Document Type

Article

Publication Date

2015

Abstract

Financial contracts come in many forms and serve many functions in both the financial system and the broader economy. Repos secured by U.S. Treasury securities act as money substitutes and can play an important role as part of the money supply, while similarly structured repos, secured by more volatile collateral, may be used as speculative devices or hedges. Swaps can be used to insure against various types of market risk, from interest rates to oil prices, or they can operate as vehicles for highly leveraged investments. The parties to these instruments are sometimes major financial institutions and, other times, ordinary businesses. Default poses differing risks to the financial system depending upon the type of instrument and the nature of the parties. Under current U.S. law, however, financial contracts receive one of only two radically different types of treatment in insolvency depending on the identity of the insolvent party: banks and systemically important financial institutions (SIFIs) get one treatment; everyone else gets another. More specifically, the Federal Deposit Insurance Corporation (FDIC) resolves banks under the Federal Deposit Insurance Corporation Improvement Act (FDICIA), and, unless an orderly resolution can be accomplished in bankruptcy, the FDIC also now has authority to resolve SIFIs under Title II of the Dodd-Frank Act. Everyone else makes use of the Bankruptcy Code.


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