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

                          EXPLORING CHAPTER 11 REFORM:
                      CORPORATE AND FINANCIAL INSTITUTION
                     INSOLVENCIES; TREATMENT OF DERIVATIVES

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

                                    HEARING

                                   BEFORE THE

                                SUBCOMMITTEE ON
                               REGULATORY REFORM,
                          COMMERCIAL AND ANTITRUST LAW

                                     OF THE

                           COMMITTEE ON THE JUDICIARY
                            HOUSE OF REPRESENTATIVES

                        ONE HUNDRED THIRTEENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                 MARCH 26, 2014

                                   __________

                               Serial No. 113-90

                                   __________

             Printed for the use of the Committee on the Judiciary

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          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                   ZOE LOFGREN, California
    SPENCER BACHUS, Alabama              SHEILA JACKSON LEE, Texas
    DARRELL E. ISSA, California          STEVE COHEN, Tennessee
    J. RANDY FORBES, Virginia            HENRY C. ``HANK'' JOHNSON, Jr.,
    STEVE KING, Iowa                       Georgia
    TRENT FRANKS, Arizona                PEDRO R. PIERLUISI, Puerto Rico
    LOUIE GOHMERT, Texas                 JUDY CHU, California
    JIM JORDAN, Ohio                     TED DEUTCH, Florida
    TED POE, Texas                       LUIS V. GUTIERREZ, Illinois
    JASON CHAFFETZ, Utah                 KAREN BASS, California
    TOM MARINO, Pennsylvania             CEDRIC RICHMOND, Louisiana
    TREY GOWDY, South Carolina           SUZAN DelBENE, Washington
    RAUL LABRADOR, Idaho                 JOE GARCIA, Florida
    BLAKE FARENTHOLD, Texas              HAKEEM JEFFRIES, New York
    GEORGE HOLDING, North Carolina       DAVID N. CICILLINE, Rhode Island
    DOUG COLLINS, Georgia
    RON DeSANTIS, Florida
    JASON T. SMITH, Missouri
    [Vacant]

               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          HENRY C. ``HANK'' JOHNSON, Jr.,
    TOM MARINO, Pennsylvania               Georgia
    GEORGE HOLDING, North Carolina       SUZAN DelBENE, Washington
    DOUG COLLINS, Georgia                JOE GARCIA, Florida
    JASON T. SMITH, Missouri             HAKEEM JEFFRIES, New York
                                         DAVID N. CICILLINE, Rhode Island

                          Daniel Flores, Chief Counsel

                                C O N T E N T S

                                  ----------

                                 March 26, 2014

                                                                       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 Henry C. ``Hank'' Johnson, Jr., a Representative in
      Congress from the State of Tennessee, and Ranking Member,
      Subcommittee on Regulatory Reform, Commercial and Antitrust Law     3

                                   WITNESSES

    The Honorable Christopher S. Sontchi, United States Bankruptcy
      Judge for the District of Delaware, Wilmington, DE
      Oral Testimony.................................................     7
      Prepared Statement.............................................    10

    Seth Grosshandler, Partner, Cleary Gottlieb Steen & Hamilton LLP,
      New York, NY
      Oral Testimony.................................................    31
      Prepared Statement.............................................    33

    Jane Lee Vris, Partner and General Counsel, Millstein & Co.,
      Washington, DC
      Oral Testimony.................................................    51
      Prepared Statement.............................................    53

    Thomas H. Jackson, Distinguished University Professor & President
      Emeritus, University of Rochester, Rochester, NY
      Oral Testimony.................................................    94
      Prepared Statement.............................................    96

    Michelle M. Harner, Professor of Law, Director, Business Law
      Program, University of Maryland Francis King Carey School of
      Law, Baltimore, MD
      Oral Testimony.................................................   129
      Prepared Statement.............................................   131

                                    APPENDIX
                   Material Submitted for the Hearing Record

    Prepared Statement of the Honorable John Conyers, Jr., a
      Representative in Congress from the State of Michigan, and
      Ranking Member, Committee on the Judiciary.....................   161

    Response to Questions for the Record from the Honorable
      Christopher S. Sontchi, United States Bankruptcy Judge for the
      District of Delaware, Wilmington, DE...........................   163

    Questions for the Record submitted to Seth Grosshandler, Partner,
      Cleary Gottlieb Steen & Hamilton LLP, New York, NY.............   171

    Response to Questions for the Record from Jane Lee Vris, Partner
      and General Counsel, Millstein & Co., Washington, DC...........   172

    Response to Questions for the Record from Thomas H. Jackson,
      Distinguished University Professor & President Emeritus,
      University of Rochester, Rochester, NY.........................   176

    Response to Questions for the Record from Michelle M. Harner,
      Professor of Law, Director, Business Law Program, University of
      Maryland Francis King Carey School of Law, Baltimore, MD.......   179

                          EXPLORING CHAPTER 11 REFORM:
                      CORPORATE AND FINANCIAL INSTITUTION
                     INSOLVENCIES; TREATMENT OF DERIVATIVES

                                  ----------

                           WEDNESDAY, MARCH 26, 2014

                           House of Representatives,

                      Subcommittee on Regulatory Reform,
                          Commercial and Antitrust Law

                          Committee on the Judiciary,

                                Washington, DC.

        The Subcommittee met, pursuant to call, at 4 p.m., in room
    2141, Rayburn Office Building, the Honorable Spencer Bachus
    (Chairman of the Subcommittee) presiding.
        Present: Representatives Bachus, Marino, Holding, Collins,
    Johnson, and Jeffries.
        Staff present: (Majority) Daniel Flores, Subcommittee Chief
    Counsel; Anthony Grossi, Counsel; Jaclyn Louis, Legislative
    Director for Rep. Marino; Jon Nabavi, Legislative Director for
    Rep. Holding; Jennifer Lackey, Legislative Director for Rep.
    Collins; Ashley Lewis, Clerk; (Minority) Susan Jensen, Counsel;
    Norberto Salinas, Counsel; and Slade Bond, Counsel; and
    Rosalind Jackson, Professional Staff Member.
        Mr. Bachus. 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.
        I want to welcome our witnesses. This is a little unusual
    to have a 4 hearing, but we have had other scheduling
    difficulties, so we apologize. And there may be a vote on the
    floor starting fairly soon, so I am going to read my opening
    statement as quick as I can and then recognize the Ranking
    Member, and then we will go to the introduction of our
    panelists.
        And as Chairman of the Financial Services Committee,
    obviously I had a lot of exposure to these same issues back in
    2008, 2009. And it is a very important issue, and I know there
    was a lot of good work done bringing us to this hearing by the
    panelists. And it is a real esteemed body of experts that we
    have here today.
        An integral component of the American economy is the
    ability of companies to turn to chapter 11 of the Bankruptcy
    Code to overcome unexpected financial troubles. These companies
    may use Chapter 11 to restructure their debt obligations while
    continuing their business operations, which preserves jobs and
    increases the value of return to the company's creditors,
    suppliers, customers, and the American economy.
        Meanwhile, creditors of companies rely on Chapter 11 to
    assess the risks associated with their investment and can
    depend on Chapter 11's transparent judicial process to gain a
    level of certainty regarding their potential recoveries from a
    bankrupt business. Chapter 11 has evolved since its inception
    and has adapted to changing to changing and emerging markets.
    It may be time for that again.
        Thirty years ago companies did not have complex capital
    structures with layers of intertwined debt, nor did a robust
    derivatives and repurchase agreement market exist. Similarly,
    the participants in the Chapter 11 process have become
    increasingly sophisticated. Given the constantly developing law
    and related practices, it is important that the Committee
    undertake a periodic review of the application of Chapter 11
    and related issues.
        In part to assist Congress and this Committee's oversight
    of Chapter 11, the American Bankruptcy Institute has a similar
    collection of premiere bankruptcy judges, practitioners,
    professionals, and academics to discuss and debate wide-ranging
    issues related to Chapter 11. While their process is not
    complete, it will be helpful to hear from the ABI regarding
    their review of the issues that have played a central role in
    the process, and whether there is any emerging consensus on
    particular issues. We are grateful for the work that ABI has
    completed today. I look forward to their report at the end of
    this year.
        In connection with its ongoing oversight of bankruptcy
    issues, the Committee recently held a hearing on whether the
    Bankruptcy Code could be improved to better facilitate the
    resolution of a financial institution's insolvency. The
    witnesses at that hearing unanimously agreed that the
    Bankruptcy Code could be enhanced and reformed to achieve this
    goal.
        Today we will continue this discussion by further examining
    what types of amendments to the Bankruptcy Code and potentially
    Chapter 11 would assist with an efficient, successful
    resolution of a financial institution. The bankruptcy process
    has long been heralded as the primary means of resolving
    distress companies' insolvencies because of its established
    history of laws and impartial administration.
        It is our responsibility to ensure that the Bankruptcy Code
    has all the tools necessary to address the unique issues
    presented by financial institutions' insolvency. Today's
    hearing should assist the Committee in discharging this
    responsibility.
        An issue that could impact the ability of the Bankruptcy
    Code to effectively administer financial institutions'
    bankruptcy is the nature of existing safe harbors for certain
    financial contracts. These safe harbors have been expanded over
    time, and now apply to a wide variety of financial contracts.
        One of the primary rationales for creating the safe harbors
    was to prevent contagion of risk in the financial market. Given
    the recent financial crisis, it would be beneficial to review
    the existing safe harbors, their effectiveness, and the effect
    of their continued expansion. Safe harbors have a broad impact
    on liquidity in the short-term financial markets. And we will
    be mindful of this impact as we conduct our review.
        Today's witnesses collectively have decades of experience
    on these issues, and I look forward to hearing their testimony.
        At this time, I recognize the Ranking Member, Mr. Hank
    Johnson of Georgia, for his opening statement.
        Mr. Johnson. Thank you, Mr. Chairman. Before I begin, I
    would like to take a moment to acknowledge the tragic landslide
    that occurred this past weekend in Oslo, Washington--excuse
    me--Oso, Washington. Oso is the congressional district of Suzan
    DelBene, our colleague on this Subcommittee. I know that Susan
    cannot be with us today because she is doing everything back
    home to help those in need, and we empathize with her and her
    community. They are going through so much pain and loss. And
    our thoughts and prayers are with the community of Oso, the
    brave rescuers and search parties, and also our colleagues from
    the State of Washington.
        Now, turning to today's hearing, I would like to thank
    Chairman Bachus for convening this hearing on such an important
    topic. This July will mark the 4th year since President Obama
    signed the Dodd-Frank Act into law to address the financial
    crisis that nearly brought this country to its knees. Though
    imperfect, passing the Dodd-Frank Act was a crucial step in
    resetting our Nation's economic course.
        It addressed the root cause of the financial crisis by
    reigning in too big to fill financial institutions on Wall
    Street that caused immeasurable hardship to so many American
    families. It is my belief that we could have done more to
    create financial stability by limiting the size of the largest
    institutions and holding wrongdoers accountable, both civilly
    as we have done and also criminally as we have not done.
        But opportunities remain to safeguard the public through
    congressional and regulatory oversight. Today, the Subcommittee
    is exercising its important responsibility of oversight by
    asking how best to perfect and strengthen the Bankruptcy Code
    to create soft landings instead of financial crashes.
        While we may not always agree on matters before this
    Subcommittee, today's hearing presents an opportunity to forge
    a bipartisan consensus and cooperation. I hope that this
    cooperation will guide us to explore the strengths and
    weaknesses of the Bankruptcy Code in other areas, particularly
    consumer bankruptcy.
        Perhaps no other area is as important to most Americans as
    the exponential growth and crippling effects of the student
    loan debt that many face. According to the most recent
    quarterly report by the Federal Reserve Bank of New York,
    student loan debt has tripled in the last decade, rising to
    over $1 trillion. In my home State of Georgia, students
    graduate with an average of $23,089 according to the Institute
    of College Access and Success.
        And while more people are defaulting on student loans than
    any other form of debt, these loans are practically non-
    dischargeable. Why? Although unsecured debt is typically
    dischargeable in bankruptcy, the Bankruptcy Code has a specific
    carve-out that does not exempt student loans unless the debtor
    is able to demonstrate that continued repayment of the debt
    would pose an undue hardship on the debtor.
        This standard is nearly impossible for distressed borrowers
    to establish. In fact, earlier this month, Reuters reported
    that in 2007, courts granted some form of relief to only 81
    debtors out of the 170,000 student loan debtors who filed for
    bankruptcy protection in 1 year alone.
        This ballooning problem is already affecting the housing
    market. David Stevens, the chief executive of the Mortgage
    Bankers Association echoed this concern, noting that ``student
    debt'' trumps all other consumer debt. It is going to have an
    extraordinarily dampening effect on young people's ability to
    borrow for a home, and that is going to impact the housing
    market and the economy at large.
        The goal of bankruptcy long has been to provide debtors a
    financial fresh start from burdensome debt. The Supreme Court
    recognized this principle in the 1934 decisions Local Loan v.
    Hunt, noting that bankruptcy gives the honest, but unfortunate,
    debtor a new opportunity in life, and a clear field for future
    effort, unhampered by the pressure and discouragement of
    preexisting debt. This principle applies to businesses and
    consumers alike. As we work together to improve the Bankruptcy
    Code, it is imperative that we also look at consumer
    bankruptcy.
        I again thank the Chairman for holding this hearing, and I
    look forward to the testimony from this distinguished panel of
    witnesses. And I thank you all for coming.
        Mr. Bachus. Thank you. We have 4 minutes, 54 seconds left
    on a floor vote. And I am thinking just to keep it in an
    orderly way, instead of introducing maybe two of our witnesses,
    I will come back, introduce the entire panel, and then we will
    have your opening statements, and go from there.
        So I understand none of you have a time constraint as such,
    right? So thank you. One interesting thing, and I appreciate
    the Ranking Member's statement, he mentioned criminalizing some
    of these things or criminal cases. This Committee has formed a
    bipartisan group of five Republicans and five Democrats to talk
    about over-criminalization because we continue to add to the
    long list of Federal crimes. And many of them are by
    regulation. We pass something not intending it to be a criminal
    act, and yet the different departments of the government are
    interpreting it and turning into criminal acts.
        And so, we have literally filled our prisons with hundreds
    of thousands of inmates, and some of them for actually
    violations of regulations as opposed to laws because of the
    interpretation, which is something we are going to be looking
    at in a bipartisan way. And, of course, mandatory sentencing
    has added to that, so we have to be kind of careful about
    defining something as a crime if there is no mens rea. And you
    and I agree on that.
        Mr. Johnson. We do, and I think we have a discussion coming
    up about two types of crime. One is legal and the other illegal
    crime. And the legal crime tends to wear a white collar, and
    the illegal crime, they tend to wear blue collars. And so, when
    we can get to the point of rectifying the disparity in the two
    crimes, then we can start consolidating offenses and working on
    other problems in our criminal justice system.
        Particularly, I am interested in the effect that the
    private prison industry has on our public policy.
        Mr. Bachus. I did not mean to start this. [Laughter.]
        Thank you. We will recess this Committee and probably be
    back in about 35 or 40 minutes. Thank you.
        [Recess.]
        Mr. Bachus. The hearing is reconvened, and we appreciate
    your patience.
        Our first witness is Judge Sontchi. Judge Sontchi, actually
    Christopher Sontchi, is a United States bankruptcy judge from
    the District of Delaware and a frequent speaker in the United
    States and Canada on issues relating to corporate
    reorganizations. He was recently appointed to the Committee on
    Financial Contracts Derivatives and Safe Harbors of the
    American Bankruptcy Institution's Commission to Study the
    Reform of Chapter 11. In addition, he is a member of the
    American Bankruptcy Institute and the National Conference of
    Bankruptcy Judges.
        In 2010 and '12, he was selected as outstanding bankruptcy
    judge by the magazine Turnarounds and Workouts. He recently
    published Valuation: A Judge's Perspective in the American
    Bankruptcy Institution's Law Review.
        Judge Sontchi received a B.A. with distinction in political
    science from the University of North Carolina at Chapel Hill
    where he was elected to Phi Beta Kappa. He received his J.D.
    from the University of Chicago Law School. And I guess you have
    quit watching the NCAA tournaments, right?
        Mr. Sontchi. At least we won one more game than Duke.
        Mr. Bachus. That is right. Duke was out in the very first
    round.
        Seth Grosshandler is a partner of Cleary Gottlieb Steen--is
    it Stein or Steen?
        Mr. Grosshandler. Steen.
        Mr. Bachus. Steen, and Hamilton where he has been
    practicing law for over 30 years. His practice focuses on
    financial institutions, derivative products, securities
    transactions, secured transactions, and structured finance. As
    an instrumental player in the development of the safe harbor
    provisions of the Bankruptcy Code, the Federal Deposit
    Insurance Act, and orderly liquidation authority, Mr.
    Grosshandler is regarded as a preeminent expert on derivatives
    and security transactions, and as well on the risk to
    counterparties of regulated financial institutions in the event
    of their insolvency.
        During and after the financial crisis, he advised major
    Wall Street firms, including Bear Stearns, and Lehman Brothers,
    and various government agencies on market stabilization
    efforts. Boy, you must have been paid well. Bear Stearns and
    Lehman Brothers. You had your hands full.
        Mr. Grosshandler. They are counterparties to Bear Stearns.
        Mr. Bachus. Oh, they are counterparties. Well, they did
    pretty well.
        Mr. Grosshandler. Probably better than representing the
    debtors.
        Mr. Bachus. That is right. Thank you. He received his
    undergraduate degree from Reed College and his J.D. cum laude
    from Northwestern University.
        Ms. Jane Vris is general counsel and partner at Millstein &
    Company. And I did do that right. During her legal career,
    including as a partner at Wachtell--is that right, Wachtell--
    she has advised board special committees, creditors, potential
    purchasers of assets from distressed companies, and equity
    investors and companies emerging from Chapter 11. She most
    recently served as a partner at Vincent & Elkins and was a
    founding partner of Cronin and Vris.
        And she is a member of the National Bankruptcy Conference.
    She has been designated by Chambers USA as one of America's
    leading lawyers for business, named a New York Super Lawyer by
    New York Super Lawyers, and is included in the Guide to the
    World's Leading Insolvency and Restructuring Lawyers by Legal
    Media Group, and the International Who's Who of Insolvency and
    Restructuring Lawyers. It is kind of a who's who of insolvency.
    I am sorry. I am just joking. [Laughter.]
        She received her B.A. magna cum laude from the University
    of Pennsylvania and her J.D. from New York University School of
    Law, where she served as the managing editor of the Law Review.
    Quite impressive.
        Professor Thomas H. Jackson is with the William H. Simon
    School of Business at the University of Rochester. Professor
    Jackson holds faculty positions in the Simon School of Business
    and the Department of Political Science at the University of
    Rochester, where he also served as president from 1994 to 2005.
        You know, Steve Covey in his book, I do not know if you are
    aware, he says the job of a college president is the most
    difficult job in America.
        Mr. Jackson. [Off audio.]
        Mr. Bachus. Thank you. Before he became Rochester's ninth
    president, Mr. Jackson was vice president and provost at the
    University of Virginia, where he first joined as dean of
    Virginia's School of Law. Previously he was professor of law at
    Harvard and served on the faculty at Stanford University.
        He clerked for U.S. District Judge Marvin Frankel in New
    York from 1975 to '76, and then for Supreme Court Justice and
    later Chief Justice William Rehnquist from 1976 to 1977.
        Professor Jackson is the author of bankruptcy and
    commercial law texts used in law schools across the country,
    and served as special master for the U.S. Supreme Court in a
    dispute involving every State in the country over the
    disposition of unclaimed dividends held by brokerage houses.
        He received his B.A. from Williams College and his J.D.
    from Yale Law School. Welcome to you.
        Professor Michelle Harner is a professor at University of
    Maryland Francis King Carey School of Law. She teaches courses
    in bankruptcy and creditors' rights, business associations,
    business planning, and professional responsibility at the
    University of Maryland School of Law.
        Prior to joining the University of Maryland, Professor
    Harner served as Assistant Professor of Law at the University
    of Nebraska, and was voted professor of the year by her
    students during the 2006 and 2008 academic years. That is quite
    an honor.
        Professor Harner is widely published and lectures
    frequently on corporate governance, financially distressed
    entities, and related legal issues. Professor currently is
    serving as the reporter to the ABI Commission to study the
    reform of Chapter 11. She previously was in private practice in
    the business restructuring insolvency bankruptcy and related
    transactional fields. Most recently as a partner of the Chicago
    office of the International Law Firm Jones Day.
        Professor Harner is a member of a number of professional
    organizations, including the American Law Institute, American
    Bankruptcy Institute, the American Bar Association, and the
    International Association of Restructuring, Insolvency, and
    Bankruptcy Professors.
        Professor Harner received her B.A. from Boston College and
    her J.D. from Moritz College of Law at Ohio State University.
        All right. That is a very impressive group of witnesses.
    Did you want to ask them whether they had ever represented the
    Koch brothers?
        Mr. Johnson. The Koch Brothers?
        Mr. Bachus. Koch Brothers, that is right.
        Mr. Johnson. Have any of you ever represented the Koch
    Brothers before?
        Voice. No, sir.
        Mr. Johnson. All right.
        Mr. Bachus. We are in good shape.
        Mr. Johnson. How about Sheldon Adelman?
        Mr. Bachus. No, we will get that out of the way. You only
    have one. [Laughter.]
        I do not know about that. The Koch Brothers, his opening
    statement normally contains some reference to them, and you did
    not work that into the statement.
        Mr. Johnson. Well, I did not want any of that Koch Brothers
    money coming into my reelection campaign. That is the
    situation.
        Mr. Bachus. But you got legal crimes in there, which is
    kind of an oxymoron, so that is a new one. Pretty good.
        Each of our witnesses' written statements will be entered
    into the record in its entirety. I ask each of the witnesses to
    summarize his or her testimony. Actually, we are not going to
    hold you to 5 minutes. If you go 6 or 7 minutes, that is fine.
    This is something they tell me to read every time about
    quitting and everything, but we are just going to go with that.
        Now, I will recognize the witnesses to their testimony.
    And, Judge, we will start with you.

       TESTIMONY OF THE HONORABLE CHRISTOPHER S. SONTCHI, UNITED
         STATES BANKRUPTCY JUDGE FOR THE DISTRICT OF DELAWARE,
                             WILMINGTON, DE

        Judge Sontchi. Thank you. Chairman Bachus, Ranking Member
    Johnson, and Members of the Committee, thank you for inviting
    me to testify today. My name is Christopher Sontchi. I am a
    bankruptcy judge in the District of Delaware, and I have
    presided over a number of cases and issued numerous opinions
    involving the safe harbors for financial contracts,
    derivatives, and repurchase agreements.
        Most notably, I presided over the American Home Mortgage
    case. At the time of its filing in 2007, American Home Mortgage
    was the 10th largest home mortgage originator in the country,
    and as part of its origination and securitization business, the
    company was a party to numerous repurchase agreements involving
    billions of dollars. As you also stated, I have had the honor
    of serving as a Member of the Committee on Financial Contracts,
    Derivatives, and Safe Harbors of the American Bankruptcy
    Institute's Commission to Study the Reform of Chapter 11.
        Today I would like to discuss two important issues related
    to the safe harbors. First, I believe Congress should amend
    Section 546(e) of the Bankruptcy Code to significantly narrow
    its scope. Section 546(e) exempts from avoidance as preferences
    or fraudulent conveyance settlement payments. I believe
    Congress' intent was to insulate the securities transfer
    system. Security industry transferees are generally not the
    beneficial owners of the subject transactions, but rather are
    the conduits. Subjecting the conduits to avoidance actions
    could trigger a series of unintended and disastrous defaults in
    the interconnected securities markets.
        As written and applied, however, the Section 546(e) safe
    harbor has insulated settlement payments to the ultimate
    beneficiaries of leveraged buyouts and other transactions, even
    if the securities were privately issued. Absent the safe
    harbors, these payments often made to directors, officers, and
    other insiders that led the company into bankruptcy in the
    first place would be potentially voidable as fraudulent or
    preferential transfers.
        The safe harbor of Section 546(e) should protect the
    securities transfer system, but not settlement payments or
    other transfers with respect to the beneficial owners of
    privately placed debtor equity securities. And with regard to
    publicly-traded securities, Section 546(e) should only protect
    transfers to the beneficial owners of public securities that
    have acted in good faith.
        I have and continue to be faced with a flurry of motions to
    dismiss and for summary judgment filed by insiders of bankrupt
    companies seeking shelter from liability through the 546(e)
    safe harbor.
        The secret is out, and defense attorneys are seeking to
    take advantage of the almost too good to be true safe harbor to
    the fullest extent possible. And I respectfully urge Congress
    to act quickly to close this unintended loophole in the safe
    harbor for the securities transfer system.
        The second subject I would like to discuss is more
    controversial. What is the proper scope of the safe harbor's
    governing mortgage repurchase agreements? I respectfully urge
    Congress to remove mortgages and interests in mortgages from
    the safe harbors relating to repurchase agreements and
    securities contracts.
        The genesis of my request is my experience in the American
    Home Mortgage bankruptcy case. One of the primary arguments
    offered in favor of the safe harbors is that it is important
    for assets subject to the safe harbors to remain liquid. The
    argument is that without the liquidity supplied by the safe
    harbors, the cost of lending would increase, and in the event
    of default, there could be a cascading series of defaults that
    might spread to the repo counterparty lender and parties to
    other agreements with the repo counterparty.
        It became quickly apparent to me during American Home that
    mortgages and interests in mortgages are not liquid assets. In
    fact, it can take several months to complete the sale of one
    bundle of mortgages. The reality is that the counterparties to
    repurchase agreements, i.e., the lenders, are not interested as
    much in preserving the liquidity of their investment in the
    mortgages originated by a debtor as they are in owning what
    would otherwise be property of the estate and the lender's
    collateral.
        The business of originating mortgages requires access to a
    large amount of capital. Traditionally, a mortgage lender would
    borrow the money necessary to originate mortgage loans through
    a warehouse secured line of credit or loan. In the event of a
    bankruptcy by the mortgage lender, the mortgage loans would
    become property of the bankruptcy estate. The automatic stay
    would prevent the warehouse lender from taking control of the
    mortgage loans. And the warehouse lender would both have a
    secured claim against the estate, collateralized by those
    loans, and be entitled, for example, to adequate protection.
        But as part of BAPCPA, Congress expanded the definition of
    ``repurchase agreement'' to include mortgages. And since then,
    the bulk of lending to mortgage originators has been through
    repurchase agreements. The repurchase agreements and warehouse
    secured loans are really identical in all aspects for the most
    part, other than in a repo the mortgage belongs to the repo
    counterparty lender rather than to the mortgage lender.
        In the event of a default or a bankruptcy by a mortgage
    lender, the repo counterparty has a right to declare a default
    and require the mortgage lender to immediately repurchase the
    mortgage. And in the event the mortgage lender cannot do so,
    which is normal, the repo counterparty would obtain permanent
    ownership of the loan and be able to sell it directly to
    investors, a securitization trust, or keep the repo.
        In my experience, that is what the repo counterparty is
    interested in doing. Rather than preserving liquidity by
    selling the mortgage, it is likely to hold the loans for later
    disposition, especially in a crisis such as 2007 through 2009
    where the value of the mortgage was low. The safe harbors allow
    the repo counterparty, rather than the debtor, to hold the
    mortgage and obtain the upside of any increase in value. As
    applied to mortgages, the safe harbors allow for the repo
    counterparty to grab what otherwise would be its collateral,
    and prevent the mortgage lender debtor from maximizing the
    value of those loans for the benefit of the estate.
        This is contrary to the treatment of secured loans in
    bankruptcy and turns the Code on its head. The economic reality
    is that a mortgage lender, such as American Home Mortgage, can
    be stripped of its assets in days or even hours, leaving no
    ongoing business, and denying its creditors in general of the
    value of its assets, i.e., its mortgage loans. And while these
    safe harbors may make sense in the context of assets that are
    actually liquid, such as U.S. treasuries, they do not in the
    context of an illiquid assets, such as mortgages.
        Based on my experience, I respectfully urge Congress to
    consider removing mortgages and interests in mortgages from the
    definition of repurchase agreement, as well as the definition
    of securities contract. And thank you again very much for
    asking me to testify on these important issues. I am more than
    happy to answer any questions you might have.
        [The prepared statement of Judge Sontchi follows:]

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                                   __________
        Mr. Bachus. Thank you.
        Mr. Grosshandler?

    TESTIMONY OF SETH GROSSHANDLER, PARTNER, CLEARY GOTTLIEB STEEN
                      & HAMILTON LLP, NEW YORK, NY

        Mr. Grosshandler. Thank you, Chairman Bachus. Thank you for
    having me here. You have my written testimony. I am not going
    to repeat what is in there. The only reference to the written
    testimony I want to make is to thank my colleagues Knox
    McIlwain and Timmy Coldorovo who put it together in such short
    order.
        I was the co-chair with Judge Peck of the Lehman bankruptcy
    of the ABI Safe Harbors Committee that Judge Sontchi was on as
    well. And we started that a few years ago, and we were given by
    the ABI commissioners several pages of topics to cover. We
    could not get to them all. This is a very, very complicated
    topic, the safe harbors, the treatment of financial contracts
    in bankruptcy.
        Part of that has to do with there are lots of different
    players involved, and you may have different answers depending
    on who the players are, so you have systemically important
    financial institutions. You have hedge funds. You have
    industrial companies. You have individuals on the debtor side.
    It may depend on who the creditor is. Is the creditor a
    securities clearing agency, like DTC, or is it a non-dealer
    party? And there are different policy considerations depending
    on who you are talking about on the debtor and on the creditor
    side.
        Although we had many disagreements among the committee
    members, there were several things we agreed on. First of all,
    really complicated. Could not get it all done in the time we
    had. And then, the safe harbors do derogate from the general
    principles of the Bankruptcy Code, and that needs to be
    justified, right? And the justification, and different people
    on the committee disagreed as to what was and was not justified
    under these standards. But I think that the basic standards
    were agreed to, which is the safe harbors, if they promote
    stability and liquidity, that those are things that might
    justify derogating from the usual rules of the Bankruptcy Code.
        I think people generally agreed that the derivatives,
    creditors, and repo creditors, at least some of them, maybe not
    the whole loan repo creditors. I disagree with Judge Sontchi on
    that, but we can talk about that if you would like. But that
    some of the risks they face are different from other creditors
    under the Bankruptcy Code, and, therefore, at least some of the
    safe harbors were justified under those standards.
        The safe harbors also underpin very important markets. The
    derivatives market, the repo market, they might not cease to
    exist if you got rid of the safe harbors, but they would
    certainly shrink a lot. And is that good or bad depends on a
    lot of things.
        And one of the problems with just getting rid of the safe
    harbors is it is a very blunt instrument because it would
    basically mean everybody is not safe harbored as opposed to,
    for instance, regulatory change. So if you look at short-term
    funding transactions, like repos, the Federal Reserve Board is
    all over it, in terms of greater liquidity requirements,
    capital requirements, that sort of thing, to give a
    disincentive to over reliance on those kinds of transactions,
    whereas just getting rid of a safe harbor under the Bankruptcy
    Code, again, would be a very blunt instrument.
        I think an interesting example is insurance insolvency, not
    the subject of this Committee. It is State law. Insurance
    insolvency is governed by State law.
        Little known to most people because why would they be
    focusing on this, but in the past 5 years, at least 10 States
    have enacted new safe harbors for insurance company insolvency
    for derivatives and repos. We are up to about 20, 22 now. But
    the bulk of that has happened since the financial crisis. Why?
    It is the insurance companies, the users of those products that
    wanted the safe harbors to have access to those markets because
    Wall Street was unwilling to give them access or limited access
    because of the risk. So this is not only about protecting Wall
    Street. It is also end users like insurance companies who want
    the safe harbors.
        All that being said, there are clearly issues with
    everybody liquidating all at once. You want to avoid that if
    you can. In Lehman, I think that that actually helped prevent
    more contagion. If all the creditors had been stayed from
    exercising their rights, there would have been a lot of
    problems. But the liquidations caused their own problems, of
    course.
        So I think mechanisms that achieve continuity--Chapter 14,
    the Federal Deposit Insurance Act, single point of entry--all
    of these designed to avoid close out and are very, very good
    things. The key to them working from a creditor perspective is
    that there is somebody who is creditworthy who is able to
    continue the performance, and that is not only balance sheet
    creditworthiness. It is liquidity, liquidity to be able to
    perform.
        And then the final thing I would say is to the extent that
    Congress believes that changes to the fundamental safe harbor
    provisions are necessary, we need to be very careful. It is
    really complicated. There are a lot of international aspects to
    this. There are safe harbors around the world, capital
    implications for financial institutions.
        And the final thing is on the committee we dealt with a
    number of issues, the really hard issues like the scope of the
    repo exemption. There was a lot of division. There were several
    other issues that we picked first because it was so-called low
    hanging fruit where there was actually a lot of agreement about
    changes that would make the safe harbors better for America.
    Thank you.
        [The prepared statement of Mr. Grosshandler follows:]

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                                   __________
        Mr. Bachus. Thank you.
        Ms. Vris?

       TESTIMONY OF JANE LEE VRIS, PARTNER AND GENERAL COUNSEL,
                    MILLSTEIN & CO., WASHINGTON, DC

        Ms. Vris. Thank you. Thank you, Chairman Bachus----
        Mr. Bachus. Maybe pull that mike a little closer. It will
    actually put less of a strain on----
        Ms. Vris. There we go. Is that better?
        Mr. Bachus. Yes, there you go.
        Ms. Vris. Okay, great. Thank you, and thank you, Ranking
    Member Johnson, as well for this opportunity to speak on behalf
    of the National Bankruptcy Conference. I am the chair of the
    Capital Markets Committee there, and I am submitting for our
    testimony today position papers and proposed changes to the
    Bankruptcy Code that the conference has previously prepared.
    And these topics cover both safe harbors for, let us call them,
    the qualified financial contracts. By that I mean the
    derivatives, the swaps, the repos that you have been hearing
    about, as well as some form of bankruptcy proposal for
    treatment of SIFIs, the systemically important financial
    institutions.
        So in a sense, I sort of appropriately sit in the middle
    here because I am dealing both with the QFCs and safe harbors,
    as well as the Chapter 14 topic that I think you are going to
    be hearing more about.
        I will start with the SIFIs. We recognize in the conference
    that SIFIs face extraordinary challenges in bankruptcy.
    Ordinarily the mission in bankruptcy, and I think the
    Bankruptcy Code does a good job of this, is to preserve asset
    value for the benefit of all of the constituents. The automatic
    stay is a key component of that protection. It protects the
    debtor's assets from actions of creditors that would otherwise
    allow them to get at the assets, favor the first to act
    creditors, and leave less value behind for the other creditors.
        When a SIFI files, we are concerned that to some extent the
    reverse happens, that the filing itself can trigger a loss of
    asset value to the detriment of all parties concerned. I think
    it is important to think for a moment what we mean when we say
    ``when a SIFI files.'' By that I mean a parent holding company
    whose assets are the equity in operating subsidiaries,
    institutions like banks, insurance companies, broker dealers.
    So it is the parent that we are focusing on when we talk about
    bankruptcy solutions, including, I think you will hear, for
    Chapter 14 type solutions.
        The parent when it files has its assets protected by the
    automatic stay, but the operating subsidiaries do not have the
    benefit of the same protection. First, many of them are not
    eligible to file. Insurance companies, banks, they cannot file
    for bankruptcy under any chapter. Some subsidiaries can file,
    but only liquidation, and one conducted by a trustee, which is
    not really conducive to maximizing asset value for anybody.
        So for these reasons when the parent files, the regulated
    subsidiaries may be seized by their regulators, both here in
    the U.S. and abroad. Even if they are not seized, parties who
    have deposits with the banks are likely to demand their
    deposits back, a lack of confidence in the SIFI. And parties
    who may previously have been extending short-term financing are
    likely to stop extending that financing to those enterprises.
    All of this increases the need for liquidity at the
    subsidiaries at the same time that liquidity is no longer
    available to those subsidiaries. In these circumstances, value
    dissipates quickly.
        We think that the safe harbors for QFCs to some degree
    contributes to this dynamic. Even at the parent level the
    counterparties are not bound by the automatic stay. They may
    seize collateral, as you heard from the judge. They may sell
    the collateral, and they may terminate contracts. Not only at
    the parent level, but because the parent often guarantees these
    qualified financial contracts on behalf of its subsidiaries,
    when the parent files, because it is a guarantor, that can
    trigger the rights of the counterparties down at the
    subsidiaries to also terminate contracts, grab collateral. So
    as a consequence, when the parent files, there is a ripple
    effect throughout the entire enterprise that can cause assets
    to dissipate and also increase the need for the liquidity.
        We have thought about the ways in which the Bankruptcy Code
    could be modified to help a SIFI when it files. We support some
    limited modifications to the safe harbors. We think that would
    be beneficial. But we do not support the wholesale revocation
    of those safe harbors. We do recognize the single point of
    entry, and I think you will hear more about this, framework for
    a bankruptcy solution for SIFIs. Its chief component is
    allowing assets to be moved rapidly away from the parent, and
    to allow new management, and with the help and the input of
    regulators, to make fundamental decisions about how best to
    stabilize those subsidiaries away from the battleground that
    bankruptcy can sometimes be and that the parent will be under.
        However, even for the single point of entry solution to
    work, we think there must be a temporary stay of the safe
    harbors for the qualified financial contracts. And we also
    believe that the entire enterprise will need access to
    liquidity of some sort. And so, we think while the Chapter 14
    single point of entry is a very positive development in the
    thinking about how to resolve SIFIs in bankruptcy and the
    Bankruptcy Code can be amended to incorporate that, we think it
    also requires some changes to the safe harbors and requires
    some access to liquidity.
        On behalf of the National Bankruptcy Conference, again I
    want to thank you for allowing us to present this testimony
    today.
        [The prepared statement of Ms. Vris follows:]

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                                   __________

        Mr. Bachus. Professor Jackson? And thank you.

       TESTIMONY OF THOMAS H. JACKSON, DISTINGUISHED UNIVERSITY
       PROFESSOR & PRESIDENT EMERITUS, UNIVERSITY OF ROCHESTER,
                             ROCHESTER, NY

        Mr. Jackson. Chairman Bachus, and Ranking Member Johnson,
    and other Members of the Subcommittee, thank you for inviting
    me here this afternoon. And it is an honor to have an
    opportunity to testify before you on a subject near and dear to
    my heart, which is bankruptcy law, and specifically the role
    bankruptcy law can and should play in the best possible
    resolution of a troubled large financial institution, and how
    modest, but important, amendments to the Bankruptcy Code can
    facilitate that outcome.
        First, what do I mean by the best possible resolution of a
    troubled financial institution? I mean a resolution process
    that meets three important tests: first, one that both
    minimizes losses and places them on appropriate pre-identified
    parties; second, one that minimizes systemic consequences;
    third, one that does not result in a government bailout.
        In reflecting on the 2008-'09 financial crisis, everyone
    seemed to acknowledge that bankruptcy law should play a major
    role, but few had confidence that it was up to the task. The
    Dodd-Frank Act, while placing bankruptcy at the core of a
    resolution regime, nonetheless created an administrative
    backstop to it. Bankruptcy's core role in Dodd-Frank is
    reflected in two places, first in the requirement of resolution
    plans--living wills--under Title I, which are focused on and
    tested against a bankruptcy resolution process. It is also
    reflected in the statutory requirements for implementing an
    administrative resolution proceeding, the orderly liquidation
    authority under Title II.
        Such a resolution proceeding cannot be commenced without a
    finding that use of bankruptcy law would have serious adverse
    effects on U.S. financial stability. It is widely acknowledged
    that bankruptcy is the preferred resolution mechanism.
        But there is a disconnect between those premises in today's
    Bankruptcy Code. There is an emerging consensus that the best
    resolution system, one that meets the three standards I noted
    above, involves, first, loss bearing capacity known in advance
    that can be jettisoned in a rapid recapitalization of a
    financial institution. In the United States, this system is
    represented by the FDIC's single point of entry proposal for
    the recapitalization via a bridge company of a SIFI holding
    company under Title II.
        Compared to this administrative resolution proposal, the
    current Bankruptcy Code is, in my view, kind of ``close but no
    cigar.'' Yes, Chapter 11 of the Bankruptcy Code is increasingly
    used to effectuate a going concern sale of a business,
    sometimes rapidly through a pre-packaged plan. But it will
    struggle to do this in the case of a large financial
    corporation. The essence of the recapitalization is, first,
    leaving behind equity and the loss-absorbing debt, presumably
    long-term, unsecured debt, to bear the losses. And second, the
    transfer of everything else--assets, liabilities, rights, and
    subsidiaries--to a bridge company that because of the stripping
    off the loss-absorbing debt is presumably both solvent and in a
    position to deal with the needs of its subsidiaries. And this
    must be done with great speed so as to restore market
    confidence without a contagion-producing run.
        Yet because of the exemption of qualified financial
    contracts from most bankruptcy's provisions, including the
    automatic stay, and because of the lack of clear statutory
    language permitting the assignment of liabilities or the
    override of cross defaults or change of control provisions, the
    current Bankruptcy Code cannot provide the necessary assurance
    of a rapid recapitalization. This will lead, in my view, either
    to ineffective resolution plans and/or the reality that Title
    II will, contrary to desires, become the default resolution
    mechanism.
        In my view, amending bankruptcy law is the solution. Doing
    so can harmonize resolution plans with what currently is
    perceived to be the best way to deal with a troubled large
    financial institution, and those fixes can assure that Title II
    of Dodd-Frank becomes, in fact, a process of last resort to
    deal with emergencies that we are simply not able to foretell.
        What is required? In addition to specified loss absorbency
    capacity known in advance, and that I understand the Federal
    Reserve Board is working on, it requires explicit statutory
    authorization for a rapid transfer of the holding company's
    assets, liabilities, rights, and subsidiaries, minus the loss
    absorbing debt and equity to a bridge institution, and stays
    and overrides of certain provisions to enable that to happen.
        In my written statement, in a proposed Subchapter 5 to
    Chapter 11, and there are other proposals that are called
    Chapter 14 that are referenced in it as well, goes into detail
    as to how to accomplish this. And while the details are many,
    the concept is simple. Through modest amendments to the
    Bankruptcy Code it indeed can become the primary resolution
    vehicle for large financial institutions as envisioned by the
    Dodd-Frank Act.
        And because it is a judicial proceeding, bankruptcy places
    primacy on the rule of law, on market-based solutions rather
    than agency control, and on a process that is fair and known in
    advance, indeed planned for via resolution plans. I urge that
    you consider amending the Bankruptcy Code along these lines.
        Again, I want to thank the Subcommittee for allowing me
    this opportunity to present my views. I would, of course, be
    delighted to answer any questions you may have.
        [The prepared statement of Mr. Jackson follows:]

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                                   __________

        Mr. Bachus. Thank you very much, Professor Jackson.
        Professor Harner?

     TESTIMONY OF MICHELLE M. HARNER, PROFESSOR OF LAW, DIRECTOR,
    BUSINESS LAW PROGRAM, UNIVERSITY OF MARYLAND FRANCIS KING CAREY
                      SCHOOL OF LAW, BALTIMORE, MD

        Ms. Harner. Thank you. Chairman Bachus, Ranking Member
    Johnson, and Members of the Subcommittee, thank you for the
    opportunity to testify today. I am honored to appear before
    you.
        My research at the University of Maryland Francis King
    Carey School of Law focuses on corporate governance and
    financial distress, so I am very familiar with the topic of
    today's hearing. I want to note, however, that I am testifying
    in my capacity as reporter to the ABI Commission to Study the
    Reform of Chapter 11. My comments are on behalf of the
    commission and not my personal capacity.
        The commission was formed in 2012 to study the utility of
    the Bankruptcy Code. The commission comprises 20 of the
    Nation's leading practitioners, judges, and academics, and it
    was constituted by the American Bankruptcy Institute, the
    largest multidisciplinary, non-partisan organization dedicated
    to research and education on matters related to insolvency.
        My testimony will summarize the potential need for Chapter
    11 reform, the commission study process, and certain testimony
    and research received by the commission.
        The Bankruptcy Code has served us well for many years.
    Nevertheless, today's financial markets, credit and derivative
    products, and corporate structures are very different than what
    existed in 1978 when the Bankruptcy Code was enacted.
    Companies' capital structures are more complex and rely more
    heavily on leverage. Their asset values are driven less by hard
    assets and more by services, contracts, and intangibles. And
    both their internal business structures and their external
    business models are more global. In addition, claims trading
    and derivative products have changed the composition of
    creditor classes.
        These developments are not necessarily unwelcome or
    unhealthy, but the Bankruptcy Code was not designed to
    rehabilitate companies in this environment. Moreover, anecdotal
    evidence suggests that Chapter 11 has become too expensive,
    particularly for small and middle market companies, and is no
    longer achieving certain policy objectives, such as stimulating
    economic growth, preserving jobs and tax bases, and helping to
    rehabilitate viable companies.
        The commission study process was designed to explore the
    new environment in which financially distressed companies
    operate, and to determine what is and is not working as
    effectively as possible. Notably, the commission study process
    has involved over 250 individuals who work in or are affected
    by business insolvency. These individuals are serving as
    commissioners or advisory committee members or have testified
    as hearing witnesses.
        The commission has been actively engaged in the study
    process since January of 2012. It has received detailed
    research reports from its advisory committees on 12 broadly
    defined areas of Chapter 11 practice, such as governance,
    finance, financial contracts and derivatives, sales, and plans.
    It also has received a comparative analysis of many of these
    issues from an international working group representing over 12
    different countries. The commission is currently reviewing this
    impressive body of work.
        In addition, the commission has held 16 public field
    hearings in 11 different cities. The testimony at each of these
    hearings has been substantively rich and diverse and has
    covered a variety of topics. Several common themes have emerged
    from the field hearings, including an acknowledgment that
    Chapter 11 cases have changed over time, that Chapter 11 may no
    longer work effectively for small and middle market companies,
    that the safe harbors for financial contracts and derivatives
    have in some respects been extended beyond the original intent
    of that legislation, and that despite some issues, Chapter 11
    continues to be an important restructuring tool for U.S.
    companies.
        The commission's study process is winding down, and the
    commission is beginning its deliberations. It currently
    anticipates producing a preliminary report in December of this
    year. Although the commission does not yet know what it
    ultimately will recommend, it is guided by its mission
    statement to study and propose reforms to Chapter 11 and
    related statutory provisions that will better balance the goals
    of effectuating the effective reorganization of business
    debtors with the attendant preservation and expansion of jobs,
    and the maximization and realization of asset values for all
    creditors and stakeholders.
        Again, I want to thank the Subcommittee for this
    opportunity to testify, and I, of course, am happy to answer
    any questions.
        [The prepared statement of Ms. Harner follows:]

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                                   __________

        Mr. Bachus. Thank you very much. At this time, with consent
    of Mr. Marino, we are going to Congressman Collins first. Is
    that right?
        Mr. Collins. Thank you, Mr. Chairman. I do appreciate my
    dear friend, Congressman Marino, for allowing me to go here.
    Professor Jackson, in looking----
        Mr. Bachus. He has been in the back listening on TV, so he
    is----
        Mr. Collins. You all make great television stars. You all
    ought to think about this. You look good back there.
        Mr. Bachus. And they are wondering, this guy shows up and
    he starts asking questions, and he has not heard a thing.
        Mr. Collins. Yes, I have heard every bit of it back there.
    It is great. But again, Professor Jackson, your testimony
    indicates, and also your written statement, that transparency,
    certainty, judicial oversight of the bankruptcy process make it
    the preferred method for resolution of a financial firm. I just
    have a question. Could those same attributes make bankruptcy
    the ideal process for the resolution of Fannie and Freddie?
        Mr. Jackson. I am not an expert on the details of Fannie
    and Freddie, but in general it seems to me the structure of
    bankruptcy law, with well-defined rules about how you deal with
    assets and liabilities and priorities, a huge body of judicial
    law and judicial review of the processes, in my view, generally
    makes it the preferred resolution mechanism for almost any
    institution.
        That does not mean that there will not be perturbations to
    a system if a Fannie or Freddie went into a bankruptcy
    proceeding, but bankruptcy is pretty good at knowing how to
    deal with this. Trust assets will be set aside, priorities will
    be determined by the kind of priorities that they should have
    had.
        So as I said at the start, I am a big fan of bankruptcy law
    because I think it, in general, we have decades of decision
    making under it. We have strict priority rules. We have a
    judicial process that I think is pretty free from political
    pressure most of the time, that does a wonderful job of
    adhering to the rule of law.
        Mr. Collins. Okay. And I think that is the interesting, you
    know, process here of amending the Bankruptcy Code because it
    does have the history, for not only Fannie and Freddie, but
    also large and middle-sized banks as well. Would that follow
    along that same pattern of your answer?
        Mr. Jackson. Yes. When you are talking about depository
    banks, they are historically done under the Federal Deposit
    Insurance Corporation, but there is an actual feature of
    depository banks that makes them distinguishable from other
    kinds of even financial institutions. The Federal Government
    is, in fact, the residual owner of these institutions almost
    anyway because of the deposit insurance guarantees. So it is
    really their own institution that they are resolving at the end
    of the day, and that is very different from all other financial
    institutions.
        Mr. Collins. I am very glad you all are here. Just on the
    question line now, Professor Jackson, doing that, especially
    with Fannie and Freddie, I am looking at derivatives, the
    bigger issues that we have here, whether stockholder equity and
    enterprise is meeting its financial obligations to creditors,
    but it needs to be restructured or, you know, put into a run-
    off. This is where the bankruptcy if we amend it would probably
    work in situations like that given its history, given its
    structure. Would that be a fair statement?
        Mr. Jackson. That would be a fair statement. Again, what
    bankruptcy would do is impose losses first on the shareholders,
    on the equity. And then if any company was, in fact, insolvent,
    it would impose those losses on the lower tiered debt in the
    first instance. For example, in the SIFI process, the stripped
    off long-term debt that is left behind will be the group that
    bears losses in case the entity is insolvent so that you have
    to go deeper than wiping the equity out. But all of that is
    firmly established by priority rules in the Bankruptcy Code,
    which is one of the reasons I am such a fan of it.
        Mr. Collins. Okay. And a final part here just is looking at
    this and continuing on this sort of theme that we have
    developed here. And after this, if anybody else would like to
    jump in on this question. I see that bobble head going.
        Financial obligations. Are Fannie and Freddie right now
    meeting the financial obligations to creditors? If we did have
    a process like this, you know, should a bankruptcy filing
    leaves derivatives contracts and other financing arrangements
    in place? Would that be something that could be done through
    this?
        Mr. Jackson. Well, again, leaving them in place requires
    something like what I have been talking about with the single
    point of entry. It requires you to transfer everything to a new
    entity.
        Mr. Collins. Right.
        Mr. Jackson. Currently under the Bankruptcy Code if you did
    not have a stay to allow that continuation process to occur,
    and the others who were talking about the qualified financial
    contracts, under the Bankruptcy Code, those people can run. So
    you do need amendments to the Bankruptcy Code to at least allow
    you to transfer these to an entity where everything could stay
    in place.
        Mr. Collins. Go ahead.
        Mr. Grosshandler. Yes. I agree with everything Professor
    Jackson said, but I wanted to put one important point, extra
    point, which is Fannie and Freddie, of course, issue guaranteed
    securities, right?
        Mr. Collins. Right.
        Mr. Grosshandler. And those securities consist of the
    holder has a right to the payments on the mortgage loans that
    they are holding in trust, plus the Fannie and Freddie
    guarantee. What is going to happen to that guarantee in the
    bankruptcy? And the usual Bankruptcy Code rule is there is a
    long time to determine what happens to that guarantee in
    bankruptcy. It is a contingent claim. You do not know whether
    those mortgages are going to default or not, whether you need
    to draw on it. And it is very complicated. I think that kind of
    extended uncertainty in a regular bankruptcy proceeding would
    make the value of those securities tank.
        Mr. Collins. Well, even though this is the late hour and
    all, this is something that needs to be looked at, I think, as
    we look at the vast derivatives and other things that need to
    be looked at possibly in the structure bankruptcy. And I thank
    you, and I do thank my colleagues for allowing to question. And
    I hope you all have a wonderful evening. Thank you.
        Mr. Bachus. I thank the gentleman. Now, Ranking Member
    Johnson is recognized.
        Mr. Johnson. Thank you, Mr. Chairman. To be clear, Title II
    of Dodd-Frank is only triggered by the determination of the
    Treasury Secretary that a non-bank financial institution is
    systemically important. Could an entity like Lehman Brothers,
    whose impending failure puts the financial marketplace into a
    free fall and freezes the lending market? Is that enough to
    trigger a Title II orderly liquidation?
        Mr. Jackson. Everybody can jump in on this. I think
    actually Title II designed precisely for an entity such as
    Lehman. I mean, if you look at when Dodd-Frank was being
    enacted, Lehman was the elephant in the room because of the
    Lehman bankruptcy, and a sense that Lehman had done zero pre-
    bankruptcy planning.
        And so, I think a lot of effort that went into Dodd-Frank
    and Title II was trying to design a process that could, in
    fact, happen for Lehman. So, yes, I would assume that the
    Treasury and the Fed and the FDIC would conclude that Lehman
    was a systemically important financial institution for purposes
    of triggering Title II.
        Mr. Grosshandler. I think that is right certainly if Title
    II was in effect in 2008. Today the question would be, because
    the standard is would there be severe and adverse effects on
    the economy if there were not a Bankruptcy Code proceeding. If,
    in fact, the Bankruptcy Code were changed along the lines of
    Chapter 14, et cetera, in fact, and given the resolution
    planning that is happening, it might be that Lehman today or
    tomorrow, assuming changes to the Bankruptcy Code, would not
    require the Title II intervention.
        Mr. Jackson. I think that is completely correct. I was
    playing with the world that exists today where I think you have
    a disconnect between the desire of the Dodd-Frank Act, which is
    bankruptcy takes primacy. You cannot trigger a Title II
    proceeding until you have found the bankruptcy is not up to the
    task. And the reality is, which is because have not changed
    bankruptcy law, I think today if a Lehman Brothers was to fail,
    it is almost inevitable that the trigger would be pulled on
    Title II
        The proposals I have talked about today, it seems to me,
    are explicitly designed to reduce almost to the vanishing point
    the need to implement Title II, and instead use a judicially-
    based proceeding in bankruptcy. So that I believe if you went
    in the direction I talked about today with a Chapter 14 or
    Chapter 5 of Chapter 11, you today would use bankruptcy and not
    Title II for Lehman Brothers.
        Mr. Johnson. Well, Professor Jackson, it is clear that you
    believe that the judicial system would be better equipped to
    deal with the resolution of a SIFI as opposed to a regulatory
    body. Can I ask each of you what you think----
        Mr. Bachus. But he is saying with the changes that he has
    proposed.
        Mr. Johnson. Yes. Yes. But what Professor Jackson is saying
    is that we need to do this judicially as opposed to
    administratively. And I would like to get the other witnesses'
    opinions on that.
        Judge Sontchi. Well, I think that----
        Mr. Johnson. And I would also point out the case of GM
    bankruptcy and the government money that went into that. And,
    of course, Professor Jackson, you do not want any bailouts, any
    government bailouts. And so, how can you restructure a company
    like GM in a bankruptcy proceeding without public dollars? So
    in light of that, what is the best way to deal with this?
        Mr. Jackson. Do you want me to take that one on, and I
    think the other question went to the other people at the table.
    The difference between General Motors, I think, and what we are
    talking about here is I am explicitly talking about a system in
    which there is loss absorbency built into the financial
    structure so that what you do in the financial institution
    case, it is like a bail-in. You strip the debt out, leave it
    behind in the bad company, and you start out with a new company
    that is solvent again.
        That option was not really available at the time of General
    Motors, nor was it available at the time of the 2008-2009
    financial crisis for other institutions. The beauty of this,
    and it does require regulatory requirements that there is loss
    absorbency capacity built into the system, is that by doing
    that, you get away from what I think is the Hobson's choice
    that they faced in 2008-2009, which is either allow the
    financial system to crater or to bail them out. And what this
    does is I think it allows you to get away from that Hobson's
    choice.
        It is a very different thing because the financial
    institutions have a different sort of structure and importance
    than a General Motors so that I am not really talking now about
    what you do with corporate reorganization.
        Mr. Johnson. I understand. I understand. Could I, Mr.
    Chairman?
        Mr. Bachus. You want to----
        Mr. Johnson. Yes, if the others could respond.
        Mr. Bachus. That is all right.
        Mr. Johnson. Thank you.
        Ms. Harner. Certainly. Thank you, Ranking Member Johnson,
    for that question. So first, I will say in my personal
    capacity, I, like Professor Jackson, am a true believer in the
    bankruptcy system. I think the transparency, the due process,
    the certainty and the judicial oversight hold tremendous value
    when you are trying to restructure any company, including SIFIs
    and companies like GM. Do we need to change the Bankruptcy Code
    to accommodate those types of companies? Yes, I think we do.
        Now, from the commission's perspective, we have not made
    any determinations about the type of issues Professor Jackson
    or you, sir, have raised, but we are looking at them. In fact,
    we have asked the Subcommittee that Judge Sontchi and Mr.
    Grosshandler are on to help us consider ways to handle issues
    that come up in a Chapter 14 and SIFI type situation.
        I also will just point out that one of the themes we are
    hearing continuously is that a one-size-fits-all approach in
    bankruptcy may not be the most effective or best approach. So
    we may be considering ways to think differently about very
    large corporations, very small corporations, and then what
    constitutes the majority of U.S. companies and U.S. debtors,
    the small middle market companies.
        Judge Sontchi. If I may very quickly. First of all, it is
    nice to hear everybody trusts the bankruptcy system.
    [Laughter.]
        I do not know if we deserve it, but I will take it.
        Mr. Grosshandler. You may hear a little dissent.
        Judge Sontchi. I think one of the primary problems is time
    is your enemy. Time is your enemy in almost every Chapter 11.
    But when you are talking about these SIFIs, you are talking
    about trying to close out billions dollars in very short order,
    time becomes a very difficult thing to deal with. And what the
    bankruptcy court gives you is transparency. It gives you due
    process, but it takes time.
        So the difficult balance in trying to figure out how you
    can handle a SIFI in a bankruptcy process I think has a lot to
    do with the balance of due process, which takes time, and the
    need, the real economic need, to move very, very quickly.
        We actually do this every day. Every Chapter 11 case I
    have, when you have an operating business under court
    supervision, time is critical. And we are required to, and I
    think we do a pretty good job, of balancing the issue about due
    process with the emergent nature of the case. And why I say
    that is because you will hear that a regulatory position or a
    regulatory answer might be better for it because things can
    happen more quickly because we cannot wait around for a court
    to get around to doing things.
        And I would counter that, yes, there is a tension there.
    There is no question. But I think the bankruptcy system does a
    pretty good job of handling that on a day-to-day basis in all
    our cases. And I think it would be a challenge, but I think we
    would be more likely than not to handle it in a SIFI type
    situation that we are talking about.
        Ms. Vris. I think that the bankruptcy judges are very good
    at some tasks and some missions, and that the regulators are
    better for other tasks and other missions. I think if we are
    talking about a claims dispute process resolving disputes, I
    think the bankruptcy judges are better for that. I think if we
    are talking about a planned process or valuation, I think the
    bankruptcy judges are better suited for that.
        I think if we say for resolution of SIFIs we are broadening
    the mission and we want to also try and safeguard the
    disruptive effect on our entire financial system and the
    economy of the country, I think that is a lot to put on the
    shoulders of our bankruptcy judges, as wonderful as they are.
    In Lehman, Judge Peck had an extraordinarily short period of
    time to decide whether or not to approve the sale of the broker
    dealer to Barclays. He did an admirable job. Everybody and
    their brother objected. He had, as I said, very little time.
        And ultimately he made a decision, which I think most
    people would say was the right decision, notwithstanding that
    people later tried to upset that decision. But I do not think
    that is really what we should ask of the bankruptcy courts if,
    as I say, our mission with the SIFIs is to look at the broader
    effect on the economy as a whole, and to do so quickly.
        But I would also note that I think with any of the sort of
    Chapter 14 or bridgeco solutions that we are thinking of, those
    require extraordinarily fast action at the beginning of the
    case. Twenty-four hours, 48 hours. If you are anywhere in that
    kind of timeframe, it is very hard, as the judge has said, for
    the judges to really provide due process and make all the
    decisions they will be asked to make in that process.
        So I think that it is hard to ask the judges to make too
    many concrete decisions for approving the transfer of assets
    and certain liabilities to bridgeco.
        I do want to address your GM question, but if you will
    allow me, I will speak instead to Chrysler since I was involved
    in that. I represented the equity there, so I can speak more
    from personal knowledge.
        I think it was the same situation in the sense that there
    was no one else who would have provided the liquidity that was
    needed. There was testimony presented that Chrysler needed $100
    million a month just to keep the lights on, and there was no
    one who was willing to do that. If the government had not
    stepped in, I think everyone there who had heard that testimony
    would agree the company would have to have been shut down,
    including the people who were objecting to the whole process in
    Chrysler. They acknowledged that there was no one else there to
    step in and provide that liquidity.
        And perhaps a little less optimistically than Professor
    Jackson, I think we at the conference believe that with a SIFI,
    they are going to need liquidity, too. I do not think that the
    single point of entry structure removes the need for liquidity.
    And so, the question is who provides that liquidity. And, you
    know, I cannot speak to that today, and I do not know how much
    would be needed and what the private markets would or would not
    be willing to do at that point. But some liquidity and access
    to it will be needed we think.
        Mr. Johnson. Thank you.
        Mr. Grosshandler. I agree very much with Judge Sontchi and
    Ms. Vris. Time is the enemy, and also the bankruptcy courts, I
    think, are very well situated for sort of the after the fact
    adjudication of things. But approving that transfer is a lot to
    put on a bankruptcy judge. And I am just not so wary of the
    Federal regulators' ability to make those decisions.
        Mr. Bachus. Thank you.
        Ms. Vris. I am sorry. Could I just interject briefly?
        Mr. Bachus. Sure.
        Ms. Vris. I would just also point out that with the living
    will process, hopefully regulators will have had access to more
    information. They will know more about the assets and the
    liabilities. And even if the living wills are not a perfect
    blueprint to solve the problem, it is at least a huge head
    start.
        Mr. Bachus. Thank you. And what we did, and I think it is
    good. I mean, instead of just shoehorning everything into 5
    minutes, we actually went 15 minutes with this, but I think
    that is good because we can get into the substance. And so, you
    can have as long as you want. I mean, 15 minutes.
        Mr. Marino. I have one issue that I want to zero in on. I
    was a prosecutor for 18 years, and I was a U.S. attorney, so I
    am used to the Federal court system. And I actually shared an
    office with one of the bankruptcy judges because we needed
    room, and we split things. [Laughter.]
        So I have heard a lot of war stories. And I am going to ask
    each of you to respond to this. I am going to ask Professor
    Harner, would you respond first, and I am going to set up the
    scenario.
        Whatever position you take, whether we need to change the
    Bankruptcy Code particularly concerning safe harbors or not,
    what impact would the change or not having the change have on
    our international financial system, particularly dealing with
    the EU at this point, because my area of expertise-ish
    concerning finance is international finance. So could you
    please address that?
        Ms. Harner. Certainly. Thank you, Congressman, for the
    question. So I think you raise a key point. Markets are no
    longer domestic. They certainly are global in nature. And that
    was one reason the commission felt so strongly about
    constituting an international working group.
        And so, we are working with academics and practitioners in
    the following countries, Austria, Australia, Belgium, Canada,
    France, Germany, Italy, Japan, the Netherlands, People's
    Republic of China, South Africa, Spain, and the United Kingdom,
    to help consider possible reform if the commission would
    determine it is necessary. And they have been giving us very
    thoughtful research reports on issues that would integrate and
    impact the financial markets just as you mentioned.
        So I think like any change to the Bankruptcy Code, it is a
    matter of finding that sweet spot, finding the balance where we
    are not disrupting the financial markets either domestically or
    globally significantly. But we are actually giving companies an
    opportunity to rehabilitate.
        Mr. Marino. Okay. Thank you. Professor Jackson, please?
    Thank you, Professor Harner.
        Mr. Jackson. Not particularly my expertise area, but I have
    a couple of comments on it.
        Mr. Marino. Please.
        Mr. Jackson. I think we need to think about doing what we
    think is right with respect to qualified financial contracts. I
    think even if you wanted to modify, the world is not going to
    look like they have been repealed. I think you want to look at
    what the rest of the world does particularly with, I will go to
    the large financial institutions, these holding companies and
    subsidiaries. Lehman had over a thousand different
    subsidiaries. That is probably too complicated. But the reality
    is these are global companies, and anything we try to do that
    is going to work for these, even at the holding company level,
    is going to require the cooperation of the subsidiaries and the
    regulators of the subsidiaries to go along.
        We can solve that domestically, but when we are dealing
    with foreign subsidies, and if our rules look weird to the
    foreign regulators, we are going to have a hard time getting
    them to play by our rules. And so, I think those cross-border
    issues, particularly at the large financial institutions, is
    something we need to be very sensitive to.
        Mr. Marino. Thank you, sir. Ms. Vris?
        Ms. Vris. I agree with what Professor Jackson said. And the
    conference believes that any kind of resolution will require
    discussion between the U.S. and the foreign regulators. They
    have to have confidence in whatever we are proposing to do. If
    they do not, then they are going to circle the fences around
    the assets in their country. This happened in Lehman. It has
    happened in other cases. And so, cash that is overseas is going
    to stay there. Those creditors are going to get favored.
        Mr. Marino. Yes.
        Ms. Vris. And you have to put it in context. Even with the
    best of coordination, you may still encounter that in
    countries. It is a natural instinct of the regulators to want
    to hold the cash in their own country. But if you do not at
    least work with them up front, you are going to have no chance
    at cooperation.
        Some of our big SIFIs, I think, Lehman did have
    subsidiaries around the world. I had the pleasure of
    representing the Central Bank of Germany in that case. But you
    have to look a little more carefully. Not all foreign
    subsidiaries are necessarily critical to the long-term survival
    of some of our SIFIs. So it is a case by case situation.
        Mr. Marino. Sir. Thank you.
        Mr. Grosshandler. Yes. I have two basic points to make. The
    first is, as I had indicated earlier, the safe harbors are an
    international phenomenon in Europe as well as Asia. Most of the
    developed countries have safe harbors for financial contracts.
    And so if one were to get rid of them here or substantially
    narrow them, that would have competitive issues, all of those
    sorts of things.
        Also the single point of entry mechanism, one of the
    reasons for it is because of the very difficult cross-border
    issues. So the idea is the holding company goes under, but the
    operating bank, broker dealer does not, and, therefore, the
    operating banks and broker dealers overseas do not go under.
    Great thing if it works. It requires cooperation.
        At a very technical level, I think it is very important to
    think about cross-border recognition. So Europe, the European
    Union, is considering the BRRD, the Banking Recovery and
    Resolution Directive, which in Article 85 gives local
    regulators in Europe the ability to recognize U.S. law. So, for
    instance, if U.S. law, like under Title II overrides defaults
    and cross-defaults in financial contracts, Article 85 allows
    recognition of that.
        There is no comparable vice versa. So if the U.S. wants to
    recognize a European law, which the BRRD also has that
    overrides defaults and cross-defaults, it is just basic comity
    law, which in many courts very, very difficult. It would be
    wonderful if there were a centralized bankruptcy court kind of
    mechanism like Chapter 15, which does not apply to many of
    these contexts because it does not apply to financial
    institutions, but a Chapter 15 expansion to recognize European
    law.
        Mr. Marino. Thank you. Judge?
        Judge Sontchi. First of all, I think you just found out how
    incredibly knowledgeable Mr. Grosshandler is about these
    issues. His encyclopedic knowledge is amazing, and I have a lot
    of respect for him.
        I think about it just maybe a little differently. I was at
    a conference in Vancouver last month, and one of the main
    issues was corporate groups. What do we do about cases like
    this where we have holding companies, we have subsidiaries,
    they may be in different countries? How do we deal with that on
    a cross-border basis? And the Chapter 15 we have today that
    covers cross-border cases does not deal with that.
        So UNCITRAL, which is the UN organization that came up with
    Chapter 15 in the first place, and the European Union, and
    people in those entities, are today exploring, and there is a
    lot of talk about how do we deal with corporate groups on an
    international level.
        And I do not know frankly whether anyone in the United
    States is sort of on board with that discussion. But the
    discussion is going forward, and I would hope and I think that
    as that moves forward, I think you are going to start to see an
    international consensus growing, at least on a procedural way,
    to deal with some of these issues from a cross-border
    perspective.
        Mr. Marino. Thank you all very much. I could talk with you
    for hours, but I am sure that you folks have important things
    to do as well. But thank you very much, and I yield back.
        Mr. Bachus. Thank you. Listening to the testimony, I had
    written several things down. And the second thing I wrote down
    was international institutions during the testimony, and then
    Mr. Marino went into that. I was actually thinking I might want
    to move that up to number one, and I think this discussion has
    gotten around it.
        When we talk about SIFIs, we are talking about
    international institutions. I am not sure we knew that before
    2007, 2008, Members of Congress, but we sure did after that
    because with AIG, you had a British subsidiary that caused all
    the problems. The insurance business was fully reserved, so
    bailout was not of AIG. It was the counterparties, and they
    were paid 100 cents on the dollar.
        And that money went through AIG within a matter of hours.
    It went to the counterparties. Most of those were in Europe.
    And then many of them then had agreements back with Goldman,
    had agreed to ensure that. So you had the credit default swaps.
    So you had money coming in here, going out there, coming back
    to the United States. And it took literally a year before the
    public and many Members of Congress knew where the money went.
        If you are talking SIFI, you could not possibly have a
    chapter that you used on middle and small or even large
    companies, and these too big to fail. That is another word for
    that. And, you know, there is a big debate here whether or not
    we are going to allow too big to fail or SIFIs significantly.
        There is tremendous debate on does that give them a
    preference. Does that give them an advantage? And of course the
    regulatory agencies are saying, well, we are going to protect
    them by requiring more capital of them. And then they are
    saying, well, you know, that makes us less efficient. So there
    are all these subplots.
        But sitting here, I believe when it comes to the SIFIs,
    maybe not the only, but the most rational approach would be a
    Chapter 16 or whatever, you know, a chapter for this because
    Chapter 15 is not designed for that. And it is going to be an
    international agreement because there are some that I have
    disagreed with that say we do not need financial institutions
    that big. Well, they are going to exist. They will exist in
    other countries if they do not exist here. And those are maybe
    the first choices, but I think they are going to exist.
        When it comes to them getting in trouble, there is going to
    have to be an international resolution because if you try to
    change Title 11 to fit that, then you are going to have smaller
    companies. You are going to have them structuring different
    things to fall under safe harbor. And you are going to have all
    kinds of abuses because, according to the judge, we are already
    having some market distortions or people designing things to
    take advantage or to get a preference when that was not what
    was intended.
        The second thing I wrote down, and this is sort of
    reminiscing, but the American Securitization Forum, I asked one
    of the staffers, I said, that was about 10 years ago. Find out
    when their first annual conference of the American
    Securitization Forum was because I spoke at their first
    conference, and it was 2004.
        And the reason I went is because Chairman Oxley said, we
    were sitting around, and the Subcommittee Chair of securities,
    Chairman Oxley, said, do you want to go and speak. And he said,
    well, what would I speak about? And he said, CDOs, and CDSs,
    and mortgage-backed securities. And he said, you know, I do not
    think I want to go. [Laughter.]
        And I had read sort of a book like derivatives for idiots.
    And so, I was able to--what is a credit default swap? I said,
    well, it is a form of insurance. So that one question got me a
    trip to Arizona because we were dealing with things that we
    really did not know what they were. I mean, Members of Congress
    did not know the difference in a CDS and a CDO and a mortgage-
    backed.
        And if you think about it, the Budget Control Act, 1978, a
    lot of things we now have instruments we did not have then. And
    2005 we may have had them, but I am not sure we knew we had
    them, and we certainly did not know how prevalence they were.
    And the OTS who regulated Thrift regulating, they were the
    regulator for the AIG. And they may have been the least
    qualified, and I do not mean that in a bad sort of way.
        I will say this. Dodd-Frank, half of it was written in a 2-
    week period in the Senate. But one thing that we actually in a
    bipartisan way discussed--Chairman Frank, myself, others--we
    worked on a living will, Title I. Does everybody agree that is
    a good thing? And I think that you again, we have talked. I
    have very little debate since then, and everybody agrees that
    is a good thing.
        But we also, and you have talked about this, another thing
    I wrote down is ``panic/stable economic environment.'' You
    know, a lot of what works in a stable economic environment in a
    panic, you know, it is a different environment, much of what
    was done then. And I, for instance, received a call from
    Speaker Boehner, who may have been minority leader--no, he was
    Speaker then--that had I lost my mind because I had said we
    needed to get warrants from these institutions. And the his
    staffer called and said he is saying we need to get arrest
    warrants for these people. [Laughter.]
        And I was talking about warrants, you know, the money that
    we loaned them, which was not an arrest warrant.
        So, you are dealing with Members of Congress who simply on
    an ordinary day are overwhelmed. But on a day like this, we do
    not understand. We were listening, and, you know, to varying
    degrees we understand what we are talking about. But something
    this complex has got to have your institutions and your groups
    to tell us what to do.
        Safe harbor to most of us that have a legal background
    means shielding from liability. That is usually how we consider
    it. It shields us, not that it gives a preference to one asset
    or one creditor or one over another. So we are going to need an
    awful lot of guidance on these things. And that is what we are
    going to depend heavily on you for. And I think part of it we
    may could do this year, but when it comes to the SIFI part, it
    is going to have to be some international agreement because,
    you know, a lot of the things that were put in as a safe
    harbor, the original intent was not to allow some of the things
    that happened.
        But I found everything else said has been very helpful to
    us. And what I think this Congress does best is not when it
    makes sweeping changes in a crisis, but if you can come to
    agreement on a few things, it can be done now. Not a reform
    bill to reform a whole thing, but something to address a few
    specifics. And we might could actually accomplish that this
    year.
        So I am not going to ask any questions. You have answered
    the question that needed to be asked without anybody asking it.
    But if any of you want to make final comments, we would love to
    hear those.
        Judge Sontchi. Well, Chairman Bachus, what you said at the
    very end about being able to deal with perhaps discrete items,
    I would take you back to what I talked about, which is amending
    Section 546(e) of the Bankruptcy Code. I think that is not a
    very controversial topic. There are some, you know, bumps about
    how exactly you treat public shareholders, for example. But I
    think for the most part it is not controversial.
        And I think frankly there is an immediate need to deal with
    that safe harbor because as it is being applied now, and we
    have really no choice given how it is drafted, there are people
    who are directors, officers, insiders who are using 546(e) to
    shield themselves from potential fraudulent conveyance
    liability in private transactions.
        Mr. Bachus. And that undermines the people's trust----
        Judge Sontchi. I think so.
        Mr. Bachus [continuing]. When they hear things of that
    nature. And obviously it is not fair to shareholders. It is not
    fair to creditors, you know. Anybody else?
        Ms. Vris. Yes. The conference agrees with that, and, in
    fact, we did propose some specific statutory changes to, I
    think, pretty much, in fact, what you are discussing, Judge.
    And, you know, we would be more than pleased to dust that off
    and work with your staff on that.
        Mr. Grosshandler. And the Committee on Safe Harbors, in
    addition to mostly agreeing on changes to 546(e), and the
    differences are in some of the details that are very detailed.
    There were a number of other items where we agreed on things.
    But when you get to issues of the scope of the repo safe
    harbor, there was a lot of disagreement, but there was a lot of
    agreement on a number of things.
        And I think the process is that the full commission is
    going to take the committee's recommendations and come out with
    something. But I would be surprised if they did not take the
    recommendations that were pretty much unanimous.
        Ms. Harner. And, Chairman Bachus, I will just add onto that
    the commission would be more than happy to work with the
    Subcommittee in any way that would be helpful. And to the
    extent that there are issues that you would like us to
    prioritize, certainly let us know. And the safe harbor issues
    may be a starting point.
        Mr. Bachus. Well, obviously, Judge, what you said in your
    testimony was disturbing that that is going on, that there are
    people that are sort of insulating or looking out for
    themselves as opposed to the corporation.
        I personally would rather you make the determination of
    what is a priority because you know much more than I do on this
    subject. Now, if it is railroad law, come to me and I will give
    you some advice, but most of it will be 22 years old.
        Mr. Johnson. Well, Mr. Chairman, you told me about that
    railroad case, and I find those country experiences to be
    inconsistent with your knowledge in this particular area.
    [Laughter.]
        And so I am perplexed, but I am also intrigued. And I look
    forward to our Committee doing some good work in this area.
    This has been a great panel, and I have learned a lot myself.
    And I realize that our process often impedes our ability to
    learn from the private sector, the academic sector, the
    commercial sectors. And when we can take a few minutes to let
    ourselves question and try to understand outside of the 5-
    minute period that many so rigorously adhere to, it gives us a
    better chance of coming to some sound decision making. So I
    definitely appreciate you.
        Mr. Bachus. Let me say this. In a bipartisan way, the
    Congress was concerned over not following rule of law, you
    know, not going by an established Bankruptcy Code. What
    Professor Jackson--I am not saying yes, yes, yes. You know,
    this is the preferred method. This is rule of law. This is
    precedent. This is people. There is predictability. There are
    all these things, the transparency. It is not politics or
    somewhat insulated, I mean, I think, to a great extent. And you
    would really be doing, I think, a great service to the American
    people because if this issue is not resolved, I mean, then
    there is going to be an outcry from the American people to do
    things that I think would damage our free market system and our
    capitalism, and would be damaging to our financial system.
        What you are saying is people are beginning to think, well,
    the government owns the banks anyway, which I hope that is not
    the case. But I can understand exactly what you meant. And so,
    you would be doing a great service, even if we were able to
    make a few changes to the things that most all of you agree
    with. And we would have a much greater likelihood of enacting
    some law this year. So I think this hearing is adjourned.
        But I think your testimony has been excellent. The
    interchange between the panel I think has been most helpful.
    And where you can reach a reasonable consensus, if you can do
    that, I think we can do our part.
        So thank you very much, and this concludes today's hearing.
    I thank all the witnesses for attending.
        Without objection, Members will have 5 legislative days to
    submit additional written questions for the witnesses or
    additional materials for the record.
        This hearing is adjourned.
        Mr. Johnson. Thank you, Mr. Chairman.
        Voices. Thank you.
        [Whereupon, at 6:28 p.m., the Subcommittee was adjourned.]
                                A P P E N D I X

                                  ----------

                   Material Submitted for the Hearing Record

    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 is the second hearing examining 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
    exactly 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.
        As I noted, this is the second hearing at which this Subcommittee
    is exploring how the Bankruptcy Code could be improved to deal with
    systemically significant financial institutions.
        Indeed, the Committee and Subcommittee combined have held 23
    hearings since the last Congress on various anti-regulatory matters and
    measures that have absolutely no hope of becoming law.
        But when it comes to examining how the bankruptcy law can better
    accommodate the needs of consumers and municipalities struggling with
    financial distress, the Subcommittee has not held a single hearing on
    any of these critical issues: not during the last Congress and not
    during the current Congress as of this date.
        And, these are not frivolous issues. They include, for example:

              exploring ways to give homeowners who are victims of
            predatory lending relief from excessive mortgage interest rates
            and hidden ``gotcha'' penalties;

              determining how to provide relief to well-meaning
            students ensnared by profit-driven schools and private
            educational loan lenders into obligations they will never be
            able to repay; and

              conducting a long-overdue examination of the various
            ways how Chapter 9 of the Bankruptcy Code, which deals with
            municipal bankruptcies, could be improved.

        Accordingly, I implore the esteemed Chairman of Subcommittee to
    focus on these other issues that are more than equally deserving of
    being considered before the end of the current Congress.
        Finally, as one who was here during the consideration of the 2005
    amendments to the Bankruptcy Code, I can attest that measure
    illustrates just what happens when special interests control the
    legislative process.
        One of the issues that will be addressed at this hearing is whether
    the expansion in 2005 of the Bankruptcy Code's safe harbors for
    derivatives--in the aftermath of the Great Recession--may have, in
    fact, contributed to the Nation's near economic collapse.
        Over the course of prior hearings, we have learned how these
    derivative safe harbors not only destroyed billions of dollars of value
    in the Lehman Brothers bankruptcy case, but how the precipitous
    collapse of that entity nearly froze the Nation's financial
    marketplace.
        As I recall, these safe harbors were included in the 2005 law at
    the special insistence of the industry, which later was very much
    traumatized by them.
        I would hope that this could be at least one area where there may
    be the potential for bipartisan resolution.
        In particular, the National Bankruptcy Conference has a number of
    thoughtful suggestions about how we can restore the original intent of
    these safe harbors, namely, to protect the stability of the financial
    marketplace not the bottom lines of private parties.
        For example, the Conference recommends:

              closing the financial contract loophole that allows
            creditors to foreclose collateral consisting of the debtor's
            operating assets; and

              limiting recourse for settlement payments that
            otherwise constitute constructive fraudulent transfers.

        Accordingly, I look forward to hearing the testimony from our
    witnesses about these and other recommendations to improve the
    bankruptcy process.

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       Questions for the Record submitted to Seth Grosshandler, Partner,
              Cleary Gottlieb Steen & Hamilton LLP, New York, NY*
    ---------------------------------------------------------------------------
        *The Subcommittee had not received a response to these questions at
    the time this hearing record was finalized and submitted for printing
    on September 25, 2014.

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