Orderly Liquidation Authority

Orderly Liquidation Authority

August 25, 2017
Orderly Liquidation Authority
This In Focus provides background information and
demonstration of TBTF problems. Certain large institutions
discusses some of the issues related to the Orderly
had taken on out-sized risks that ultimately caused their
Liquidation Authority (OLA), an authority Title II of the
failure. In response, the U.S. government took actions to
Dodd-Frank Wall Street Reform and Consumer Protection
stabilize the financial system, including infusing large
Act (the Dodd-Frank Act; P.L. 111-203) granted to the
amounts of government funds into certain individual
Federal Deposit Insurance Corporation (FDIC) to resolve
institutions.
large, failing financial institutions under certain
circumstances. The Financial CHOICE Act of 2017 (H.R.
Following the crisis, certain analysts asserted that the
10) that passed the House in June 2017 would repeal OLA.
FDIC’s existing authority was insufficient to contain
systemic distress. Many large, complex financial firms are
Background
not depositories, and the largest and most complex are
Companies in a market economy are generally restrained in
generally bank holding companies (BHCs) that own many
their risk-taking by market discipline—potential losses
non-depository subsidiaries. Furthermore, the bankruptcy
incent firms to carefully manage risk. If risks are not
process under the current Bankruptcy Code does not take
appropriately managed and a firm fails as a result, the
systemic stability implications of a firm’s failure into
judicial bankruptcy process under the Bankruptcy Code can
consideration. Proponents of this view commonly cite what
impose losses on stakeholders. However, this process
they assert to be the chaotic aftermath of the Lehman
arguably may not always be amenable to smoothly
Brothers bankruptcy filing as an illustration of this problem.
resolving certain financial firms.
Dodd-Frank Title II
Liquidating a firm vitally important to financial market
The Dodd-Frank Act implemented multiple mechanisms to
segments could disrupt the availability of credit, and the
try to eliminate the taxpayer exposures and distorted
potentially deliberate pace of the bankruptcy process may
incentives created by institutions whose failure could
not be equipped to avoid the runs and contagion
destabilize the financial system. One approach was to create
characteristic of a financial firm failure. Such disruptions
the OLA (Title II of the Dodd-Frank Act), a resolution
can cause devastating economic outcomes. To address this
regime designed specifically for certain financial
potential problem at depository institutions, the FDIC has
institutions outside of the Bankruptcy Code. OLA is an
the authority to resolve FDIC-insured, deposit-taking
administrative process in which the FDIC is granted the
institutions outside of bankruptcy in an administrative
authority to resolve a financial institution if the Secretary of
resolution regime.
the Treasury determines (following a recommendation by
the Federal Reserve and FDIC) that (1) the institution is in
Table 1. Acronyms
default or likely to default and (2) the default would pose a
systemic risk. The institution is granted the opportunity to
BHC
Bank Holding Company
appeal the determination in court. Although it differs from
FDIC
Federal Deposit Insurance Corporation
the FDIC’s existing depository resolution authority in
certain ways, OLA is sometimes described as extending a
OLA
Orderly Liquidation Authority
similar resolution regime to certain non-depository
TBTF
Too Big To Fail
institutions.
Source: CRS.
OLA can only be used to wind down a firm, and the FDIC
must liquidate the company in a manner that mitigates
The ability to resolve a financial firm (whether a depository
systemic risk and minimizes moral hazard. To accomplish
or non-depository) without causing systemic disruption may
this, the FDIC would take control of the failing institution
reduce the likelihood that the government would feel
and have the authority to transfer or sell assets. In addition,
compelled to save the firm with measures such as providing
the FDIC can set up “bridge” companies to take ownership
emergency funding. If it is expected that a firm’s failure
of certain assets and assume certain liabilities in order to
would result in such a response, it is said to be “too big to
facilitate the liquidation. The FDIC first uses proceeds it
fail” (TBTF).
generates through the liquidation to cover costs related to
receivership. If those proceeds are insufficient, the FDIC
The expectation of government support to a TBTF firm
may draw funds from the Orderly Liquidation Fund (OLF)
exposes taxpayers to losses and causes market distortions,
at the Treasury. The OLF is not prefunded, but the FDIC is
including creating moral hazard—excessive risk taking due
required to repay the funds used after the fact through
to protection from losses—and lower funding costs for
assessments on certain large financial institutions. Title II
TBTF firms relative to competitors. Many observers assert
also sets out liquidation rules and claim priorities designed
that certain events of the financial crisis were a
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Orderly Liquidation Authority
to ensure that losses resulting from the failure are borne by
whether the FDIC would ultimately be able to fully recoup
the shareholders and not by the government and taxpayers.
losses through assessments on the industry.
Notably, a resolution under the Bankruptcy Code of a
Fiscal Implications
systemic financial firm remains the first option for the
In May 2017, the Congressional Budget Office (CBO)
resolution of financial institutions under Title II. OLA is
projected that the elimination of the OLA would reduce the
designed to be only an alternative if the aforementioned
budget deficit by $14.5 billion over 10 years based on the
conditions are met. In addition, to facilitate a preplanned
probability of a firm being resolved through OLA over the
bankruptcy process, Title I of the Dodd-Frank Act requires
next 10 years multiplied by the net cost to the government
certain financial companies to periodically submit “living
of doing so. The deficit reduction is mainly due to scoring
wills” to financial regulators. Living wills are meant to
conventions. The FDIC is required to assess sufficient fees
demonstrate how a company would be resolved under the
on large financial firms after the fact to completely offset
Bankruptcy Code without posing systemic risk and must be
the costs of an OLA resolution. CBO assumes that some of
approved by regulators. Only when the Secretary of the
these fees and proceeds from asset sales would be collected
Treasury determines such a resolution is not feasible or
outside of the 10-year scoring window.
poses a systemic risk would a resolution under OLA begin.
Legislative Alternatives
Policy Issues
Opponents to the OLA assert that large financial firms
Proponents argue that OLA offers an alternative to saving
should be resolved through bankruptcies to instill market
failing institutions with government assistance or suffering
discipline and protect taxpayers from potential losses. If
systemic consequences. They assert a preplanned orderly
Congress agrees, it could repeal the OLA. Furthermore,
resolution of complex financial institutions carried out by
Congress could amend the Bankruptcy Code to create a
technical experts familiar with the institution is likely to be
special chapter designed to address the unique
less disruptive to the financial system than a process
characteristics of complex financial firms.
overseen by a bankruptcy judge who may be unfamiliar or
inexperienced with such institutions. Also, because bank
Some have suggested OLA could potentially be repealed
regulators across countries may more regularly coordinate
through the budget reconciliation process; however, OLA’s
and share information than bankruptcies judges, OLA may
eligibility for this is unclear. For more information on
facilitate better international coordination during the
reconciliation, see CRS Report R40480, Budget
resolution of an internationally active firm.
Reconciliation Measures Enacted Into Law: 1980-2010, by
Megan S. Lynch.
In addition, proponents note the similarities between the
OLA and the FDIC’s depository resolution regime, which
Conclusion
successfully resolved large depositories—such as
Until OLA is used, it is an open question as to whether it
Washington Mutual—during the crisis. Furthermore, the
could successfully achieve what it is intended to do—shut
resolution of more than 500 depository institutions during
down a failing firm without triggering systemic disruption
and after the crisis was arguably less disruptive to the
or exposing taxpayers to losses more efficiently than a
financial system than the failure of Lehman Brothers, which
resolution through bankruptcy. Given the size of the firms
went through the bankruptcy process.
involved and the unanticipated transmission of systemic
risk, no consensus exists on the best policy alternative.
Critics argue that the resolution of a depository—even a
large one—is substantially different from the resolution of a

more complex firm and voice doubts that the OLA could
CRS Resources
smoothly resolve such an institution. Also, critics assert that
CRS Report R42150, Systemically Important or “Too Big
the OLA gives policymakers too much discretionary power,
to Fail” Financial Institutions, by Marc Labonte
which could result in higher costs to the government and
preferential treatment of favored creditors during the
CRS Report R43801, “Living Wills”: The Legal Regime for
resolution, thus perpetuating the moral hazard problem.
Constructing Resolution Plans for Certain Financial
Institutions, by David H. Carpenter
Furthermore, if the FDIC does face the same short-term
incentives to limit creditor losses in order to contain
CRS Report R44839, The Financial CHOICE Act in the
systemic risk that caused policymakers to rescue firms in
115th Congress: Selected Policy Issues, by Marc Labonte et
the recent crisis, the only difference between a resolution
al.
regime and a “bailout” might be that shareholder equity is
wiped out, which may not generate enough savings to avoid
David W. Perkins, Analyst in Macroeconomic Policy
costs to the government. Because the OLF is not
“
Raj Gnanarajah, Analyst in Financial Economics
prefunded,” there could be temporary taxpayer losses.
Also, given the large size of potential losses, some question
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Orderly Liquidation Authority

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