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Living Wills: Putting the Caboose Before the Engine and Designing a Better Engine

Current proposals for regulatory reform of the financial system to reduce the probability of and damage from the failure of large banks and other complex financial institutions frequently include a requirement for these institutions to prepare a living will. These wills describe how the institutions will unwind themselves when they become insolvent to minimize inefficient and costly failures and must be approved by the regulators. But these plans depend greatly on the resolution regime expected to be in place. Thus, development of an efficient resolution regime needs to precede the development of a living will. Most proposed resolutions regimes build on the existing special bank resolution regime under the Federal Deposit Insurance Act. However, this administrative-based regime has been unable to prevent costly “too big to fail” resolutions by protecting uninsured creditors. The alternative judicial-based bankruptcy regime that applies to most other corporations is less likely to protect these counterparties but has its disadvantages when applied to banks. This paper develops a hybrid Chapter 11-type resolution regime that chooses the best of both regimes and promises to reduce the cost of TBTF resolutions.