Paul Ryan on Hart-Zingales and Resolution Authority

Sigh. (This will be denser than normal, but it’s important for where the Senate debate stands.)

Representative Paul Ryan is now going on television saying that he wants a market based trigger for resolution based on Hart-Zingales’ model of how to tear down a large systemically risky firm. Within seconds, he is also calling the Dodd Bill a bailout bill, and a bill that picks winners because a resolution authority fund would give out haircuts, and he thinks we need to do bankruptcy on large financial firms.

We’ve been through this before, but Hart-Zingales is a resolution authority based reform for how to deal with a large systemically failing financial firm like Lehman Brothers. This is not bankruptcy for large systemically failing firms.

Bankruptcy reform would mean that we wait until the firm can’t make a payment before declaring it bankrupt, and then having a bankruptcy court handle the wind down of the firm. The Great Depression taught us that waiting until a person can’t access their checking account is a bad timing device to declare a commercial bank failed, and as such we have the FDIC wind down a failing bank earlier. Lehman’s bankruptcy judge declared: “This is the most momentous bankruptcy hearing I’ve ever sat through. It can never be deemed precedent for future cases. It’s hard for me to imagine a similar emergency”, so I think the idea holds. Resolution authority does the same exact thing for shadow banks and large, highly-leveraged and interconnected financial firms.

The question is when to pull the trigger. Hart-Zingales wants a market-based trigger based on the price of a CDS contract. If you look at the past few years and think that conclusion of AIG-FP and Magnetar is that the price of a CDS contract is a great predictor of default rates (has an expected value of 0), and that this won’t incentivize market participates with well defined goals to force a profitable banking run, run with it.

Hart-Zingales soft-pedal it, but their description: “and issuing equity did not improve its situation, the regulator would replace the institution’s CEO with a receiver or trustee. This person would be required to recapitalize and sell the company, guaranteeing in the process that shareholders were wiped out and creditors — while not wiped out — received a ‘haircut,’ meaning that the value of what they were owed would be reduced by some set percentage…this regulatory receivership would be similar to a mild form of bankruptcy” is exactly what the Dodd Bill and Obama’s White Paper are trying to do.

If we wanted to implement Hart-Zingales, we’d tear open Title I of the Dodd Bill, place a shunt into Section 166: “Early Remediation Requirements”, and start pouring in additional regulations about how firms have to issue certain types of debt and certain types of financial instruments.

(Also, he claims that he wants to reform the derivatives market. Did he ever mention derivatives reform when it mattered, when HR 4173 was going through the House? I highly doubt this, but would love to see some evidence of it. I remember few, if any, Republicans getting behind this.)

I’ll end my venting now. But the Republicans and conservatives really seem to be late to this, and just throwing everything against the wall they can find.

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