was most vividly illustrated in 
the Bear Stearns case. The Bear Stearns had a substantial 
amount of RP borrowing that was maturing overnight every day, 
every morning actually. And there were--there was a substantial 
amount of lending overnight, via purchase agreements, to 
several other investment banks. And the fear was that, should 
Bear Stearns not get support and should those lenders get 
collateral back instead of their cash and have to sell the 
collateral for an uncertain value, that that would cause 
lenders to pull away from other financial firms as well.
    The ambiguity about that was what drove--is what created 
this awful dilemma for policymakers. And that is an example of 
the kind of dynamic that set up the precedence that led to the 
widespread expectation coming into the crisis for this. I think 
that providing that discretion to policymakers is likely to 
lead to this dynamic replicating itself in the future.
    Mr. Smith of Missouri. So, if the Bankruptcy Code was 
adequately equipped to handle these insolvencies for the 
financial institutions, what is your belief on this ``too big 
to fail'' policy?
    Mr. Lacker. I think that the combination of good 
improvements to the Bankruptcy Code and the ``living will,'' 
the resolution planning process, can get us to a position where 
regulators are comfortable and confident that, should a large 
financial institution experience financial distress, they are 
willing to take it through bankruptcy without extraordinary 
government assistance. And once they are confident about that, 
we can convince creditors that that is going to be the norm. 
That will shift incentives in financial markets. That should 
lead to less short-term funding, less of the fragility that we 
see, less of the maturity transformation that creates so many 
problems to begin with. So--and that maturity transformation, 
that short-term lending like in the Bear case I described, is 
what gives rise to these terrible dynamics. And that is, I 
think, our best hope for getting out of the ``too big to fail'' 
box.
    Mr. Smith of Missouri. Is the bankruptcy--this question 
could be for anyone. But, is the Bankruptcy Code prepared for a 
big company, other than just a financial institution but a big 
company that may be the largest employer in the United States 
let us say, that decided to, you know, be insolvent? I mean, is 
that going to be the same type of situation where it comes back 
to Congress and we have to bail out this big corporation? Or is 
the Bankruptcy Code prepared right now to handle a situation 
that has maybe 200,000 employees?
    Mr. Roe. I think I could address that. I believe that the 
bankruptcy system now is capable of handling the bankruptcy of 
a very large industrial firm. And you could put some of this 
in, not historical perspective, but perspective over the 
decades, something I was mentioning while we were offline. When 
the Bankruptcy Code was passed in 1978, the general thinking 
was that a large industrial firm, such as the kind of firm you 
are describing, could not survive Chapter 11.
    And, in fact, we bailed out Chrysler right after the 
Bankruptcy Code was passed. And Lee Iacocca, the president and 
chairman of Chrysler, persisted and was very convincing with 
the argument that, if Chrysler entered Chapter 11, it would not 
exit Chapter 11 intact, that consumers would simply not buy 
cars from a bankrupt Chrysler.
    Over the subsequent decades, the system has learned how to 
reorganize very large industrial firms effectively. You know, 
in the last few weeks I flew American Airlines in bankruptcy 
and US Air outside of bankruptcy. And I might have been the 
only one on the plane who just noted that when I got on I was 
flying a bankrupt airline. It has just become a normal part of 
business. It will be very good for the economy of the United 
States if, over the next couple of decades, we could routinize 
the bankruptcy of financial institutions so that it just 
happens in the background and works effectively.
    So, one additional cost of--one additional advantage of 
bankruptcy over alternatives is, for example, that to use title 
II, somebody has to be saying this is a systemically important 
financial institution whose failure would be very detrimental 
to the American economy. That is the kind of thing that could 
help propel more panic than we really need to have. If this 
entity could go right into bankruptcy and be handled by the 
bankruptcy institutions, which I believe an amended Bankruptcy 
Code could do, the waters would be calmer and bankruptcy would 
do better for us.
    Mr. Bernstein. I would like to comment on that question 
also.
    First of all, the Bankruptcy Code was designed for the 
biggest companies. In fact, it really was designed to follow 
the pattern of equity receiverships in the 19th century which 
took the railroads, which were the biggest companies that 
existed at that time, and reorganized them.
    But there are two issues that it is very hard for the 
Bankruptcy Code to deal with. One is, will the company be able 
to continue in business? And I think what Mark is saying is 
that, in a lot of instances where people thought companies 
couldn't continue in business, they have actually been able to 
sell their product in bankruptcy. Now, whether that would have 
been true, had the auto manufacturers stayed in bankruptcy for 
more than 6 weeks, would somebody buy a car with a 5-year 
warranty and the like? The answer may be that they would, as 
long as somebody stood behind the warranty other than the 
debtor.
    And that gets to the second question, which is somebody has 
to be willing to finance these entities in order for them to 
reorganize. And one of the problems in a downturn that goes 
beyond just the individual company and effects the whole 
economy is the money may not be available to finance you until 
you can reorganize. You know, the Tribune Company went into 
bankruptcy about 4 or 5 years ago. And, at the beginning of 
that bankruptcy case everyone thought its value was one-third 
what it turned out to be when it emerged from bankruptcy.
    And, because of the degradation of value in a depressed 
market, it may be difficult to find private financing. And 
there has to be some form of bridge financing, probably other 
than DIP financing, in that kind of market that is available. 
And that is why it may be difficult without that sort of 
liquidity backup for the largest company in America to fail. 
And that was the experience with the auto companies recently.
    Mr. Bachus. Thank you.
    I have got some prepared questions that I would like to go 
through. There are two for Governor Lacker. These are from 
staff members or the Chairman.
    Can you explain why you believe that shifting away from 
short-term financing for financial firms will increase the 
probability that they may be orderly resolved through the 
bankruptcy process?
    Mr. Lacker. So, Mr. Roe has argued this eloquently in his 
statement.
    Mr. Bachus. Right.
    Mr. Lacker. There is a great deal of maturity 
transformation that goes on outside the banking system, outside 
of deposit taking. And it is the type of financial arrangement 
that is most likely to pin down a policymaker, put him in a box 
and make him feel as if he needs to rescue creditors rather 
than let bankruptcy proceed.
    I think setting the criteria for these large financial 
institutions that they ought to structure themselves so that 
they can be resolved in bankruptcy without government-provided 
``debtor-in-possession'' financing, with just the debtor-in-
possession financing they have planned for is a good criteria. 
If that means they do less maturity transformation, if that 
means that they do less borrowing short and holding longer in 
liquid assets, then I think so be it. I think that the system 
we have now is--artificially favors the maturity transformation 
that goes on in qualified financial contracts, particularly in 
RP lending. And I think reforms to the Bankruptcy Code and the 
kind of planning, the kind of resolution planning that Mr. 
Bernstein described, can help us get to a situation where we 
have a more socially appropriate quantity of maturity 
transformation going on.
    Mr. Bachus. You know, look Bear Stearns--in Bear Stearns I 
have had knowledgeable people that have said to me, ``You 
should have been able to look at the balance sheet and told 
they were insolvent.'' So, I think maybe a more clear 
accounting or examination of their balance sheet. But also they 
were going through some, what I call, some financial 
shenanigans of shifting things back and forth. But I am just--
you know there are ways in bankruptcy, there are ways to go 
back and capture some of that, I think. So that would probably 
be another advantage of bankruptcy.
    But anyway, I will get back to it. One of the questions I 
think sort of tracks on the question I have just asked Governor 
Lacker, for you Professor Roe. If the safe harbor exemptions 
create incentives for short-term financing, in your view, how 
does that make the financial system more difficult to resolve 
through bankruptcy?
    Mr. Roe. This will parallel Jeffrey Lacker's comments, in 
this way, if we have safe harbors for short-term debt but don't 
have it for long-term debt, we will tend to get more short-term 
debt that can run off very quickly in a bankruptcy or during a 
financial failure. So we have rules that facilitate the runoff 
when we should either want the rules to be neutral or maybe to 
slow down that sort of runoff. And this actually feeds into the 
point that Donald Bernstein was making. One of the big problems 
in a large financial institution bankruptcy would be financing.
    And this--the remark that I am going to make now is not 
going to make the problem go away. But, the safe harbors 
increase the difficulty of financing because some significant 
portion of the financial structure of a failed financial 
institution, if they are in safe harbored repo, will runoff 
immediately and then, in the extreme case, will have to be 
replaced. If it couldn't runoff immediately the financial 
pressure would be less on the firm.
    So, one example, when Bear Stearns filed--when Bear Stearns 
failed and was taken over by JP Morgan Chase, it had about a 
quarter of its liabilities in repo. Only a couple decades 
before its repo level was only about 6 percent of its total 
liability. When it failed in 19---in 2007, 2008, it is much 
more difficult for it to go through a bankruptcy because so 
large a portion of its structure is going to be immediately 
withdrawn.
    Mr. Bachus. And I think, just from reading you all's 
testimony and sort of coming into this, it is just clear that 
the safe harbors does create some big problems. And the one you 
have described is pretty clear. I don't know that--Mr. 
Bernstein, that is to you----
    Mr. Bernstein. I definitely agree that----
    Mr. Bachus. Yeah.
    Mr. Bernstein [continuing]. In order to resolve financial 
institutions you have got to give them the ability to preserve 
the book of financial contracts and move it on to the 
continuing entity.
    Mr. Bachus. And, you know, that seems to be a point if we 
are going to do something. If we don't do something 
comprehensive incrementally that would be a good first step 
that I think would beat a little dissension.
    This is for Governor Lacker. Do you think there should be 
any regulatory involvement in the resolution of a financial 
firm through the bankruptcy process? I guess if we ask 12 
different Fed governors, we would get 12 different answers to 
that question.
    Mr. Lacker. I don't know.
    Mr. Bachus. I think that the answer you----
    Mr. Lacker. I think it makes--I have seen proposals that 
give regulators some standing. I think some standing makes 
sense. But I think you have to be careful about this. I think 
having a regulator initiate insolvency proceedings seems 
useful. I think you would want to carefully prescribe through 
the principles that they ought to be adhering to in making that 
decision. I think you would want to give them that right, but 
preserve as much clarity as you can for market participants as 
to when it is going to be exercised. So, try and do it in a way 
that provides some bounds around it that provides clarity about 
when it is going to be exercised.
    Mr. Bachus. I was just thinking the word boundaries. And, 
you know, statutorily there ought to be some, with some 
marginal, I mean, you know, some discretion. But, you would 
need to define the boundaries of that participation. Whether it 
was to advise, just to offer advice or to assist, as opposed to 
not to dictate to them.
    Mr. Lacker. Yeah. So, the reason I think that is important, 
is it is important to, in a situation in which there is the 
potential for creditors to expect government rescues, you want 
the regulator to be able to force action and force bankruptcy 
before things unwind, before actions are taken that just make 
the matters dramatically worse and force the regulator's hand 
later. So, now, there is other aspects of standing that I don't 
have a--I really don't have a view on. You know, pleadings and 
I guess things that these guys are an experts in.
    Mr. Bachus. Okay.
    Mr. Bernstein?
    Mr. Bernstein. Yeah. I generally agree with what has just 
been said. The--you know, if in fact you retain orderly 
liquidation authority as a backup, it will be less likely to be 
used if the regulator has the option of using bankruptcy. So, I 
think that is probably, on balance, a good thing. The--as to 
other matters, I mean, there may be other issues such as, you 
know, if you did this single point of entry approach in 
bankruptcy that the regulator would want to be heard on. So, 
there may be other standing issues the regulator wants to be 
involved in.
    Mr. Bachus. Well, and I think you could provide for a 
regulator to actually sit, if not part of the panel, in some 
position because you would have to assemble people that had the 
expertise.
    Mr. Bernstein. Or at least give the regulator the 
opportunity to be heard on any issue.
    Mr. Bachus. Okay.
    And I think the last question is for you, Mr. Bernstein. 
Based on your experience working with and developing ``living 
wills,'' setting aside the question of how a financial firm 
will be financed through a restructuring, what are the major 
impediments to efficient resolution of a financial firm through 
the bankruptcy process as the Bankruptcy Code is currently 
drafted? And actually, you have covered an awful lot of this.
    Mr. Bernstein. Yeah, I did. Well, I strongly believe that 
the ability to separate the--first of all, I believe the 
ability to recapitalize rather than liquidate is extremely 
important. And I think the tools that are there today will 
permit it for some entities but not for all entities in the 
group. And it would be good if the tools were there to have 
that happen for all entities. I do think liquidity is an 
important issue and I distinguish that very importantly from 
capital. The capital losses are going to be suffered in the 
private sector, but if the liquidity is not there to stabilize 
the firm through a lender of last resort that is problematic. 
Banks have the discount window, they can do that; but, broker-
dealers don't. So, I think that is an important aspect.
    And so, I think really focusing on the good work that has 
been done by the FDIC on single point of entry. And taking that 
and saying, ``How can we do that in a procedurally appropriate 
way, under the Bankruptcy Code,'' would be an excellent step.
    Mr. Bachus. Thank you.
    Let me--and I am going to conclude with a question that--
and more maybe not a question but to sort of try to encourage 
some action and that is--you know, National Bankruptcy 
Conference, the American Bankruptcy Institute, the American Bar 
Association, the regulators. It would be extremely helpful to 
the Judiciary Committee and I know the Senate is also looking 
at this, so this is not something that is--in fact they have 
had ongoing discussions and we have had discussions with them. 
So there is a willingness and a desire to make changes in the 
Bankruptcy Code. But, we--it would be so much easier if, as in 
the case of some other things, we had a model act or we had a 
something brought to us. And I know the Senate actually has 
some draft language, but that would be extremely helpful. It 
would give us quite a bit of comfort because it would be very 
hard for us to do that. And so, I would encourage the 
different--the Conference, the Institute, the regulators to 
continue discussion and give the Congress some guidance. And, 
if not, a draft.
    So, thank you.
    This concludes the hearing. Thanks to all our witnesses for 
attending. This is a very--we, in this case, both the democrats 
and republican agreed that you were as qualified witnesses as 
any.
    And without objections all our Members of the Committee 
will have 5 legislative days to submit additional written 
questions for the witnesses or additional materials for the 
record.
    And this hearing is adjourned.
    [Whereupon, at 3:50 p.m., the Subcommittee was adjourned.]



                            A P P E N D I X

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               Material Submitted for the Hearing Record

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 Prepared Statement of the Honorable Steve Cohen, a Representative in 
Congress from the State of Tennessee, and Ranking Member, Subcommittee 
           on Regulatory Reform, Commercial and Antitrust Law
    I voted for the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 and remain a supporter of the law.
    The Dodd-Frank Act's passage by Congress was an acknowledgment of 
the fact that insufficient regulation led to the problem of so-called 
``Too Big to Fail'' financial institutions--that is, financial 
institutions that were allowed to become so big and so interconnected 
that their insolvencies threatened to paralyze the Nation's financial 
system and its broader economy. This situation, in turn, resulted in 
extreme pressure for a taxpayer bailout when those institutions fell 
under financial distress.
    The bankruptcy filing of Lehman Brothers in 2008--the largest 
bankruptcy in U.S. history, involving more than $600 billion in 
assets--vividly illustrated aspects of the ``Too Big to Fail'' problem. 
Lehman's bankruptcy filing greatly exacerbated a financial panic on 
Wall Street, leading to a severe financial crisis and the greatest 
economic downturn since the Great Depression, the effects of which we 
continue to feel today.
    More importantly, the financial markets' reaction to the Lehman 
Brothers bankruptcy highlighted the potential limitations of the 
Bankruptcy Code in handling the resolution of financially distressed 
systemically important financial institutions.
    I remain a strong supporter of the Dodd-Frank Act, although I also 
support certain enhancements to it. For example, I support legislation 
that would increase the minimum required amount of capital for covered 
financial institutions under Dodd-Frank.
    We should also consider the potential need for other enhancements, 
like adding a representative of the Antitrust Division of the 
Department of Justice to the Financial Stability Oversight Council, 
created by Dodd-Frank to oversee the stability of the financial system.
    It is in this spirit that I approach today's hearing, which will 
focus on whether the current Bankruptcy Code is sufficient to allow for 
the orderly reorganization or liquidation of systemically important 
financial institutions under Title I of the Dodd-Frank Act.
    Whether one supports or opposes the Dodd-Frank Act, we can agree 
that today's inquiry is an important one. To the extent that modest 
revisions to the Bankruptcy Code will help ensure that we avoid the 
need for any future taxpayer bailouts of financially struggling large 
financial institutions, we should be able to work together on crafting 
such changes.

                                

Prepared Statement of the Honorable Bob Goodlatte, a Representative in 
  Congress from the State of Virginia, and Chairman, Committee on the 
                               Judiciary
    The Bankruptcy Code has existed in this country for well over a 
hundred years. Over this time, our bankruptcy system has evolved to 
become one of the most sophisticated regimes in the world. The bedrock 
principle embedded in the bankruptcy system of providing for the 
efficient resolution and reorganization of operating firms has allowed 
our economy to grow and flourish.
    Nevertheless, a periodic evaluation of the Bankruptcy Code to 
ensure its adequacy to address the challenges posed by the changing 
nature of operating firms is one of the fundamental responsibilities of 
this Committee.
    I applaud Chairman Bachus for holding today's hearing to examine 
whether the existing Bankruptcy Code is best equipped to address the 
insolvency of large and small financial institutions.
    The bankruptcy process confers a number of benefits to all 
operating companies, including financial firms. The bankruptcy court 
provides transparency and due process to all parties involved. 
Furthermore, bankruptcy case law has been developed over decades, 
providing consistency and predictability.
    Additionally, the bankruptcy process has been sufficiently dynamic 
to administer the resolution and restructuring of complex operating 
companies with billions of dollars in assets as well as smaller 
companies and individuals. But despite the bankruptcy system's ability 
to accommodate complex operating companies, financial firms may possess 
unique characteristics that are not yet optimally accounted for in the 
Bankruptcy Code.
    For example, efficient and orderly resolution of financial firms 
can require an unusual level of speed. Refinements to the Code might be 
considered to better provide that speed while still assuring due 
process.
    Additionally, in some circumstances the failure of financial firms 
can pose unique threats to the broader stability of the economy. To 
account for that, title I of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act requires certain firms to prepare ``living 
wills'' to plan for resolution in bankruptcy in the event of failure.
    The Bankruptcy Code is well-crafted to maximize the recoveries of a 
debtor's creditors while providing an opportunity for the debtor to 
either reorganize or liquidate in an orderly fashion. It might, 
however, bear improvements designed specifically for the efficient 
execution of title I ``living wills.''
    These are some of the issues that may need to be examined as part 
of the broader evaluation of the existing Bankruptcy Code's adequacy to 
address financial institution insolvencies. I look forward to the 
testimony from today's excellent panel of witnesses on these important 
issues.
    Thank you Mr. Chairman, and I yield back the balance of my time.

                                

Prepared Statement of the Honorable John Conyers, Jr., a Representative 
 in Congress from the State of Michigan, and Ranking Member, Committee 
                            on the Judiciary
    This hearing examines whether current law would adequately address 
the insolvency of a significant financial institution given what we 
learned from the near collapse of our Nation's economy just five years 
ago.
    As we consider this issue, it is critical that we keep in mind what 
precipitated the Great Recession.
    Basically, it was the regulatory equivalent of the Wild West.
    In the absence of any meaningful regulation in the mortgage 
industry, lenders developed high risk subprime mortgages and used 
predatory marketing tactics that targeted the most vulnerable by 
promising them that they could finally share in the Great American 
Dream of homeownership.
    This proliferation of irresponsible lending caused home prices to 
soar even higher, ultimately resulting in a housing bubble.
    In the absence of any meaningful regulation in the financial 
marketplace, these risky mortgages were then bundled and sold as 
investment grade securities to unsuspecting investors, including 
pension funds and school districts.
    Once the housing bubble burst, the ensuing 2008 crash stopped the 
flow of credit and trapped millions of Americans in mortgages they 
could no longer afford, causing vast waves of foreclosures across the 
United States, massive unemployment, and international economic 
upheaval.
    And, to this day, we are still dealing with the lingering effects 
of the Great Recession of 2008 in the form of a sluggish national 
economy, neighborhoods blighted by vast swaths of abandoned homes, and 
municipalities struggling with reduced revenues.
    Fortunately, the Dodd Frank Act reinvigorates a stronger regulatory 
system that makes the financial marketplace more accountable and 
institutes long-needed consumer protections.
    It also establishes a mandatory resolution mechanism to wind down a 
systemically significant financial institution that cannot be resolved 
under bankruptcy.
    The Act also imposes various requirements on financial institutions 
that will allow regulators to better assess the risks such institutions 
present to Wall Street and, most importantly, Main Street.
    A key component of the Dodd Frank Act process requires these 
companies and the regulators to assess resolution under current 
bankruptcy law.
    In recent years, some of the Nation's largest companies have used 
the Bankruptcy Code to regain their financial footing, including 
General Motors, American Airlines, and Washington Mutual.
    Questions have been raised, however, as to whether the Bankruptcy 
Code can be improved upon to better accommodate large inter-connected 
financial institutions like those subject to the Dodd Frank Act.
    Some have even suggested that a new form of bankruptcy relief that 
specifically deals with these institutions may be the most expedient.
    There may, in fact, potentially be consensus that some changes to 
the Bankruptcy Code may be warranted.
    In any event, today's hearing should elicit some helpful guidance 
and I look forward to the testimony from these experts.
    Thank you Mr. Chairman, and I yield back the balance of my time.

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