Bankruptcy and the Macroeconomy : A New Paradigm for Governmental Response to Economic Crisis

During times of crisis, governmental interventions leave lasting impacts on the structure of financial markets. The twin economic crises of the 21st century – the 2008 financial crisis and the 2020 Covid-19 pandemic – illustrate both the depth of the policy response and the instability that follows. In the United States, traditions of central bank independence, severe politicization of fiscal intervention, and rising inflation after 2020 make the playbook for crisis response to provide macroeconomic stability unusable in the future. The policy-economic tension leads the Federal Reserve – the US central bank often tasked by law or exigency with economic crisis response – to veer between two extremes: conducting macroeconomic stability efforts exclusively through monetary policy or unleashing a tsunami of directed credit through its emergency operations. This Article contends that neither of these crisis responses is adequate. The first is too general: monetary policy in a crisis becomes quickly exhausted, particularly in an era of low-interest rates. The second is too specific: the Fed’s suite of emergency facilities quickly runs afoul of political will, credit rationing, and equitable concerns, never mind the risk for exacerbating post-crisis inflationary pressures. The Article argues for a new paradigm of macroeconomic stability, focused not on monetary policy alone nor on emergency lending except in extreme circumstances. The best governmental response to macroeconomic crisis is resurrecting the Fed’s ample, traditional, but mostly unused authority to channel credit through the banking system by using its discount window. To show how such bank-intermediated credit channeling might work, the Article focuses on a highly dysfunctional market, the market for credit in bankruptcy, and argues for a revised system that would protect the Fed, protect small- and medium-sized enterprises, and protect the macroeconomy