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:
- Advance resolution planning: The resolution plans, or living wills, mandated under Title I of the Dodd-Frank Act would have required Lehman to analyze and take action to improve its resolvability and would have permitted the FDIC, working with its fellow regulators, to collect and analyze information for resolution planning purposes in advance of Lehman’s impending failure.
- Domestic and International Pre-planning: The Lehman resolution plan would have helped the FDIC and other domestic regulators better understand Lehman’s business and how it could be resolved. This would have laid the groundwork for continuing development of improved Lehman-specific cross-border planning with foreign regulators to reduce impediments to crisis coordination.
- Source of Liquidity: A vital element in preserving continuity of systemically important operations is the availability of funding for those operations. The FDIC could have provided liquidity necessary to fund Lehman’s critical operations to promote stability and preserve valuable assets and operations pending the consummation of a sale. These funds are to be repaid from the receivership estate with the shareholders and creditors bearing any loss. By law, taxpayers will not bear any risk of loss.
- Speed of Execution: The FDIC would conduct due diligence, identify potential acquirer and troubled assets, determine a transaction structure and conduct sealed bidding -- all before Lehman ever failed and was put into receivership under Title II. A suitable acquirer would be ready to complete the acquisition at the time of Lehman’s failure. A critical element in quickly completing a transaction is the power, provided by the Dodd-Frank Act, to require contract parties to continue to perform under contracts with the failed financial company so long as the receiver continues to perform. This is particularly critical to avoid the lost value, as exemplified in the Lehman bankruptcy, when counterparties immediately terminate and net financial contracts and liquidate valuable collateral.
- Flexible transactions: The FDIC’s bidding structure would provide potential acquirers with the flexibility to bid on troubled assets (e.g., questionable real estate loans) or leave them behind in the receivership. Similarly, creditors could receive advance dividends (i.e., partial payment on their claims) to help move money back out into the market and further promote financial stability. Advance dividends would not be provided if they would expose the receivership to loss.
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.