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Federal Reserve Bank of Chicago

Resolving Large Complex Financial
Organizations
Robert R. Bliss

WP 2003-07

Resolving Large Complex Financial Organizations
by

Robert R. Bliss
Research Department
Federal Reserve Bank of Chicago
230 South La Salle Street
Chicago, IL 60604-1413
U.S.A.
(312) 322-2313
(312) 322-2357 Fax
Robert.Bliss@frbchi.org
June 30, 2003

JEL Classifications: K23, K41, G28
The author thanks Douglas Evanoff, Christian Johnson, George Kaufman, William
Lloyd, and seminar participants at the Federal Reserve Bank of Chicago, the Bank of
England, and the Financial Management Association’s 2003 European Annual Meeting.
The research assistance of Aiden Harmston is gratefully acknowledged. Any remaining
errors are my own. The views expressed herein are those of the author and do not
necessarily reflect those of the Federal Reserve Bank of Chicago. Portions of this paper
appear in Bliss, 2003, “Bankruptcy law and large complex financial organizations: A
primer,” Federal Reserve Bank of Chicago, Economic Perspectives, First Quarter, 48–54.

Resolving Large Complex Financial Organizations

Abstract
The resolution of a large complex financial organization (LCFO) presents numerous
problems, including organizational complexity, opacity of positions, and conflicting legal
jurisdictions. Of particular concern is the potential impact of large derivatives books.
Widespread adoption of laws permitting close-out of derivatives contracts exempts these
contracts from the usual stays that provide time for the orderly resolution of claims by the
courts. Thus, a potentially significant part of the LCFO’s assets and liabilities are
exempted from normal bankruptcy procedures, creating the potential for a disorderly
dismemberment of an insolvent LCFO. Nonetheless, however inconvenient they may be
for bankruptcy administrators, the closeout netting privileges enjoyed by derivatives are
essential to reducing legal uncertainty, increasing liquidity, and minimizing the systemic
impact of large failures. The solution advocated in this paper is for regulators to provide
“facilitated private resolution” for dealing with systemically important financial
institutions, along the lines of the Long-Term Capital Management workout and the
“London Approach” practiced in the last century. To make this early intervention
effective, consolidated supervision is needed to ensure that comprehensive information is
available and intervention takes place while the firm is still solvent.

Resolving Large Complex Financial Organizations
1 Introduction
The avoidance of financial distress has been the subject of voluminous research
and protracted debate. The successive draft proposals of the Basel Committee on Banking
Supervision to revise bank capital standards, which have occupied regulators’ and
bankers’ attention for several years now, are aimed at ensuring the safety and soundness
of banks. Financial institutions have themselves been at the forefront in the quantification
and management of risk and have developed a multitude of financial instruments for this
purpose, both for their own uses and for the benefit of other sectors of the economy—
credit and energy derivatives to name two notable recent innovations.1
These processes and innovations have improved, at least potentially, the
management of risk. However, they can not eliminate entirely the chance of financial
distress. From time to time, even in the best of all possible economic worlds, financial
firms will fail through unforeseen economic shocks, mismanagement, or fraud.
That the failure of some large financial firms might pose particular problems for
the financial system is a widely, though by no means universally, held idea.2 For instance,
the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) provides
a systemic risk exemption to the usual least cost resolution procedures mandated for
resolving a failed bank.3 Earlier concerns about size per se making failure intolerable (too
big to fail) have been replaced by a more nuanced consideration of mitigating the
systemic effects of a failure. Greenspan (2000, p. 14) has noted that “…an organization
that is very large is not too big to fail, it may be too big to allow to implode quickly.” If
such systemically important financial institutions indeed exist, the processes that come

1

These innovations include a multitude of financial instruments such as swaps, options, forwards, futures,
and securitizations, variously repackaged. For convenience, I use the term “derivatives” in this article
generically.
2
Whether or not any financial institution is truly systemically important is a matter of some debate and
rather depends on how the term is interpreted. It is unlikely that the failure of any one or few firms would
lead to a total collapse of the financial system, and it is likely that the collapse of some firms in some
circumstances would impose considerable costs on the financial system and the economy, though perhaps
not catastrophic costs.
3
12 USC 1823(c)(4)(G)

1

into play when such a firm becomes distressed will determine how costly and disruptive
the event proves to be. Preventing quick implosion requires an understanding of the
economic and legal issues surrounding the possible financial distress of a large complex
financial organization (LCFO), and the regulatory and market mechanisms for dealing
effectively with these issues. It thus behooves us to try to anticipate what might happen
when an LCFO fails. In addition, the study of failure resolution is important to the
understanding of market structure and risk management; for what happens when a firm
fails determines at least in part the arrangements entered into when the firm is solvent and
constrains the actions of various interested parties when the firm becomes distressed.
To understand why the resolution of LCFOs is particularly challenging to legal
systems, I first provide an overview of the goals, objectives, and mechanisms of
insolvency proceedings in different jurisdictions. It is against this background that the
resolution process will play out and that efforts to reform the process must take place.
Next, I examine the treatment of derivatives, specifically the ability of counterparties to
terminate and net contracts. This represents a widespread exception to normal bankruptcy
procedures that is critical for the operation of derivatives markets and has important
implicatin for the resolution of LCFOs. Finally, I propose a model for resolving LCFOs
that aims to overcome many of the problems in the current system: Timely intervention
by regulators, working with counterparties to resolve a financially distressed LCFO
without recourse to the formal bankruptcy process. This solution rests on two key
elements: first, access to timely, relevant, accurate, and consolidated information on the
distressed firm; and second, agreement among counterparties that it is in their best
interests to have an informal coordinated resolution rather than to risk exercising their
close-out rights through formal bankruptcy proceedings.
The organizational structure and complexity of LCFOs have evolved beyond
simplistic corporate structures and contract types historically anticipated in our
insolvency legislation and common law traditions, or in our economic models of firm
structure for that matter. An important part of the evolution of financial markets over the
last 30 years has been the development of derivatives and other nontraditional financial
instruments. The involvement of large systemically important institutions in these
markets makes it important to consider how these contracts are treated under insolvency

2

and whether this affects the ability of legal and regulatory authorities to resolve these
institutions in an orderly and efficient manner.
Taken together, these factors suggest that our current practices, laws, and
institutions are ill equipped to minimize the costs of failure of an LCFO. This paper
suggests one alternative for mitigating the potential problem: timely regulatory
intervention to facilitate voluntary non-judicial resolution of weak or insolvent financial
companies. The resolution of Long-Term Capital Management (LTCM) in 1998 provides
a recent example of such an approach.

1.1 Why LCFOs?
The distinction between banks (insured depositories) and other financial
institutions has important bases in law and regulatory frameworks, particularly in the
U.S., but is increasingly anachronistic in today’s financial markets. Financial markets are
increasingly broad and interlinked. Few of the largest banks are engaged solely in
traditional banking activities—deposit taking, lending, and payment processing. Most of
the largest U.S. banking organizations embed one or more chartered, insured deposittaking banks within a bank holding company that also owns non-bank subsidiaries. The
importance of asset securitization, derivatives dealing, and structured finance has deeply
involved banks in the broader financial markets: Banks and non-banks participate in the
same financial markets, offer many of the same financial products, compete with each
other, and are each others’ major counterparties. The U.S. practice, confirmed in the 2000
Gramm–Leach–Bliley banking reform legislation, of segregating depository institutions
from other financial firms for regulatory treatment, even when they coexist in the same
holding company, ignores this reality. In Europe, universal banks have long been the
norm, so the regulatory treatment there is more consistent with market practices.
European regulation already recognizes the importance of LCFOs, as exemplified by the
EU Financial Conglomerates Directive. The consolidation of regulatory powers in unified
authorities, such as the Financial Services Authority (FSA, 2001) in the U.K. and the
Bundesanstalt fur Finanzdienstleistungsaufsict (BAFin, 2002) in Germany, has further
facilitated a unified approach to supervising large complex financial groups. In contrast,

3

in the U.S., historical bifurcations between investment and commercial banking, a “banks
are special” idée fixe, and a preoccupation with deposit insurance issues (moral hazard,
pricing, examination) have long held sway, leading to a more narrow focus on the part of
banking system regulators.
Developed financial markets are generally robust, and the failures of small
financial firms, while painful for the parties directly involved, rarely endanger significant
numbers of counterparties. This being widely understood, the failure of a small financial
institution raises few systemic concerns. However, the failure of a large institution raises
concerns that it will directly trigger other failures; for example, by failing to pay its
creditors, the insolvent LCFO may cause these other firms to become insolvent.4
Furthermore, uncertainty in the markets as to who is directly affected by the failure, and
to what extent, may lead participants in the payments system and the short-term capital
markets to take defensive measures, thus causing a general contraction of liquidity. This
in turn may lead to financial distress in vulnerable firms that do not have direct exposures
to the firm whose failure triggered the crisis.
The failure of an LCFO, of all firms, raises the greatest potential for such
systemic consequences. This is because financial institutions provide capital and other
financial services to all sectors of the economy and they form the backbone of the
financial markets, markets that rely to a great extent on trust. Thus, the failure of a
financial intermediary calls into question a multitude of business relations. In contrast,
the failure of a non-financial corporation of comparable size is more easily localized:
Witness the recent string of bankruptcies of technology firms that have raised no fears of
systemic risk in the usual sense of a freezing up of financial markets, in spite of the
unprecedented size of the firms involved. Nor are banks the sole source of systemic risk
concerns. The latest distressed firm episode to have raised systemic risk concerns in the

4

Recent research suggests that fear of such “direct contagion” may be unwarranted, for example, Furfine
(2003).

4

minds of a significant number of observers was LTCM, a hedge fund.5 Though not huge
by financial institution standards, with $145 billion in assets, the possible failure of
LTCM was viewed as potentially much more serious at the time than the actual failure in
2002 of WorldCom with a comparable $107 billion in assets. Other examples of nonbank systemic risk episodes include the stock market crash of 1987, any number of
sovereign debt defaults, and the failure of Drexel Burnham Lambert in 1990.
This highlights two important points. The first is that it is not only banks, but also
other major financial market participants that are potential sources of systemic financial
market risk. The second is that size per se is not the sole determinant of systemic concern.
Rather it is the real or perceived risk to financial markets that a particular firm’s failure
might engender that matters. This potential impact is certainly correlated with size, but it
depends importantly on the depth and importance of the particular markets in which the
firm is involved.

1.2 Overview of the paper
LCFOs present a number of challenges that affect the resolution process. These
are broadly issues of coordination, relating to reconciling the objectives of different
regulators, legal jurisdictions, and creditors; opacity, relating to the inability of traditional
accounting methods to provide sufficient information about contingent liabilities in offbalance-sheet activities and derivatives portfolios; and time, relating to the difficulty of
managing the orderly resolution of firms that have large portfolios of derivatives, some of
which are exempted from the “time out” imposed on other counterparties in bankruptcy
proceedings. I explore all of the issues in detail in the following sections. While none of
these issues are unique to LCFOs, they are apt to come together with particular severity if
an LCFO becomes distressed.

5

LTCM was a large hedge fund with an illustrious set of general partners, including two Nobel laureates
and a former Governor of the Federal Reserve Board. Equity grew from $1.3 billion in February 1994 to
$7.0 billion in December 1997, at which time it had approximately $1 trillion in notional value of
derivatives positions outstanding, making it the largest investor in a number of financial markets. In late
1998 the fund experienced massive losses, which threatened to wipe out its equity. The Federal Reserve
Bank of New York, which had been monitoring the situation and fearing that default would trigger severe
disruptions of the financial markets, convened a consortium of 16 major creditors, who agreed to inject
additional capital into LTCM to ensure its solvency while its positions were unwound. Thereafter, LTCM
was gradually liquidated without further losses.

5

The essential fact is that markets move quickly, while courts do not. Normal
bankruptcy procedures involve a stay or “time out” while the courts gather information;
explore resolution possibilities; and in liquidations, pay off claims in an orderly manner,
in reorganizations, oversee renegotiation of contracts. Central to this solution process is
the ability to delay settling claims, thus keeping assets under the control of the insolvency
administrator, until things can be sorted out. LCFOs are heavily involved in derivatives
markets, and for these contracts the ability of the courts to suspend their execution
(termed “stays”) has been effectively eliminated.6 This, in turn, raises the possibility that
a substantial portion of the firm may quickly disappear out from under the control of the
bankruptcy administrator(s), frustrating their efforts at orderly resolution. In addition, the
complexity of LCFOs, both their legal and financial structures and their financial
positions vis-à-vis counterparties, and the volatile values of derivatives contracts create
problems for bankruptcy administrators forced to act in a rapidly changing environment.
This dark picture is further dimmed by the conflicts across jurisdictions—as to the
specifics of their bankruptcy processes, as well as how they react when multiple
jurisdictions are involved. Bankruptcy law is designed to solve various coordination
problems amongst the creditors of the insolvent firm and other parties. For firms
operating across multiple legal jurisdictions, the insolvency process itself creates a
coordination problem across the very agents charged with solving the coordination
problem amongst creditors.
The organizational complexity of financial companies and the integration of their
products into the financial system demands effective consolidated supervision of those
that may properly be viewed as systemically important. This would require legislative
changes in the U.S., as well as an informal understanding among regulators and market
participants as to the norms for achieving early and cooperative intervention. Sadly, the
prospects for addressing the problem by means of legal convergence and formal

6

Not all derivatives—swaps, options, futures, forward rates agreements—are exempted, though most of
those covered by master agreements (vide infra) are. Just what is and what is not covered is a source of
legal uncertainty. A few additional (non-derivative) financial contracts are also exempted—including
repurchase agreements and various transactions cleared through clearing houses (payments and exchange
traded derivatives). Most financial contracts, however, are not exempt from bankruptcy stays.

6

mechanisms for international crisis resolution through political processes, both in the
U.S. and abroad, are remote.

2 Bankruptcy objectives and procedures
Early Roman personal bankruptcy procedures purportedly involved dividing up
the debtor and distributing the parts to the creditors if he could not pay within a stipulated
period.7 Placing the debtor into slavery was an alternative and widely practiced resolution
procedure that preserved the productive capacity of the debtor but transferred the benefits
to the creditor.8 Similar thinking underlies modern corporate bankruptcy processes, and
these ancient solutions find their modern equivalents in the two major outcomes to
corporate bankruptcy: liquidation and reorganization.
While the evolution of legal processes to deal with bankruptcy dates back to the
beginnings of written history, the analysis of these processes in an economic framework
is comparatively recent. Jackson (1982) argues that bankruptcy procedures function to
provide a collective debt collection mechanism designed to maximize the returns to
creditors.9 If creditors are allowed individually to enforce their claims, an uncoordinated
bankruptcy proceeding involving multiple creditors is likely to lead to the
dismemberment of an insolvent corporation and to a loss of value. Many insolvent firms
have greater value as going concerns than can be extracted by liquidating their physical
and financial assets. The intangible assets—such as human capital and business
relationships—are dissipated or destroyed in the process of liquidation. Furthermore,
creditors who are successful in seizing assets have little or no incentive to maximize the
liquidation value of those assets once their own claim is satisfied, because any excess
recoveries must invariably be turned over to the remaining creditors. Thus, without a
credible means of ensuring cooperation amongst creditors, each creditor has every
incentive to try to act in their own interest and seize what assets they can, even though
they are aware that in doing so, they diminish the value that will be recovered by the
creditors as a group.
7

See Kennedy (1994) and Knight (1992). This process would today be considered undesirable. Whether
this insolvency procedure was helpful in reducing the incidence of default is unrecorded.
8
Homer (1977) notes that the Code of Hammurabi (Babylonia, circa 1800 BC) limited the bankrupt’s term
of personal slavery for debt to three years—an early form of debtor protection.

7

Corporate bankruptcy processes solve this problem by coordinating the resolution
of claims. A court (or administrator), interposed between the insolvent firm and its
creditors, imposes a time out, termed a “stay,” to prevent the untimely and inefficient
liquidation of assets. Having taken control of the situation, the court then determines the
best method of realizing the value of the firm (orderly liquidation of assets and/or
reorganization), ascertains the value of all creditors’ claims, and then determines how
those claims will be discharged. Of these several steps, the power of the court (or
administrator) to stay the execution of creditors’ claims on the firm’s cash flows and
assets is absolutely crucial.
The creditor-coordination perspective views bankruptcy law as a means of
protecting creditors from each other. An alternative perspective is that the function of
bankruptcy is to provide a means of protecting the debtor from the creditors. In the U.S.,
firms that file for protection under Chapter 11 of the bankruptcy code enjoy considerable
powers to manage the renegotiation of their creditors’ claims. The purpose of Chapter 11
is to preserve the insolvent firm as a viable economic entity.10 Reorganization frequently
involves violation of seniority rights in the final settlements and reduced recovery rates
for creditors.11 Notwithstanding, reorganization is viewed in many cases as socially
desirable as it may benefit non-creditors (for instance, employees) who are not formally
party to insolvency proceedings. Again, critical to the success of a reorganization is the
ability of courts to compel counterparties to stay claims (for payment of debts) and to
keep contracts (for instance, for services) in force.
The recent development of credit protection has altered the incentives of parties to
an insolvency proceeding and poses a potentially serious threat to future resolutions.12
Credit protection, for instance in the form of credit default swaps, protects the creditor
who purchases the protection in the event of a counterparty’s default. However, “default”
may be narrowly defined so that the protection only obtains in certain events. Thus, a
creditor who has purchased credit protection from a third party may be better off if the
9

Armour (2001) provides a thorough analysis of this and alternative analytic frameworks.
Kahl (2002) finds that “Chapter 11 may buy poorly performing firms some additional time, but it does not
seem to allow many of them to ultimately escape the discipline of the market for corporate control.”
11
See, among others, Franks and Torous (1994).
12
See discussions on the impact of credit default swaps on the restructuring of Marconi debt in the
Economist, May 17th, 2003, p. 67 and Derivatives Weeks, September 16th, 2002, p. 8.
10

8

debtor is liquidated. Their recovery from the debtor may be reduced vis-à-vis what they
could obtain in a reorganization, even though reorganization may result in greater
aggregate recoveries, but their losses are made good by the credit default protection
writer. Thus, creditors with protection may resist coordinated solutions that would fail to
trigger the credit protection they have purchased. Writers of the credit protection, who
would have an incentive to cooperate, are not generally party to the bankruptcy process
since they are not direct creditors of the insolvent firm. This creates a potential situation,
already made manifest in a number of distressed workouts, where protected creditors
have sharply different incentives than the unprotected creditors.

2.1 Bankruptcy laws
This neat picture of the problem of insolvency and its solutions becomes less
reassuring when we consider LCFOs. As usual, the devil is in the details. The insolvency
of an LCFO necessarily raises questions of competing jurisdictions, with potentially
conflicting objectives. And as we will see, the treatment of derivatives contracts, and the
enforceability and effect of their termination and netting provisions, to some extent
undermines the procedural niceties assumed in the bankruptcy procedures.
Bankruptcy laws vary across countries in their details, as one would expect, but
more importantly they vary in their underlying philosophies.13 This makes reconciliation
of bankruptcy codes something of a challenge. Attempts at international harmonization of
bankruptcy laws have met with only limited success, in part because of conflicting
philosophies and legal traditions. In 1997, the United Nations Commission on
International Trade Law adopted a Model Law on Cross-Border Insolvencies, which
sought to address a limited range of issues peculiar to cross-border insolvencies without
harmonizing bankruptcy codes in their entirety. As a model law rather than a treaty, it
relies on individual countries to change their own codes to conform to the model.14 In
contrast, the recently enacted European Insolvency Regulation has the advantage of being
binding on EU members. EU countries must recognize each other’s bankruptcy laws and
insolvency administrators and their agents. For cross-border insolvencies, the courts of
13

The philosophical background to differences in bankruptcy law is discussed in Bliss (2003).
As of October 2002, the model law had been adopted, at least in part, in Eritrea, Japan, Mexico, South
Africa, and within Yugoslavia, Montenegro (www.unicitral.org).

14

9

the country in which the company’s “centre of main interest” is located will take the lead,
and proceedings in other jurisdictions will play a secondary and supportive role.15

2.1.1 U.S. bankruptcy laws
Bankruptcy law in the U.S. is unusually, perhaps uniquely, complex. The Federal
Bankruptcy Code (generally referred to as simply “the Code”) governing most
corporations allows for both liquidation and reorganization. Cases involving firms subject
to the Code are heard in special federal bankruptcy courts. The Code overlays the
commercial law of the relevant state which in turn governs the contracts that underlay the
claims to be adjudicated. Thus, the law applicable in any bankruptcy proceeding is a
combination of the Federal Bankruptcy Code and various non-bankruptcy statutes,
including state commercial codes and various federal laws (ERISA, governing retirement
plans, is an example). Thus, variations in applicable law can vary from case to case. The
bankruptcy code is generally pro-debtor, with some exceptions. There is no general right
of set-offs, or netting, of obligations.
Various laws have carved out exemptions to the Code. Depository institutions
(banks), insurance companies, government-sponsored entities (GSEs, for example,
Fannie Mae), and broker-dealers all have distinct resolution procedures, and certain types
of financial contracts receive special treatment under the Code.
Insolvent insured depository institutions are resolved under the Federal Deposit
Insurance Act (FDIA), as amended by the Financial Institutions Reform, Recovery, and
Enforcement Act (FIRREA), and subsequent acts.16 Closure authority for banks lies with
the appropriate regulator, depending on the bank’s charter. Creditors cannot force a bank
into bankruptcy since banks are specifically exempted from the Code. The appointment
of the Federal Deposit Insurance Corporation (FDIC) to administer an insolvent bank is
mandated for federally chartered, federally insured institutions and is usual for state
chartered, federally insured intuitions. The FDIC either acts as receiver to liquidate the
bank or as conservator to arrange a workout (merger, sale, or refinancing).
15

This is rather a smaller step forward than it may appear. Conflicts in bankruptcy laws remain and are
likely to give rise to anomalies such as French pro-debtor courts enforcing British pro-creditor laws in
subsidiary proceedings to a UK-based bankruptcy. Furthermore, the absence of mechanisms for Europewide registration of creditors will make coordination of related proceedings difficult. (See Willcox, 2002.)
16
12 USC 1811 et seq. (1989).

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2.1.2 Conflicting jurisdictions
The resolution of an LCFO will necessarily involve multiple legal jurisdictions,
which leads to two problems. The first is whether the insolvent firm should be resolved as
a single entity regardless of the location of creditors and assets, or whether each of the
several jurisdictions in which the creditors and/or assets are located should be treated
separately. There are two basic approaches to this fundamental question: the unitary or
single-entity approach, which treats the firm as a whole, and the “ring-fence” or separateentity approach, which seeks to carve up the firm and resolve claims in each jurisdiction
separately. The second problem, which is not unrelated to the first, is whether to conduct
multiple proceedings in each relevant jurisdiction or have one jurisdiction take the lead
and other jurisdictions defer to it. Ring fencing has the practical advantage of placing
assets at the disposal of the court most likely to have control of them and minimizing the
dependence on cross-jurisdictional information sharing. It also provides an admittedly
crude solution to conflicts in laws and legal objectives. In the case of insured depository
institutions, ring fencing serves the interests of the deposit insurers by ensuring that the
insolvency of a holding company does not strip assets out of a bank subsidiary.
Potentially however, ring fencing can make coordinated cross-border (and crossjurisdiction) resolutions more difficult because it leads to differential payoffs for
creditors—(domestic) creditors in jurisdictions where the ratio of assets to claims is
higher will enjoy higher recoveries. Ring fencing also leads to potentially adversarial
competition among jurisdictions, each seeking to maximize the value of assets available
to their own creditors—the very problem that bankruptcy procedures are supposed to
solve, now writ large.
British bankruptcy law takes a single-entity approach to resolving international
firms, regardless of the location of assets or the nationality of the creditors. The UK court
makes every effort to obtain control of all the firm’s assets, which it then divides equally
among the creditors (in a liquidation). The court makes no distinction between domestic
and foreign creditors, even in the distribution of domestically controlled assets directly
under its control.17 Importantly, however, UK bankruptcy law recognizes that it may be
more appropriate in some cases for another, perhaps the home country’s, court to take the

11

lead in the resolution of an international firm. In such cases, the UK provides local
support for agents of the foreign courts, for instance in obtaining control of assets located
in the UK, so long as the creditors are not made worse off than they would be under a UK
resolution.18
The U.S. approach to these issues is complex and fragmented. Where a branch or
agency of a foreign bank becomes insolvent, a U.S. administrator can attach (seize) all of
the foreign parent’s assets in the U.S. even if they are part of a different nonbank
subsidiary.19 The U.S. court or administrator would ring fence those assets and use them
to satisfy domestic claims, paying any surplus to satisfy creditors in any foreign
proceedings.20 This necessarily means that domestic creditors are given precedence over
foreign ones. On the other hand, in resolving a U.S. bank, the FDIC takes a single-entity
approach and seeks to obtain control of offshore assets.21 Resolution of LCFOs is further
complicated because in the U.S. specialized laws and procedures apply to banks, brokerdealers, and insurance companies. Thus, where these activities are co-located in a single
holding company, the ring fencing can apply to parts of the same domestic entity. Bank
subsidiaries are ring fenced vis-à-vis nonbank subsidiaries of the same holding company.
The FDIC may seize the assets of affiliated banks (subsidiaries of the same holding
company), while federal bankruptcy courts would take control of the assets of an
insolvent parent bank holding company.
It is the policy of the Federal Reserve that bank holding companies must provide
unlimited support for their banking subsidiaries.22 Efforts to enforce this policy, either
after the bank was closed (for example, MCorp in 1989) by requiring that bank holding
company assets be transferred to the FDIC, or through asset transfers prior to closing of
the bank (for example, Bank of New England in 1991), later challenged as voidable, have
resulted in repeated litigation between the bankruptcy trustees and the regulators, the
outcome of which has been inconclusive. These examples well illustrate the potential for
17

Beaves (1999), p. 244.
Ibid, p. 246.
19
12 USC 3102(j)(1).
20
12 USC 1821(d)(11)(A) together with 12 USC 1813(l)(5)(A). See Curtis (2000) for a full discussion.
21
Mattingly et al. (1999), p. 270.
22
Banking law unambiguously acknowledges only a limited obligation to provide support—up to a
maximum of five percent of the subsidiary’s assets prior to the subsidiary becoming undercapitalized (12
USC 1831o(e)(2)(E)(i)(I)).
18

12

adversarial proceedings when multiple authorities are involved in the resolution of
complex organizations.

3 Termination and netting of contracts23
In most business relations, netting and set-off are not significant issues. Generally,
firms either buy from or sell to other firms, but rarely do both simultaneously. So, in the
event of bankruptcy, few if any contracts could be netted or set-off. However, financial
markets can generate huge numbers of bi-directional transactions between counterparties.
Interbank payments systems involve banks sending each other funds to clear thousands of
transactions throughout the day, and the direction and amount of individual transfers are
unpredictable. The gross amounts of such transactions are huge, but at the end of the day
the net transfers are relatively modest. Similarly, many large commercial and investment
banks make markets in derivatives securities and hedge their positions with each other.
Again the gross positions are huge, but the net positions are modest.24
There are two types of netting rules. Those that apply in the course of ordinary
business—payments netting, also called settlement netting or delivery netting—and those
that apply in resolutions of insolvent firms—close-out netting, also called default netting,
open-contract netting, or replacement contract netting. Close-out netting agreements
consist of two related rights: the right of a counterparty to unilaterally terminate contracts
under certain specified conditions (close-out), and the right to offset amounts due at
termination of individual contracts between the same counterparties when determining
the final obligation. In the U.S. and some other jurisdictions, the governing contracts
typically contain terms stipulating the actions to be taken in the event of default. In other
jurisdictions, such as the UK, a common law netting right exists.
Both payments and close-out netting are widely seen as reducing systemic risk by
limiting counterparty exposures to net rather than gross exposures. This in turn makes the
operation of financial markets more efficient. The widespread adoption of carve-outs,
23

The exposition in this section borrows heavily from Johnson (2000).
In 2002 U.S. banks had total derivatives credit exposures of $525 billion, 96 percent of which (measured
by notional value) was concentrated in seven banks. Netting reduced banking system-wide gross exposures
by 75.8 percent, a figure that had increased from 44.3 percent in the second quarter of 1996. Still, a number
of major banks have (net) derivatives credit exposures exceeding their risk-based capital, in the case of J. P.
Morgan Chase by a factor of 589 percent. (Preceding data are from OCC, 2002.)

24

13

providing pro-creditor protection for payments systems and derivatives securities,
particularly in the form of collateral arrangements and netting agreements, represents one
of the great successes in international legal harmonization. This process has been
shepherded by the International Swap and Derivatives Association (ISDA), a trade group
that coordinates industry documentation practices, drafts model contracts, and lobbies for
legislative changes to support the enforceability of those contracts. Central to the ISDA
approach to netting is the concept of a master agreement that governs transactions
between counterparties. The Master Agreement constitutes the terms of the agreement
between the counterparties with respect to general questions unrelated to specific
economic transactions: credit support arrangements, netting, collateral, definition of
default and other termination events, calculation of damages (on default), documentation,
and so forth. This Master Agreement constitutes a single legal contract of indefinite term
under which the counterparties conduct their mutual business. Individual transactions are
handled by confirmations that are incorporated by reference into the Master Agreement.
This device of placing individual transactions under a single master agreement that
provides for netting of covered transactions has the effect of finessing the problem of
netting under various bankruptcy codes. Having only a single contract between each pair
of counterparties to a Master Agreement eliminates the problem of netting multiple
contracts.25 Netting legislation covering derivatives has been adopted in most countries
with major financial markets (the UK being a notable exception, where netting has long
been provided for in the bankruptcy code), and ISDA has obtained legal opinions
supporting their Master Agreements in most relevant jurisdictions.

3.1 Close-out netting
Close-out netting involves not only the treatment of interrupted bilateral payments
flows, but also the treatment of outstanding contracts between solvent and insolvent
counterparties.26 The netting of obligations in the event of default is the subject of

25

In some cases, there may be several Master Agreements covering different classes of contracts and with
different divisions of the same holding company. Thus, counterparty netting protection may be less than
complete. This has led to the development of Cross-Product Master Agreements, in effect Master Master
Agreements. ISDA is lobbying for legislative recognition of these innovations to reflect industry risk
management practices. Recent proposed changes to the U.S. bankruptcy code have supported this idea.
26
An additional major issue is the treatment of collateral, which I do not cover in this discussion.

14

considerable legal debate and differences in laws, as is the related issue of termination
rights.
In general, close-out netting involves the termination of all contracts between the
insolvent and a solvent counterparty. Broadly speaking, there are two relevant classes of
contracts: executory contracts are promises to transact in the future (but where no
transaction has yet occurred), such as a forward agreement to purchase foreign currency;
and other contracts, such as a loan, where a payment by one party has already occurred, I
refer to as “non-executory contracts,” since no single legal description applies. These two
types of contracts are treated differently under close-out netting in jurisdictions where
such laws apply.
Non-executory contracts, such as loans, may contain clauses that permit the
creditor to accelerate future payments—for instance, repayment of loan principal—in the
event of default or the occurrence of a stipulated credit event, for example a downgrade
by a rating agency. Acceleration is not netting per se but a precursor to netting and
determines in part the amounts due. The handling of non-executory contracts where
payments are due to the insolvent counterparty depends on the contract terms and legal
jurisdiction. The most common treatment is to accelerate all contracts between solvent
and insolvent counterparties when determining net obligations.
Whereas non-executory contracts may be accelerated in insolvency, executory
contracts are terminated. Termination cancels the contract and creates a claim for
compensation, usually the cost of reestablishing the contract on identical terms with
another counterparty.
Where close-out netting is permitted, the general procedure is that upon default or
contractually agreed “credit event,”27 executory contracts are marked-to-market and any
payments due from acceleration of terminated non-executory contracts are determined.
These values are then netted and a single net payment is made. If the solvent counterparty
is a net creditor, the solvent counterparty becomes a general creditor for the net amount.
Usually, the solvent counterparty determines the values of the contracts being terminated
and payments owed. These computations are subject to subsequent litigation. However,

27

Termination events may include cross defaults (defaulting on other contracts), mergers, changes in legal
or regulatory status, changes in financial condition, and changes in credit rating (Johnson, 2000).

15

disputes over the exact valuation do not affect the ability of the solvent counterparty to
terminate and replace the contracts with a different counterparty.
Acceleration and termination change the amounts immediately due to and from
the solvent counterparties vis-à-vis what would have been currently due had the credit
event (default, downgrade) not occurred. Terminations of contracts with the resulting
demands for immediate payments may precipitate financial collapse of a firm and make it
impossible to resolve the firm in an orderly manner or to arrange refinancing.28 For this
reason, many jurisdictions limit the rights of counterparties to enforce the termination
clauses in their contracts. The court can impose a stay, which does not invalidate
termination clauses in contracts but rather overrides them, perhaps temporarily, at the
discretion of the court or an administrator. Staying contracts keeps them in force; normal
payments are still due. This differs from cherry picking, which involves disavowing
unfavorable contracts and forcing the counterparties to become general creditors for the
firm.

3.2 U.S. legal treatment of close-out netting
Although close-out and netting are two separate issues, they are intimately linked
in the case of derivatives. Close-out refers to the termination of contracts, while netting
refers to the setting off of multiple claims between solvent and insolvent counterparties.
For most contracts these are separate issues.
In the U.S., stays of indefinite term are automatic for most contracts when a
corporation files for protection under the Code.29 Furthermore, netting of most contracts
is not generally recognized under the Code, thus cherry picking is permitted. However, as
noted earlier, various carve-outs or exceptions provide special netting and termination
rights for certain financial contracts and certain types of counterparties, though the
treatment is Byzantine. In general, for financial contracts governed by ISDA and similar
master netting agreements, cherry picking is prevented and termination rights are
recognized.
28

A recent example is the acceleration of some $4 billion of Enron’s debt following its downgrade by rating
agencies. The firm could not meet the resulting demand for immediate payment of principal and was forced
to file for bankruptcy. Until that time, Enron had not actually failed to make a payment on any obligation,
though it was almost surely already insolvent.
29
11 USC 362.

16

Under U.S. common law, when a bank depositor also has (performing) loans
outstanding with the bank, the amount of uninsured deposits may be netted against the
principal outstanding on the loan in the event of insolvency of either the bank or a bank
borrower. Where the defaulting party is a corporation or a nationally chartered bank,
federal laws apply.30 For state-chartered banks, state law applies.31 While the common
law principle of netting of certain bank depositor obligations is widely recognized, it is
still subject to legal uncertainties and is narrow in scope. This has led to the enactment of
a number of specific laws governing certain types of financial contracts and certain types
of financial institutions.
The Code permits netting of swap contracts and prohibits stays of swap
contracts.32 Furthermore, swap contracts may be terminated for reasons of insolvency,
commencement of bankruptcy proceeding, or appointment of a trustee, though such
terminations are expressly prohibited for other types of financial contracts, for instance,
unexpired leases.33 Swaps are generally considered to include most derivatives contracts
entered into under ISDA and similar master agreements. Thus, counterparties of firms
whose insolvency is governed by the Code have some degree of protection of their
netting and termination rights, though the scope of what qualifies as a “swap” is perhaps
unclear. However, this provides no protection when the insolvent counterparty is a bank,
broker/dealer, GSE, or insurance company, which would not be subject to resolution
under the Code.
For insolvent insured depository institutions, FDIA as amended by FIRREA
provides for netting of “qualified financial contracts” between insolvent insured
depository institutions and other counterparties regardless of type. The term “…‘qualified
financial contract’ means any securities contract, commodity contract, forward contract,
repurchase agreement, swap agreement, and any similar agreement,” with the FDIC being

30

Scott v Armstrong 146 U.S. 499 (1892).
For instance, the right of the depositor to offset the value of the deposits against the depositor’s
indebtedness was recognized in Heiple v. Lehman, 358 Ill. 222, 192 N.E. 858 (1934) and FDIC v.
Mademoiselle of California, 379 F.2d 660 (9th Cir. 1967). In all cases “mutuality” of obligations must be
established. For instance, if a holding company fails, deposits made by one subsidiary usually may not be
seized to pay off a loan taken out by another subsidiary. Where insured deposits are involved, netting
occurs prior to the determination of insurance coverage.
32
11 USC 362(b)(17) and 11 USC 560.
33
11 USC 365(e)(1).
31

17

given the authority to make the final determination as to which contracts qualify.34 This
definition covers most OTC derivatives governed by ISDA and similar master
agreements. The FDIC, as administrator or conservator of a failed insured depository
institution, may transfer qualified contracts to another financial institution, for instance a
bridge bank, subject to a requirement to notify the parties involved by noon on the nextbusiness day.35 The FDIC may also repudiate any contract but must pay compensatory
damages, which has much the same effect as termination initiated by a solvent
counterparty.36 The FDIC has announced that it will not selectively repudiate contracts
with individual counterparties—that is cherry pick—but its legal obligations in this
regard are unclear. However, the FDIC may not stay the execution of termination clauses,
except where termination is based solely on insolvency or the appointment of a
conservator or receiver.37 Thus, the take-over of a bank by the FDIC is not an enforceable
“credit event” under ISDA contracts in the U.S., so long as there is not some other basis
for terminating an agreement, such as a failure to make a payment. If contracts are
transferred, all contracts between the insolvent depositor institution and a given
counterparty must be transferred together, thus prohibiting cherry picking of transferred
contracts.38
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
permits enforcement of netting agreements in financial contracts between financial
institutions.39 However, FDICIA’s support for termination rights is a matter of some
uncertainty. The FDIC maintains that FDICIA does not preempt the ability to stay
termination under FDIA when the insolvent institution is a bank under conservatorship. A
legal opinion obtained by ISDA disagrees. To date, the matter has not been tested in the
courts.40 Oft agreed, never passed, changes to the bankruptcy code (see footnote 31)
support this reading of Congressional intent. The Federal Reserve Board and ISDA’s
34

12 USC 1821(e)(8)(D)(i).
12 USC 1823(d)(2)(G) and 12 USC 1821(e)(10).
36
12 USC 1821(e)(1) and 12 USC 1821(e)(3).
37
12 USC 1821(e)(8)(E) and 12 USC 1821(e)(12). Proposed changes in the U.S. bankruptcy laws would
greatly enhance the FDIC’s ability to stay termination of qualified financial contracts for banks under
conservatorship for most reasons other than actual non-payment. For banks under receivership a one-day
stay would be provided for (H.R. 975, Sec 903(a)(3)).
38
12 USC 1821(e)(9)
39
12 USC 4401–05.
40
See Bergman et al. (2003) for a detailed discussion.
35

18

legal opinion on the enforceability of close-out termination rights under ISDA Master
Agreements conclude that the wording of 12 USC 4405, which prohibits stays of netting
agreements (but is silent on termination agreements), does preempt the FDIC’s claim of
powers to stay close-out netting for insolvent banks. Financial institutions are broadly
defined as “… broker or dealer, depository institution, futures commission agent, or other
institution as determined by the Board of Governors of the Federal Reserve System.”41
According to the Federal Reserve’s criteria for determining whether an institution
qualifies (laid out in Regulation EE), the firm must be a trader or dealer, rather than an
end user, and meet a minimum size requirement.42 For such designated financial
institutions, the ability to net payment obligations under netting agreements is quite
broad. However, this law only recognizes the enforceability of netting agreements in
contracts; it does not create a general right to net obligations. Furthermore, these
provisions are limited to contracts between designated financial institutions and, thus,
provide no protection for contracts between financial institutions and nonfinancial
institutions.
Overall, therefore, the patchwork of laws governing termination and netting of
derivatives contracts provides some protection of close-out and netting agreements, but
remains a source of legal uncertainties. For example, it is not clear whether unenumerated
derivatives contracts such as credit, equity, energy, and weather derivatives would fall
under the rubrics of either “swap” or “qualified financial contract.” Furthermore, the
enumerated classes of covered counterparties—stockbrokers, financial institutions, and
securities clearing agencies—fail to cover all important financial market participants. The
FDIC’s various rights under FDICIA remain unclear and untested in the courts. Attempts
have repeatedly been made to eliminate the legal uncertainty, going back at least to 1996.
Most recently, both the House and Senate passed broadly similar bills (H.R. 333 and S.
420) to address these issues as part of a larger reform of the Bankruptcy Code. These
efforts were strongly supported by trade groups, the Federal Reserve, and the Treasury.
However, the resulting piece of legislation failed to pass due to unrelated political
considerations.
41

12 USC 4402(9).

19

4 Other issues in resolving LCFOs
As noted earlier, bankruptcy and, in the U.S., bank resolution procedures are
predicated on the orderly liquidation or reorganization of a troubled firm under the
supervision of a court, an administrator, or in the case of U.S. banks, the FDIC. The first
step is to stay the exercise of most claims against the firm while the administrator
ascertains assets and liabilities, determines the validity of claims, realizes the value of
assets, and pays off creditors in a liquidation or negotiates with creditors to arrange a
reorganization. These procedures take considerable time, sometimes even years.43
The issues discussed above were largely related to coordination—across
competing legal and regulatory jurisdictions. Next, I discuss some additional issues
complicating the bankruptcy process for LCFOs. These issues fall into two general
categories—opacity and time.

4.1 Opacity
LCFOs tend to be informationally opaque to outsiders because accounting
methods are not designed to provide detailed information about contingent liabilities
embedded in off-balance-sheet activities and derivatives portfolios. More importantly, for
the purposes of failure resolutions, this detailed information is often unavailable to
insiders as well. Rather, much of the information available to managers, counterparties,
and regulators and/or courts is of a summary nature.
Accounting statements are simply too crude to capture these complexities, and the
infrequent and aggregated values they present are insufficiently informative of the
positions and risk exposures of a modern financial institution. Such obfuscation is
inherent in the ambiguity of financial accounting rules and is therefore endemic. It is
further exacerbated by the failure of accounting rules to come to grips with valuation of
assets and liabilities whose values change rapidly. The accounting treatment of offbalance-sheet activities also leaves much to be desired. While accounting statements can
provide estimates of the current values of assets of on- and off-balance-sheet positions,

42

The size requirements are $1 billion of gross notional principal outstanding or $100 million of gross
marked-to-market value of outstanding positions (Johnson, 2000, p. 87).
43
Franks and Torous (1994) report that in their sample of firms filing for Chapter 11, a median 27 months
was required to complete reorganization.

20

current accounting methods are unable to account for contingencies embedded in these
positions and rapidly changing portfolio composition and values render nugatory analysis
based on annual or even quarterly assessments. These problems lie in a basic disconnect
between the goals of accounting—to report what is—and the goals of risk management—
to anticipate what may be.
Take the simple case of a long-term bond with a due-on-downgrade provision in
its indenture that requires the issuer to immediately redeem the bond if its rating is
downgraded below a certain level. An investor might look at the ratio of the firm’s
income before interest and taxes to the periodic interest payments—the “times interest
earned” ratio—to assess the creditworthiness of the firm. The information for doing this
can be inferred, if somewhat imprecisely, from the balance sheet and the income
statement. But in the event that a rating downgrade triggers the obligation for immediate
repayment of principal, these computations become meaningless. If the debt is publicly
traded, the presence of these triggers will appear in the bond indentures, though few
analysts or portfolio managers trouble to read these. If the debt is privately placed, there
is unlikely to be any publicly available information regarding this contingent liability.
Mark-to-market or mark-to-model accounting (whereby assets and liabilities are
restated on the balance sheet to reflect their observed market values, or for infrequently
traded assets and liabilities, using valuation models) can do little to alleviate the
information problem. Even if the due-on-downgrade covenant was noted, evaluating that
information requires sophisticated models whose output will depend on a myriad of
assumptions. This is not information that can be synthesized in an accounting statement.
The market or model valuation itself provides some information, but it is based on
conditions at the time the evaluation was made (and the model used). Without detailed
information regarding all embedded contingencies, one cannot infer the payment
obligations for the bond or its value under possible alternative scenarios.
This is of course true for most assets and some traditional liabilities. Inventory
may prove more or less valuable depending on fluctuating market prices; the value of
pension liabilities depends on changes in rates of return and the performance of the
pension portfolio. What is special about contingent liabilities and derivatives is the
potential for rapid and large changes in payment obligations.

21

A second issue of concern has to do with the summary nature of much of the
information available to managers, counterparties, and regulators and/or courts. LCFOs
tend to manage their activities in a decentralized manner. Firm-wide coordination and
risk management (where it exists) is usually based on summary information of profits,
losses, risk exposures, and so forth passed up from the divisions to the head office(s).
This summary information, where it is correctly structured, should be sufficient for risk
management purposes. However, in the event of financial distress, when the firm or an
administrator seeks to sell off the derivatives positions, more detailed information is
needed. The problem of decentralized information is sometimes exacerbated by
incompatible legacy accounting systems arising from recent mergers. Few large complex
firms are in a position to rapidly provide detailed firm-wide information about individual
positions at a level of detail sufficient for a potential buyer to make an informed
valuation.44 The result is that buyers will only purchase a derivatives book at a price well
below the true market value, since in effect they are buying a grab bag of contracts with
only a vague idea of the contents.

4.2 Time
Banking regulation frequently seeks to avoid the resolution process by having
regulators become increasingly involved in a bank’s activities as it approaches
insolvency. In the U.S. the prompt corrective action provisions of FDICIA dictate a series
of increasingly rigorous actions that supervisors are required to take as a bank’s capital
declines below the regulatory minimum.45 These plans for preventing a bank from
becoming insolvent presume that the decline in a bank’s condition will be observable and
sufficiently gradual to permit timely intervention. Prompt corrective action cannot work
when perceived asset values change rapidly, either because their true value has been
hidden and is suddenly realized or because of fluctuations in market values. Recent
notable bank failures have been the result of fraud (First National Bank of Keystone,
1999) or incorrect valuation (perhaps fraudulent) of derivative assets (Superior Federal
Savings Bank, 2001). Changing market conditions rather than fraud caused LTCM’s
44

Following Enron’s failure, J. P. Morgan announced revised firm-wide exposures over a period of several
weeks.
45
12 USC 1831o.

22

equity to go from $4.8 billion in January 1998 to $600 million in September, with the
clear danger that leverage (approaching 100 to 1 by that time) and margin calls (forcing
liquidation of its positions in illiquid assets) would wipe out the residual in a matter of
days (see Edwards, 1999).
While fraud and rapid changes in asset values can frustrate the (ex ante)
procedures that managers, counterparties, and regulators have adopted to prevent or
minimize the incidence of insolvencies, the treatment of derivatives during an insolvency
is apt to frustrate the (ex post) procedures for the orderly resolution of firms with large
portfolios subject to close-out netting. The inability of insolvency administrators to
effectively prevent or stay close-out of a significant portion of the distressed firm’s
contracts means that these contracts and their related collateral can be terminated and
liquidated. This may leave the firm so impaired as to make reorganization impractical.
Attempts to prevent such close-outs “for reasons solely of filing for protection” are
unlikely to prove effective—contracts usually provide other termination conditions
beyond the control of courts and/or regulators, for instance, “due-on-downgrade” clauses,
which are likely to be triggered at the same time.
There exists some possibility that the close-out can be preempted by selling the
book, or in the case of a bank insolvency transferring it to a bridge bank, but these
decisions must take place with incomplete information about the assets to be sold or
transferred and under extreme time pressure—close-out can only be postponed with the
forbearance of the solvent counterparties that hold the option to exercise termination once
the firm becomes sufficiently distressed. Since large firms have multiple counterparties,
the situation is likely to be extremely unstable. The value of derivatives positions is liable
to change rapidly due to the actions of other counterparties. Once one counterparty
exercises its close-out rights, a “rush for the exit” will inevitably develop—counterparties
will seek to liquidate their collateral and positions before the actions of others depress
prices (the “fire-sale” effect) and their own losses increase.46 This is the same problem

46

This is markedly different from other assets. If a bank collateralizes a loan with a real asset such as an
apartment building and the borrower defaults, the building is not going to disappear and its value is
unlikely to change significantly over the next few weeks. On the other hand, terminated derivatives
contracts cease to exist and the value of financial assets that are held as collateral can change rapidly.

23

that gave rise to coordinated bankruptcy procedures—now recurring because removing
the stays effectively exempts derivatives contracts from the process.

5 Recommendations
I have provided an overview of the bankruptcy laws and the problems relating
specifically to resolution of LCFOs. The combination of rapidly developing insolvency,
opaque derivatives positions, and the exemption from stays has the potential to preempt
the usual options open to regulators and courts to conduct a deliberate and well
considered (that is, leisurely) liquidation or reorganization of an LCFO. Below, I present
what I believe to be a potentially effective means to resolve LCFOs.
One may be tempted to suggest that policymakers should simply reverse the
legislative carve outs from bankruptcy stays that apply to derivatives through the master
agreement mechanism. This would place derivatives back into the coordinated resolution
process and eliminate the problems that close-out netting might precipitate. But these
carve outs serve a useful purpose; indeed, the entire over-the-counter derivatives market
is predicated on the contractual mechanisms that have evolved along with these markets.
Eviscerating the master agreement concept risks massive and in this case partially
foreseeable consequences. The over-the-counter derivatives markets as we know them
would probably disappear—dealers would be unable to maintain the current levels of
positions if prudence and/or regulators required holding capital against gross instead of
net exposures, causing liquidity to shrink. This in turn would fundamentally undermine
the ability of firms across the economy to manage risks.
The alternative is to leave the carve outs in place, expand them where it leads to
improvements in markets, risk management, and systemic risk reduction, and to then
differentiate between systemically important firms and firms that are not systemically
important through regulatory oversight in a manner consistent with these “facts on the
ground.” Not every firm that fails with large derivatives positions poses a threat to the
financial markets—Enron is an example. However, firms whose failures do pose a
systemic threat and whose resolutions cannot be effectively handled under insolvency
procedures, or whose insolvency resolution presents considerable legal risks, need to be
treated differently—they need to be prevented from ever reaching formal insolvency

24

proceedings.47 In other words, the principle of “prompt corrective action,” already found
in U.S. banking regulation, needs to be applied to LCFOs. The procedure I have in mind
would require mechanisms and agencies for coordinating extra-legal and, therefore,
voluntary resolution (workouts) of these particular financial firms when they become
distressed.48
This conclusion requires subordination of two other considerations: the possible
reduced monitoring incentives that the current derivatives contracts and rules may induce,
and the pro-debtor criticism that any such informal procedure might protect derivatives
counterparties at the expense of other creditors who may not be parties to the workout.49
The first of these concerns is theoretical and has not been empirically confirmed.50 The
second is philosophical and presumes that the workout is likely to be unsuccessful, for if
the workout is successful the “other creditors” will receive their due in full. It is
worthwhile to note that workouts, including LTCM’s, frequently involve creditors who
are party to the workout putting additional capital into the financially distressed firm,
rather than stripping assets out of the firm. Informal workout procedures have proven
effective in the past in reducing the incidence of formal bankruptcy proceedings with
their attendant costs (see Armour and Deakin, 2000).
However, to be effective, voluntary coordinated intervention in a financially
distressed LCFO requires elements not currently in place. One is timely, relevant,
accurate, and consolidated information. Another is agreement among the counterparties
that it is in their interests to have an informal, coordinated resolution.
Different accounting standards make interpretation of division and subsidiary
level financial statements difficult; and consolidated statements do not provide sufficient
detail to anticipate potential problems arising from the location of assets and liabilities.
That current accounting standards produce financial statements that are not always
47

This is one of the recommendations made by the President’s Commission on Financial Markets in its
1999 analysis of lessons from the LTCM debacle.
48
Use of voluntary rather than formal (legal) procedures has been shown to reduce the deadweight costs of
resolution (Franks and Torous, 1994); an added benefit.
49
Of course, any workout cannot negotiate away these other claimants’ rights unless the claimants are party
to the negotiation and agree to the reduction. However, the workout can result in a restructuring that, if
unsuccessful, may ex post have transferred value away from those parties who were not party to the
workout. But this already happens in the case of post-insolvency (debtor in possession) financing, whereby
the administrator can negotiate debt agreements that are senior to those of the existing creditors.
50
See Bergman et al. (2003) for a detailed discussion of the theoretical arguments.

25

informative is no longer subject to question. Banking secrecy and privacy laws may
provide further impediments to information sharing across jurisdictions. Thus, while the
level of detail needed for regulators to anticipate financial distress and trigger informal
resolution procedures would not be as fine as that needed to dispose of assets, the process
would still require more and better information than is currently available.
Furthermore, to be able to implement this failure resolution process, consolidated
supervision is necessary for LCFOs so that a single regulatory agency is looking at the
entire firm in detail.51 This would help to prevent fraud that relies on no one supervisor
knowing the total position of the firm and would allow the supervisor to assess firm-wide
risk exposures. This knowledge can best come through a consolidated supervision
process.
The European Parliament has recently enacted a series of directives requiring
consolidated supervision of financial conglomerates. In the cases of EU subsidiaries of
non-EU parent companies, the home country must provide equivalent consolidated
supervision of the worldwide activities of the firm, or the subsidiary must be separately
incorporated in the EU and subject to EU supervision. The U.S. also requires
consolidated supervision by home country authorities of foreign financial firms seeking
to operate bank or financial holding companies in the U.S., but provides only rudimentary
consolidated supervision for domestic financial holding companies. The Gramm–Leach–
Bliley Act (2000) provides for the Federal Reserve to act as the umbrella supervisor of
financial holding companies, and the Federal Reserve is separately charged with
regulating bank holding companies. But under this umbrella role, the direct supervision is
delegated to other agencies—the OCC, the FDIC, the SEC, and state bank and insurance
regulators. Information flow between these parties is subject to frictions, and different
agencies have different agendas. For instance, the SEC, which focuses on investor
protection, fraud, and more recently on corporate governance, has not been historically

51

Consolidated supervision, in contrast to functional regulation by multiple regulators, requires only that a
single regulator examine and supervise a given firm in its entirety for safety and soundness. Consolidated
supervision does not necessarily imply a single regulator for all financial firms—domestically or globally—
nor does it mean that multiple regulators could not address different unrelated issues, for instance work
place safety, fair lending, or equal employment opportunities.

26

much concerned with safety and soundness or systemic risk. The result is that
consolidated supervision in the U.S. is more theoretical than real.52
Where the home country is not the principal place of business of a multinational
financial firm, the incentives for the home country supervisor to monitor are attenuated.
And where the home country is small, the ability of the home country supervisor to
monitor may be non-existent. Unfortunately, political rather than economic and
prudential considerations may result in a reluctance to prohibit firms from gaming
differential regulatory regimes. This has in the past led to strategic positioning of
countries of incorporation for purposes of minimizing oversight—BCCI’s basing itself in
Luxembourg being an example.53 The result is that consolidated supervision alone does
not guarantee good supervision.
The goal of supervision and information gathering should be to detect problems
sufficiently early to intervene. LTCM, recall, still had a positive net worth when the Fed
stepped in. Once a firm becomes clearly insolvent, counterparties may be unwilling to
continue to do business with it, and voluntary workouts may become impossible.
The second requirement after timely detection is for the counterparties to agree
that it is in their interests to have an informal coordinated resolution rather than to risk
exercising their close-out rights with concomitant costly liquidation of positions and
ultimate resolution of (net) claims through formal bankruptcy proceedings. The benefits
of informal coordinated resolution are usually obvious, but because a few creditors may
be better off if they liquidate their positions quickly enough, counterparties need a
mechanism to encourage collective rather than individual action. This requires that the
creditors agree to the process and agree on an agent to coordinate their discussions. Such
an agent has to be seen as credible and impartial. Armour and Deaken (2000) have
analyzed the development of such a “norm” in the London financial markets. The process
was driven initially by the Bank of England, which arranged the workouts, no doubt

52

This has naturally led to discussions between U.S. and EU regulators as to whether European subsidiaries
of U.S. financial institutions meet EU requirements under the Consolidated Supervision Directive.
53
BCCI is the classic example of a corporate structure designed to facilitate fraud. “BCCI’s headquarters
were established in countries with weak supervisory authorities, strong secrecy laws and neither lenders of
last resort nor deposit insurers who would have financial reasons to be concerned about the solvency of
banks chartered in their jurisdictions. … [S]eparate auditing firms were hired for each [subsidiary] bank.”
(Herring, 2002)

27

applying a bit of moral suasion to get the creditors to come to the table. However, after
informal workouts became accepted and creditors realized that they would continue to
deal with each other in the future, and hence that they would be penalized for
uncooperative behavior, the Bank of England was able to withdraw, and the creditors
determined among themselves which lead bank would coordinate (collect information,
chair discussions, and act as arbiter) the process.54 The Federal Reserve Bank of New
York provided much the same role in the resolution of LTCM. It had the ability to bring
creditors to the table (the New York Fed’s table) and to create an atmosphere that
allowed the firm to avoid the pending margin calls that would have precipitated a rush to
close-out by all. This is perhaps a useful model for dealing with future resolutions, if
impending problems can be anticipated in time.
While some may wish to keep regulatory agencies out of the process, there is no
obvious alternative. Financial markets are too competitive and institutions face too many
incentive problems to expect the self-managed London Approach to operate
internationally: The will to cooperate may be there, but the willingness to delegate
considerable power to a competitor to act as lead bank and arbiter is unlikely to be
present. Only a central bank or financial authority can have the credibility for
coordinating such a process, and only a few have the resources and expertise. Central
bank or financial authority participation is also needed because these institutions have a
unique ability to “encourage” participation—to twist arms, as it were. The key ingredient
that made the privately managed London Approach work—reputation effects based on
ongoing business relations—is disappearing as the lifespan of individual financial firms
becomes increasingly uncertain due to mergers and (non-distressed) restructurings. A key
corollary is that all parties must perceive that they benefit from the process, that each is
made better off because all arms are being equally twisted.
Some will be concerned that intervention by a central bank, or even a financial
supervisory authority, may create an implicit guarantee that the government will bail out
the participants if the restructuring is not successful. This criticism has been made of the
54

Notably, the process has begun to break down as American “vulture” funds, which purchase defaulted
debt to realize quick returns, have entered the market. These firms have no expectations of ongoing
business relations with other creditors and have aggressively pursued maximizing their current claims,
effectively breaking the bond that made cooperation possible.

28

Federal Reserve Bank of New York’s intervention in the LTCM case. It is thought that
such implicit guarantees might lead to excessive risk taking by parties to the agreement.
However, so long as participation is voluntary—so long as no party is positively barred
from exercising their legal rights to terminate or to resort to the courts—even if
participation is “strongly encouraged,” it is not obvious that guarantees need be implied.
In any case, with any guarantee being at best implicit, the central bank can decline to bail
out creditors if it perceives that they have acted unwisely. In the end though, the possible
costs of central bank or financial supervisory authority involvement in private resolution
must be balanced against the costs of not facilitating private resolution and dealing with
the resulting consequences, for a credible non-public alternative does not exist.
This recommendation more closely encompasses the principal of prompt
corrective action, rather than too-big-to-fail. The facilitated private resolution I am
proposing may return the distressed firm to economic viability or may simply allow the
firm time to be restructured so as to no longer pose a systemic threat. Again, the LTCM
example is useful—the consortium recapitalized the firm sufficiently for it to unwind its
positions in an orderly manner, after which it ceased to exist. However, the legislated
prompt corrective action mandated under FDICIA does not present a useful model.
Firstly, the political hurdles to enacting such a policy within the U.S. and internationally
make a legislative approach impractical—witness the repeated failure of bankruptcy
reform in the U.S. Secondly, the “bright line triggers” (mandated regulatory actions tied
to specified levels of capital adequacy) embedded in past prompt corrective action
legislation have invited litigation as to whether the thresholds have been breached. Lastly,
legislatures tend to be nationalistic; it is just as unlikely that France would permit passage
of an EU law allowing a U.S. regulator to facilitate the resolution of a French LCFO as it
is that the U.S. would pass one allowing for an EU facilitator of a U.S. LCFO. The
solution to the political intractability of a formal legalistic approach lies in the informality
of the old London Approach by which parties simply agreed to participate. In this case,
the parties would include the various regulatory agencies and, at least tacitly, their
governments, as well as the LCFOs and their major counterparties.
My proposal also presumes an appropriately motivated, credible, and informed
regulator with sufficient technical resources to perform the function. To the extent that

29

regulators are perceived to favor the interests of certain interested parties, for instance,
deposit insurers, their credibility as neutral arbiters may be limited. Other regulatory
shortcomings that have been mentioned by various commentators in various situations
include a disinclination to recognize problems (“not on my watch”), self-aggrandizement
(empire building), desire to steer market developments in certain directions, and
susceptibility to political interference. Notwithstanding these myriad potential problems,
the test of a regulator’s ability to facilitate a voluntary resolution lies in the market
participants’ willingness to accept them in the role. The successes of the New York Fed
in the LTCM workout and the Bank of England in initiating the London Approach show
that the requisite degree of credibility and acceptance is achievable.
However, this model would still require a minimum of legislative reform. The
Federal Reserve’s weak umbrella regulator role, acting through other functional
regulators, would need to be replaced by a consolidated regulator with direct supervisory
responsibility for systemically important LCFOs. In Europe, banking secrecy laws may
need to be modified to permit the necessary information gathering and sharing, a process
already under discussion to address other problems (such as money laundering and
terrorist financing).
Whether the appropriate regulators will be willing to take the role I am suggesting
in the future and whether they should signal their terms of engagement in advance as a
matter of principle or remain constructively ambiguous are issues that need to be further
discussed. Regulators also need to establish mechanisms for deciding which single
regulator will act in any given case, as multiple or competing coordinators opens the
possibility for mischief.
However, until the informational problems are solved, it will only be by
happenstance that LCFOs are discovered to be distressed when they are still sufficiently
solvent to allow for a voluntary coordinated resolution. Until then our financial
institutions and markets operate in a world where the normal mechanisms for resolving
potential insolvencies of our major financial organizations may prove inadequate to cope
with these systemically important institutions.

30

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32

Working Paper Series
A series of research studies on regional economic issues relating to the Seventh Federal
Reserve District, and on financial and economic topics.
Dynamic Monetary Equilibrium in a Random-Matching Economy
Edward J. Green and Ruilin Zhou

WP-00-1

The Effects of Health, Wealth, and Wages on Labor Supply and Retirement Behavior
Eric French

WP-00-2

Market Discipline in the Governance of U.S. Bank Holding Companies:
Monitoring vs. Influencing
Robert R. Bliss and Mark J. Flannery

WP-00-3

Using Market Valuation to Assess the Importance and Efficiency
of Public School Spending
Lisa Barrow and Cecilia Elena Rouse
Employment Flows, Capital Mobility, and Policy Analysis
Marcelo Veracierto
Does the Community Reinvestment Act Influence Lending? An Analysis
of Changes in Bank Low-Income Mortgage Activity
Drew Dahl, Douglas D. Evanoff and Michael F. Spivey

WP-00-4

WP-00-5

WP-00-6

Subordinated Debt and Bank Capital Reform
Douglas D. Evanoff and Larry D. Wall

WP-00-7

The Labor Supply Response To (Mismeasured But) Predictable Wage Changes
Eric French

WP-00-8

For How Long Are Newly Chartered Banks Financially Fragile?
Robert DeYoung

WP-00-9

Bank Capital Regulation With and Without State-Contingent Penalties
David A. Marshall and Edward S. Prescott

WP-00-10

Why Is Productivity Procyclical? Why Do We Care?
Susanto Basu and John Fernald

WP-00-11

Oligopoly Banking and Capital Accumulation
Nicola Cetorelli and Pietro F. Peretto

WP-00-12

Puzzles in the Chinese Stock Market
John Fernald and John H. Rogers

WP-00-13

The Effects of Geographic Expansion on Bank Efficiency
Allen N. Berger and Robert DeYoung

WP-00-14

Idiosyncratic Risk and Aggregate Employment Dynamics
Jeffrey R. Campbell and Jonas D.M. Fisher

WP-00-15

1

Working Paper Series (continued)
Post-Resolution Treatment of Depositors at Failed Banks: Implications for the Severity
of Banking Crises, Systemic Risk, and Too-Big-To-Fail
George G. Kaufman and Steven A. Seelig

WP-00-16

The Double Play: Simultaneous Speculative Attacks on Currency and Equity Markets
Sujit Chakravorti and Subir Lall

WP-00-17

Capital Requirements and Competition in the Banking Industry
Peter J.G. Vlaar

WP-00-18

Financial-Intermediation Regime and Efficiency in a Boyd-Prescott Economy
Yeong-Yuh Chiang and Edward J. Green

WP-00-19

How Do Retail Prices React to Minimum Wage Increases?
James M. MacDonald and Daniel Aaronson

WP-00-20

Financial Signal Processing: A Self Calibrating Model
Robert J. Elliott, William C. Hunter and Barbara M. Jamieson

WP-00-21

An Empirical Examination of the Price-Dividend Relation with Dividend Management
Lucy F. Ackert and William C. Hunter

WP-00-22

Savings of Young Parents
Annamaria Lusardi, Ricardo Cossa, and Erin L. Krupka

WP-00-23

The Pitfalls in Inferring Risk from Financial Market Data
Robert R. Bliss

WP-00-24

What Can Account for Fluctuations in the Terms of Trade?
Marianne Baxter and Michael A. Kouparitsas

WP-00-25

Data Revisions and the Identification of Monetary Policy Shocks
Dean Croushore and Charles L. Evans

WP-00-26

Recent Evidence on the Relationship Between Unemployment and Wage Growth
Daniel Aaronson and Daniel Sullivan

WP-00-27

Supplier Relationships and Small Business Use of Trade Credit
Daniel Aaronson, Raphael Bostic, Paul Huck and Robert Townsend

WP-00-28

What are the Short-Run Effects of Increasing Labor Market Flexibility?
Marcelo Veracierto

WP-00-29

Equilibrium Lending Mechanism and Aggregate Activity
Cheng Wang and Ruilin Zhou

WP-00-30

Impact of Independent Directors and the Regulatory Environment on Bank Merger Prices:
Evidence from Takeover Activity in the 1990s
Elijah Brewer III, William E. Jackson III, and Julapa A. Jagtiani
Does Bank Concentration Lead to Concentration in Industrial Sectors?
Nicola Cetorelli

WP-00-31

WP-01-01

2

Working Paper Series (continued)
On the Fiscal Implications of Twin Crises
Craig Burnside, Martin Eichenbaum and Sergio Rebelo

WP-01-02

Sub-Debt Yield Spreads as Bank Risk Measures
Douglas D. Evanoff and Larry D. Wall

WP-01-03

Productivity Growth in the 1990s: Technology, Utilization, or Adjustment?
Susanto Basu, John G. Fernald and Matthew D. Shapiro

WP-01-04

Do Regulators Search for the Quiet Life? The Relationship Between Regulators and
The Regulated in Banking
Richard J. Rosen
Learning-by-Doing, Scale Efficiencies, and Financial Performance at Internet-Only Banks
Robert DeYoung
The Role of Real Wages, Productivity, and Fiscal Policy in Germany’s
Great Depression 1928-37
Jonas D. M. Fisher and Andreas Hornstein

WP-01-05

WP-01-06

WP-01-07

Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy
Lawrence J. Christiano, Martin Eichenbaum and Charles L. Evans

WP-01-08

Outsourcing Business Service and the Scope of Local Markets
Yukako Ono

WP-01-09

The Effect of Market Size Structure on Competition: The Case of Small Business Lending
Allen N. Berger, Richard J. Rosen and Gregory F. Udell

WP-01-10

Deregulation, the Internet, and the Competitive Viability of Large Banks
and Community Banks
Robert DeYoung and William C. Hunter

WP-01-11

Price Ceilings as Focal Points for Tacit Collusion: Evidence from Credit Cards
Christopher R. Knittel and Victor Stango

WP-01-12

Gaps and Triangles
Bernardino Adão, Isabel Correia and Pedro Teles

WP-01-13

A Real Explanation for Heterogeneous Investment Dynamics
Jonas D.M. Fisher

WP-01-14

Recovering Risk Aversion from Options
Robert R. Bliss and Nikolaos Panigirtzoglou

WP-01-15

Economic Determinants of the Nominal Treasury Yield Curve
Charles L. Evans and David Marshall

WP-01-16

Price Level Uniformity in a Random Matching Model with Perfectly Patient Traders
Edward J. Green and Ruilin Zhou

WP-01-17

Earnings Mobility in the US: A New Look at Intergenerational Inequality
Bhashkar Mazumder

WP-01-18

3

Working Paper Series (continued)
The Effects of Health Insurance and Self-Insurance on Retirement Behavior
Eric French and John Bailey Jones

WP-01-19

The Effect of Part-Time Work on Wages: Evidence from the Social Security Rules
Daniel Aaronson and Eric French

WP-01-20

Antidumping Policy Under Imperfect Competition
Meredith A. Crowley

WP-01-21

Is the United States an Optimum Currency Area?
An Empirical Analysis of Regional Business Cycles
Michael A. Kouparitsas

WP-01-22

A Note on the Estimation of Linear Regression Models with Heteroskedastic
Measurement Errors
Daniel G. Sullivan

WP-01-23

The Mis-Measurement of Permanent Earnings: New Evidence from Social
Security Earnings Data
Bhashkar Mazumder

WP-01-24

Pricing IPOs of Mutual Thrift Conversions: The Joint Effect of Regulation
and Market Discipline
Elijah Brewer III, Douglas D. Evanoff and Jacky So

WP-01-25

Opportunity Cost and Prudentiality: An Analysis of Collateral Decisions in
Bilateral and Multilateral Settings
Herbert L. Baer, Virginia G. France and James T. Moser

WP-01-26

Outsourcing Business Services and the Role of Central Administrative Offices
Yukako Ono

WP-02-01

Strategic Responses to Regulatory Threat in the Credit Card Market*
Victor Stango

WP-02-02

The Optimal Mix of Taxes on Money, Consumption and Income
Fiorella De Fiore and Pedro Teles

WP-02-03

Expectation Traps and Monetary Policy
Stefania Albanesi, V. V. Chari and Lawrence J. Christiano

WP-02-04

Monetary Policy in a Financial Crisis
Lawrence J. Christiano, Christopher Gust and Jorge Roldos

WP-02-05

Regulatory Incentives and Consolidation: The Case of Commercial Bank Mergers
and the Community Reinvestment Act
Raphael Bostic, Hamid Mehran, Anna Paulson and Marc Saidenberg
Technological Progress and the Geographic Expansion of the Banking Industry
Allen N. Berger and Robert DeYoung

WP-02-06

WP-02-07

4

Working Paper Series (continued)
Choosing the Right Parents: Changes in the Intergenerational Transmission
of Inequality  Between 1980 and the Early 1990s
David I. Levine and Bhashkar Mazumder

WP-02-08

The Immediacy Implications of Exchange Organization
James T. Moser

WP-02-09

Maternal Employment and Overweight Children
Patricia M. Anderson, Kristin F. Butcher and Phillip B. Levine

WP-02-10

The Costs and Benefits of Moral Suasion: Evidence from the Rescue of
Long-Term Capital Management
Craig Furfine

WP-02-11

On the Cyclical Behavior of Employment, Unemployment and Labor Force Participation
Marcelo Veracierto

WP-02-12

Do Safeguard Tariffs and Antidumping Duties Open or Close Technology Gaps?
Meredith A. Crowley

WP-02-13

Technology Shocks Matter
Jonas D. M. Fisher

WP-02-14

Money as a Mechanism in a Bewley Economy
Edward J. Green and Ruilin Zhou

WP-02-15

Optimal Fiscal and Monetary Policy: Equivalence Results
Isabel Correia, Juan Pablo Nicolini and Pedro Teles

WP-02-16

Real Exchange Rate Fluctuations and the Dynamics of Retail Trade Industries
on the U.S.-Canada Border
Jeffrey R. Campbell and Beverly Lapham

WP-02-17

Bank Procyclicality, Credit Crunches, and Asymmetric Monetary Policy Effects:
A Unifying Model
Robert R. Bliss and George G. Kaufman

WP-02-18

Location of Headquarter Growth During the 90s
Thomas H. Klier

WP-02-19

The Value of Banking Relationships During a Financial Crisis:
Evidence from Failures of Japanese Banks
Elijah Brewer III, Hesna Genay, William Curt Hunter and George G. Kaufman

WP-02-20

On the Distribution and Dynamics of Health Costs
Eric French and John Bailey Jones

WP-02-21

The Effects of Progressive Taxation on Labor Supply when Hours and Wages are
Jointly Determined
Daniel Aaronson and Eric French

WP-02-22

5

Working Paper Series (continued)
Inter-industry Contagion and the Competitive Effects of Financial Distress Announcements:
Evidence from Commercial Banks and Life Insurance Companies
Elijah Brewer III and William E. Jackson III

WP-02-23

State-Contingent Bank Regulation With Unobserved Action and
Unobserved Characteristics
David A. Marshall and Edward Simpson Prescott

WP-02-24

Local Market Consolidation and Bank Productive Efficiency
Douglas D. Evanoff and Evren Örs

WP-02-25

Life-Cycle Dynamics in Industrial Sectors. The Role of Banking Market Structure
Nicola Cetorelli

WP-02-26

Private School Location and Neighborhood Characteristics
Lisa Barrow

WP-02-27

Teachers and Student Achievement in the Chicago Public High Schools
Daniel Aaronson, Lisa Barrow and William Sander

WP-02-28

The Crime of 1873: Back to the Scene
François R. Velde

WP-02-29

Trade Structure, Industrial Structure, and International Business Cycles
Marianne Baxter and Michael A. Kouparitsas

WP-02-30

Estimating the Returns to Community College Schooling for Displaced Workers
Louis Jacobson, Robert LaLonde and Daniel G. Sullivan

WP-02-31

A Proposal for Efficiently Resolving Out-of-the-Money Swap Positions
at Large Insolvent Banks
George G. Kaufman

WP-03-01

Depositor Liquidity and Loss-Sharing in Bank Failure Resolutions
George G. Kaufman

WP-03-02

Subordinated Debt and Prompt Corrective Regulatory Action
Douglas D. Evanoff and Larry D. Wall

WP-03-03

When is Inter-Transaction Time Informative?
Craig Furfine

WP-03-04

Tenure Choice with Location Selection: The Case of Hispanic Neighborhoods
in Chicago
Maude Toussaint-Comeau and Sherrie L.W. Rhine

WP-03-05

Distinguishing Limited Commitment from Moral Hazard in Models of
Growth with Inequality*
Anna L. Paulson and Robert Townsend

WP-03-06

Resolving Large Complex Financial Organizations
Robert R. Bliss

WP-03-07

6