President Obama went to Wall Street today to make the case for financial regulation. Putting aside the bank-bashing rhetoric employed just a few months ago (“…if these folks want a fight, it’s a fight I’m willing to have“), this time he was measured in his rhetoric, making the case for the reform bill now pending in the Senate.
And he made good points. “We need a system to shut [failing].. firms down with the least amount of collateral damage to innocent people and businesses…The goal is to make certain that taxpayers are never again on the hook because a firm is deemed “too big to fail.”
Exactly right. The real debate, however, is not over whether, but how to meet these goals. The Senate plan supported by the president would do this by giving regulators “resolution authority” — the power to order the seizure of big financial instititions they feel are failing, with limited judicial review. The regulators then would be given broad discretion in how to close the company. That approach is not only antithetical to notions of private property, but invites abuse. Far better to have a judicially-supervised process, with established rules. We already have such a system in place for other industries –it’s called bankruptcy. Why not use it here?
The Senate’s plan also provides for bailouts for the creditors of failing firms. Strangely, the president says it is not “legitimate” to talk about this, saying the bill has no bailouts. But, like it or not, they are there: section 204 of the bill provides that the FDIC (in closing failing firms) may “…make available funds for the orderly liquidation of [a] covered financial institution.” Now, to the bill’s credit, such funds are not to be used to avoid liquidation, or to compensate stockholders. But creditors would be eligible. The situation is similar to that of the AIG bailout in 2008, where shareholders took steep losses, but creditors — including some of the largest financial companies in the world — were held harmless through taxpayer largesse. This was a bailout.
There are other problems with the bill too. Rather than banish “too big too fail” to the dustbin of history as promised, the bill would have regulators identify a class of firms considered critical to the economy. The stated purpose is to subject them to enhanced regulation. But the practical effect would be to signal to investors worldwide that the U.S. stands behind these firms. Just as Fannie Mae and Freddie Mac enjoyed implicit federal guarantees, so would these firms.
There are other problems too. The bill, under the guise of consumer regulation, limits the choices of those very consumers. It imposes one-size-fits-all regulation on derivatives, while ignoring progress on reform already accomplished by the New York Fed. It opens the doors to allow activist groups to abuse the corporate governance system. And, it does nothing to reform government-sponsored enterprises such as Fannie Mae and Freddie Mac, who played leading roles in the housing bubble, and whose subsequent collapse put taxpayers on the hook for over $100 billion.
Yes, Mr. Obama, we share your goals. But the Senate’s plan won’t accomplish them. We need a plan that does.