The House Financial Services Committee yesterday OK’d a key part of Barney Frank’s agenda for reform of the financial industry yesterday, voting to 31-27 to adopt his plan for so-called “too-big-to-fail” banks. The measure has been widely touted as providing a way to avoid future budget-busting bailouts of the industry.
That would be welcome. After a year of seemingly endless TARP bailouts and abuses, most taxpayers want to make sure that we never go down that road again. The problem: far from making future TARPs less likely, the Frank plan actually paves the road for more.
The bill would give financial regulators sweeping powers to control firms deemed “too big to fail” — those whose messy failure would put the entire financial system at risk. But this puts quite a lot of faith in regulators, who — having missed the last crisis — clearly have no magic ball for determining risk. As Heritage senior fellow David John points out, the authority will likely be used to limit newer lines of business instead of traditional ones, depriving consumers of the real benefits of financial innovation.
Making things even worse, the real life effect of the new powers will be to signal to markets that the targeted firms are supported by the federal government, and guaranteed against failure — thus leading them to take more undue risks, not more.
American Enterprise Institute scholar Peter Wallison summed it up well, saying: “Regulation doesn’t work,” adding: “And now they’re proposing regulation that doesn’t work for the entire financial industry.”
But the Frank bill doesn’t stop at regulation. It also would give the FDIC broad power to seize and close failing financial institutions, with limited court review of its actions. And most disturbingly, it would establish a fund for FDIC to use to resolve the affairs of firms it takes over. This is the final irony: Rather than avoid future bailouts, the proposal would facilitate them. As Wallison put it, Congress will have created a permanent TARP.
There is an alternative: bankruptcy, the time-tested procedure for dealing with economic failure. With a few minor changes, the bankruptcy code could be more effectively used by failing financial firms to allow them to fail in an orderly fashion, without threatening the broader financial system.
Congress should rethink its rush to regulation and more bailouts, and instead work to make failure a real option for financial firms. This is a task which is too big to get wrong.