"Derivatives and Systemic Risk: What Role Can the Bankruptcy Code Play?"
Systemic Financial Crises: Resolving Large Bank Insolvencies
Editor(s): George Kaufman
© MIT Press,
2005
Publication type: Chapter
Research Archive Topic: Business Economics and Public Policy, Capital Markets and Investments, Corporate Finance
Abstract
In fall 1998 the Federal Reserve Bank ("Fed") arranged a bailout of the massive hedge fund, Long Term Capital Management (LTCM), which faced the prospect of immediate liquidation if it filed a petition under Chapter 11 of the Bankruptcy Code. The Fed's intervention to aid LTCM calls into question the policy rationale underlying the Bankruptcy COde's special treatment of derivatives. In this paper, we make the following claim: derivatives may deserve special treatment, but not for the reason commonly given. When systemic risk is a legitimate concern, the Code can do little to mitigate it, and may even make matters worse, especially in cases in which large financial institutions (such as LTCM) are involved.
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