Treasury Secretary Timothy Geithner stumps for Sen. Chris Dodd’s (D-CT) finance reform bill in today’s Washington Post:
As the Senate bill moves to the floor, we must all fight loopholes that would weaken it and push to make sure the government has real authority to help end the problem of “too big to fail.”
Crucially, if a major firm does mismanage itself into failure, the Senate bill gives the government the authority to wind down the firm with no exposure to the taxpayer. No more bailouts.
Excuse us if we don’t take the Secretary of Wall Street Bailouts’ word on this. To the contrary, what the Dodd bill actually does is create a new $50 billion fund to be used in “emergencies” for restructuring firms deemed too close to bankruptcy. And who gets to decide when there is an emergency and which firms are too close to bankruptcy? You guessed it: Treasury Secretary Timothy Geithner. The Dodd bill is thus nothing less a permanent extension of Secretary Geithner’s TARP powers.
But don’t take our word for it. Time reports:
That’s why the government decided to bail out most of the nation’s largest banks at the height of the financial crisis. And here’s where the problem potentially gets worse. Once bankers understand that the government will bail out their firms when their loans or other financial bets go bad, they are likely to take riskier and riskier bets. That, of course, leads to more potential bank failures and more taxpayer funded bailouts.
The Dodd bill was supposed to end all of this, and Senator Dodd says it does. Nonetheless, policy makers and economists say it’s far from clear that the proposed legislation solves the issue. Even members of the Federal Reserve, which gets a lot more power to regulate banks and financial products in the Dodd bill, are wary of the proposal’s ability to end too big to fail. Richmond Federal Reserve president Jeffrey Lacker recently said on CNBC that he believes the bill does little to stop future financial bailouts.
A better solution for the “too big to fail” problem are bankruptcy courts. Peter Wallison and David Skeel write in The Wall Street Journal:
There is another lesson in the Lehman bankruptcy. Mr. Dodd claims his bill cures the too-big-to-fail problem because it requires the liquidation of a failing firm. But Lehman has been liquidated; what is left is a shell that may or may not struggle back to profitability.
Which system is more likely to eliminate the moral hazard of too big to fail? In a bankruptcy, as in the Lehman case, the creditors learned that when they lend to weak companies they have to be careful. The Dodd bill would teach the opposite lesson.