John B. "Taylor Rule" Taylor & Kenneth Scott call for a Chapter 14

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There is a better way—and it involves adding a chapter to the federal bankruptcy code specifically for large financial institutions. A Chapter 14 would apply to all financial groups with assets over $100 billion. A specialized panel of judges and court-appointed special masters with financial expertise would oversee the proceeding, which would include all the parent's subsidiaries, including insurance and brokerage. (Under Dodd-Frank, insurance and brokerage services have to be handled separately—which adds complexity—while banks and other subsidiaries are under FDIC jurisdiction.)

A bankruptcy petition could be filed by creditors (as now) but also by the primary federal supervisor of the firm, or by a management that saw insolvency looming. The procedure to determine asset values, liabilities, sales of some lines of business, write-downs of claims, and recapitalization would take place according to the rule of law. There would be judicial hearings and creditor participation—neither of which are part of the Dodd-Frank resolution process. The strict priority rules of bankruptcy would govern (with some modifications for holders of repurchase agreements and swaps to limit their risks).

Chapter 14 would let a failing financial firm enter bankruptcy in a predictable, rules-based manner without causing disruptive spillovers in the economy. It would also permit people to continue to use the firm's financial services—just as people flew on American or United planes when those firms were in bankruptcy. The provisions also make it possible to create in bankruptcy a newly capitalized entity that would credibly provide most of the financial services the failed firm was providing before it got into trouble.

Customers would continue to do business with a financial firm after a Chapter 14 filing if they were confident the firm could meet its current obligations. That confidence would be achieved by giving post-petition creditors a high priority. In all likelihood, this priority would enable the firm to continue obtaining ample private financing—so-called debtor-in-possession financing—to provide liquidity for normal operations.

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