Author: Joseph H. Sommer
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The New York Innovation Center bridges the worlds of finance, technology, and innovation and generates insights into high-value central bank-related opportunities.
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Economic Policy Review
Why Bail-In? And How!
December
2014 Volume 20, Number 2
JEL classification: G33, G32, K00, G30
All men are created equal, but all liabilities are not. Some liabilities are more equal than others. These "financial liabilities" are products of financial firms. These products shift risk (insurance or derivatives) or provide liquidity (bank deposits or repurchase agreements). Since these liabilities have an independent value as products, they are worth more than their net present value. The value of a financial firm, then, depends on its liability structure. These special liabilities therefore affect insolvency law. Most financial firms are governed by special insolvency law; those that are not receive special treatment in the Bankruptcy Code. These special laws work well for these special firms. However, they do not work for one subset of financial firms: large financial conglomerates. This article draws three major conclusions. First, no established law can succeed with these firms. Second, the "bail-in" process, which is currently under development, should succeed. Finally, policymakers and corporate finance theorists might want to rethink the meaning of capital for financial firms.
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