Is it a bailout or isn’t it?

Mike Riggs Contributor
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Baffled by financial regulation reform? Read Jon Ward’s piece from yesterday for a blow-by-blow of what’s happening in Congress (confusion, bedlam, etc.). For a chronological sense of how things have unfolded so far and a quick look at some of the more substantive arguments for why it is a bailout, you can’t beat it. Then, watch this crazy video of Chris Dodd acting crazy.

THEN read these two pieces: One from the White House (quite lengthy) rejecting Republican claims that the bill will lead to bailouts ad infinitum, and this piece from the Wall Street Journal (excerpted below for nonsubscribers) arguing that the bill will allow for too much discretion in what measures the government can take to save faltering banks:

The bailouts of 2008 make it all the more important that any reform sends a clear message to bankers and creditors that excessive and mistaken risks will be punished with failure. The moral hazard that has built up in the system has to be addressed.

The Dodd bill, instead, still gives regulators the authority to rescue essentially the entire financial industry. While much debate has centered around the FDIC’s new “resolution” authority for failing firms, there’s been almost no discussion around a separate FDIC program under which the agency can guarantee corporate debts. To Mr. Dodd’s credit, this provision has improved slightly. In an earlier draft, the Fed and the new systemic risk council could have applied FDIC debt guarantees even if the FDIC itself opposed such bailouts.

Now the FDIC has to be on board, but the core problem remains—an even more explicit taxpayer backstop than anything Fannie Mae and Freddie Mac enjoyed during the housing bubble, and one that’s available to a virtually unlimited number of firms. Federal regulators can create a “widely available program” to guarantee the debts of not just banks, but their parent companies as well, and all of their affiliates.

Fannie and Freddie were rolling the dice with an implied backstop, but this legislation would allow regulators, without a vote of Congress, to explicitly put the full faith and credit of the U.S. government behind Goldman Sachs, JP Morgan and Morgan Stanley, among others. This list could have more than 8,000 names on it, because any bank or company that owns a bank, or is a affiliated with a company that owns a bank, is eligible.