"Too Big to Fail" May Spawn Bankruptcy Law Changes

After the rapid, pre-arranged bankruptcies of several of our country's largest companies, it seems the federal government is once again on the path toward bankruptcy reform.

This time it doesn't involve border-line unconstitutional changes to consumer bankruptcy processes. No, this time the effort may include change that some believe will carry even more impact: a specialized bankruptcy court for banks and financial firms that carry the now ubiquitous label, "too big to fail."

However, there are two approaches to the problem. One option currently being discussed by the Senate Banking Committee, is a law that would create a new legal process designed to accommodate the structured handling of a mega-institution's collapse. The new law would be part of a larger financial reform bill that is being bandied about in Washington in response to the role our largest financial players had in the onset of the recession.

The ultimate hope is that the new laws will allow these influential organizations to file bankruptcy without creating a worldwide economic tsunami when they come down. Think of it as taking apart an old building brick by brick instead of putting TNT in its foundation. (And then saving the most intact bricks for use in making even bigger, more cumbersome buildings.)

The reform measures, being led by Senate Banking Committee Chairman and Connecticut Democrat Chris Dodd, will enable the Federal Deposit Insurance Corporation (FDIC) to oversee the breakdown of a bank and minimize the impact on other banks.

The FDIC would orchestrate the use of public money (taxpayer's money) to provide creditors and other involved entities with the debt and assets they are owed. Partial payments and settlements would be expected, of course. Special consideration would also be given to vendors and supplies and third party groups to hedge against their subsequent failures.

Wait, sounds like the establishment of a regular, every day bailout system, right? Sort of. The money used to settle the debts and stabilize the collapse will be put back into taxpayer pockets by fees charged to financial institutions with more than $10 billion in assets.

A specialized bankruptcy court, the other proposal, is being introduced by Sens. Mark Warner of Virginia, a Democrat, and Bob Corker of Tennessee, a Republican. Also on the Senate Banking Committee, their bi-partisan approach would create a court to decide if the FDIC dismantling, or a "resolution process," or traditional bankruptcy, should be used to handle the shut down. Thus, it's more of an add-on to existing law.

It still would involve legal wrangling and bureaucratic processes on the part of government bank regulators to determine if the organization's demise would create enough disaster to warrant that a resolution process is needed. If so, it would be filed with the special bankruptcy court for a final decision.

Should Corker and Warner create an agreeable scenario, the Senate Judiciary Committee would then need to come into the picture, as they handle items related to bankruptcy code reform.

Proponents of a new bankruptcy court believe it would provide the failing organization the most say in its own future, providing a forum for insight on how to best distribute assets and formulate an exit strategy, if possible.

Also weighing in on the matter is the respected Pew Institute, which published a report calling for a Federal Financial Institutions Bankruptcy Court to handle the failure of the largest banks in only the most extreme circumstances. Otherwise, typical bankruptcy laws should remain as the default process.

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