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The Orderly Liquidation of Lehman Brothers Holdings under the Dodd-Frank Act

The FDIC has released a report entitled “The Orderly Liquidation of Lehman Brothers Holdings Inc. Under the Dodd-Frank Act.”  The report examines how the FDIC could have structured an orderly resolution of Lehman Brothers Holdings Inc. under the orderly liquidation authority of Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act had that law been in effect in advance of Lehman’s failure. The report concludes that the powers provided to the FDIC under the Dodd-Frank Act to act decisively to preserve asset value and structure a transaction to sell Lehman’s valuable operations to interested buyers -- which are drawn from those long used by the FDIC in resolving failing banks -- could have promoted systemic stability and made the shareholders and creditors, not taxpayers, bear the losses. The report also concludes that, due to the powers to preserve valuable assets and operations in the Dodd-Frank Act, the FDIC liquidation of Lehman would recover substantially more for creditors than the bankruptcy proceedings -- and at no cost to taxpayers. 

The report estimates that given the substantial equity and subordinated debt of Lehman in September 2008 and the power for the FDIC to implement a prompt structured sale while providing short-term liquidity to continue value-adding operations, general unsecured creditors of the parent company could have recovered more than 90 cents on every dollar of claims compared to the approximately 20 cents on claims estimated in the most recent bankruptcy plan of reorganization. 

While there remains no doubt that the orderly liquidation of Lehman would have been incredibly complex and difficult, the report concludes that it would have been vastly superior for systemic stability and achieved better recoveries for creditors than the bankruptcy process while protecting taxpayers from any loss.

Lehman’s bankruptcy filing on September 15, 2008, was a signal event of the financial crisis.  The disorderly and costly nature of the bankruptcy -- the largest financial bankruptcy in U.S. history -- contributed to the massive financial disruption of late 2008.  The lengthy bankruptcy proceeding has allocated resources elsewhere that could have otherwise been used to pay creditors.  Through February 2011, more than $1.2 billion in fees have been charged by attorneys and other professionals representing the debtors alone.

The FDIC report concludes that Title II of the Dodd-Frank Act could have been used to resolve Lehman by effectuating a rapid, orderly and transparent sale of the company’s assets.  This sale would have been completed through a competitive bidding process and likely would have incorporated either loss-sharing to encourage higher bids or a form of good firm-bad firm structure in which some troubled assets would be left in the receivership for later disposition.  Both approaches would have achieved a seamless transfer and continuity of valuable operations under the powers provided in the Dodd-Frank Act to the benefit of market stability and improved recoveries for creditors.  As required by the Dodd-Frank Act, there would be no exposure to taxpayers for losses from Lehman’s failure.

The powers provided under the Dodd-Frank Act are critical to these results.  Among the critical powers highlighted in the report are the following:

These powers would enable the FDIC to act to preserve the financial stability of the United States and to maximize value for creditors by preserving franchise value and by rapidly moving proceeds into creditors’ hands.

Report: The Orderly Liquidation of Lehman Brothers Holdings under the Dodd-Frank Act - PDF (PDF Help)