Modify bankruptcy, not U.S. financial rules -Congress aide

By Tom Hals and Chelsea Emery

NEW YORK, Nov 17 (Reuters) - The United States needs to modify its bankruptcy laws so that the largest companies can fail without causing turmoil in the U.S. financial system, a top Congressional staffer said on Tuesday.

"There are companies that are too big to fail and those companies need to be treated specially," said Daniel Flores, chief Republican counsel for the House committee that would oversee bankruptcy law, speaking at a conference in Washington.

U.S. regulators helped fuel a financial panic last year with their inconsistent policies, such as allowing investment bank Lehman Brothers Holdings Inc (LEHMQ.PK: 行情) to file for bankruptcy while rescuing rival Bear Stearns, said Flores, speaking as a panel member at the American Bankruptcy Institute's 2009 Legal Symposium.

But a so-called Chapter 14 would create a new legal process designed to help restructure troubled non-bank financial holding companies whose collapse would pose a systemic risk to U.S. economic stability, said Flores.

It is a "simple but effective set of reforms to help us handle the bankruptcies of large, interconnected firms," he said.

The new chapter would create an oversight board that would bring together the failing company, its creditors and regulators to address complicated financial issues before a bankruptcy filing.

This meeting would determine, for example, if derivative contracts can be automatically put on hold by bankruptcy. Currently such contracts are not stayed by bankruptcy, which is often cited as a reason the U.S. government rescued American International Group Inc (AIG.N: 行情).

The members of the ABI panel noted that proposals from the Obama administration and an alternative from Connecticut Sen. Christopher Dodd propose to allow regulators to deal with the failure of large financial institutions.

"No one trusts the bankruptcy bar and the courts. That's the problem," said Flores. "We don't need to abandon bankruptcy, we need to abandon government intervention that can seem inconsistent and panicky."

The bill he discussed does not allow for bailouts, he said, which removes the risk that investors and managers will always count on the government to come to their rescue, provided their company is big enough to be a threat if it collapses.

He said the United States needs to let all parties "know that when Humpty Dumpty falls off the wall, it's going to be on their dime, not the taxpayers."

NOT ALL CONVINCED

Not all conference presenters were convinced the bill, called H.R. 3310, was necessary.

"I don't know if it's necessary to have a separate chapter," said Harvey Miller of Weil Gotshal & Manges, who is the lead bankruptcy attorney for Lehman Brothers. "The bankruptcy code now is not perfect, but with some amendments, it could clearly deal with issues of non-bank financial holding companies."

"I believe the bankruptcy court is doing a very good job with Lehman," Miller added. "It's being administered, being resolved, (the current process) doesn't cost the taxpayer any money."

Other panelists questioned whether politicians would ever allow a large employer such as General Motors Corp file for bankruptcy without the kind of support that was offered by Washington before the automaker entered Chapter 11.

"Ultimately we're chicken. That's the problem," said Adam Levitin, a professor at Georgetown University Law Center in Washington. He said the proposed bill championed by Flores provided all the right incentives.

"But we're just too scared about the consequences ... We just don't want to risk a social catastrophe for the sake of holding some principles." (Editing by Phil Berlowitz)