Government bailouts are expensive, unjust, and unpopular, and they usually represent dramatic deviations from the rule of law. They are also, in some cases, necessary. The problem that bailouts pose, then, is that they are almost always inimical to the interests of society, except when they are not. This complexity is ignored under the recent Dodd-Frank Act, which improbably guarantees an end to taxpayer bailouts. Indeed, much of the Act makes bailouts more likely, not less, by making the wrong kind of bailouts available far too often.
This Article proposes to solve the problem of bailouts by retaining governmental ability to make the right kinds of bailouts possible through forcing the bailed-out firms to internalize the bailout costs. The proposal—called “elective shareholder liability”—allows bank shareholders two options. They must either change their bank’s capital structure to include dramatically less debt, consistent with the consensus recommendation of leading economists; or alternatively, they must add a bailout exception to their bank’s limited-shareholder-liability status, thus requiring shareholders—not taxpayers—to cover the ultimate costs of the bank’s failure. This liability would be structured as a governmental collection, similar to a tax assessment, for the recoupment of all bailout costs against the shareholders on a pro rata basis. It would also include an up-front stay on collections to ensure that there are, in fact, taxpayer losses to be recouped and to mitigate government incentives for overbailout, political manipulation, and crisis exacerbation. The proposed structure would also give the government the authority to declare the shareholders’ use of the corporate form to evade liability null and void, and would require that shareholders who litigate against collection and subsequently lose pay treble damages, including the government’s litigation costs. Elective shareholder liability anticipates, among its many benefits, the development of a derivatives market that would insure shareholders against liability, the price of which will contain more relevant information about risk concentration than is presently available in the capital markets. After explaining the structure and other benefits of elective shareholder liability, the Article addresses several potential objections. Close inspection of these objections, however, reveals that the overall case for elective shareholder liability is strong as a matter of history, law, and economics, though perhaps not politics.