Democrats and Republicans both want to eliminate the idea that any financial firms are “too big to fail,” since that kind of thinking led to the bailouts of Wall Street firms in 2008. The difference between opposing camps in Washington comes in their definitions of “failure” and how they think the government should handle it.
For Democrats – along with key Senate Republicans – it means giving the federal government expanded powers to seize large financial institutions on the verge of failure and unwind them in a way that limits damages to the broader economy.
But House Republicans and some in the Senate want to update the bankruptcy laws and route the dissolution of large firms through that process, with input from federal regulators to insure the impact does not ripple into the broader economy.
Their argument boils down to this: Giving the federal government broad “resolution” powers would bestow an unfair advantage to large Wall Street firms over smaller banks and financial institutions. The big firms would be seen has having the same implicit guarantee of government aid that Fannie Mae and Freddie Mac did before they were taken over by the government.
In other words, big firms would be no more risk-averse, because they would be sure to get tax-payer funded bailouts if they ran into trouble.
Some Republicans have voiced concerns about the politicization of payouts to creditors of failed firms.
Sen. Bob Corker, a Tennessee Republican who has been a central player in negotiations, said that the current legislation, most of which he supports, has a loophole: “Certain creditors can be treated differently by the FDIC than others.”
He said such a setup allows the government to make decisions on which firms it compensates on political grounds — which many feel were a consideration in the Obama administration’s handling of the Chrysler bankruptcy — and said that should be changed.
But Corker is at odds with fellow Republicans on whether the bill released by Senate Banking Committee Chairman Chris Dodd, Connecticut Democrat, would “institutionalize bailouts.”
Corker this week dismissed the argument against a “resolution authority” for the federal government. On the Senate floor, he defended a $50 billion trust that would be funded by fees from banks and financial firms and would be used to keep an institution going and to pay back creditors as the failing institution was unwound.
“If we are saying these large firms, if they fail, are going to go out of business, and it is going to be more painful than bankruptcy, that somehow they are protected or have a competitive advantage, I find that to be kind of ludicrous,” Corker said.
The process set up by Dodd’s bill, he said, would be designed to “make sure it is so painful that nobody ever wants to go through this.”
Sen. Richard Shelby, the ranking Republican member on the banking committee, said Wednesday that he is working within the Dodd framework to “make sure that there’s a message and a reality out there that nothing’s too big to fail.”
Shelby spokesman Jonathan Graffeo explained the approach: “Regulators winding up a failed firm would be able to pay that firms’ creditors what is deemed necessary to prevent a crisis from spreading. Once conditions normalize, however, regulators would have to claw back from those same creditors any payments that were made above what they would have received in bankruptcy.”
“This approach would fully protect taxpayers and send an unmistakable message to the markets that creditors will not receive bailouts. In turn, this fairer approach would reinforce market discipline, thereby reducing the likelihood of future crises,” Graffeo said.
A Dodd spokeswoman did not return an e-mail requesting confirmation that the two senators are in serious talks about such a plan. Dodd said Wednesday that he hoped Democratic leaders would bring the bill to the floor in time for a vote on Monday.
Other Republicans and conservatives say that even if the dissolution process, which would be run by the Federal Deposit Insurance Corporation with financing from the Treasury Department, is painful, there are problems with this approach.
“The FDIC, as the resolution agency for too-big-to-fail firms, would be given wide latitude to use resources to make payments to anyone in any amounts, at their own discretion,” according to a briefing document released by House Minority Leader John Boehner’s office.
John Taylor, a former undersecretary of the Treasury for international affairs in the Bush administration, said he is “particularly concerned about he resolution authority and the discretion given to the government to determine which firms are near failure, which firms are not, which firms are systemically important, which firms are not.”
One example, the Boehner memo said, would be that even if the $50 billion fund were removed, the FDIC could borrow from Treasury to guarantee “90 percent of the value of the assets of any and all too-big-to-fail firms in its control.”
“As we saw for decades with Fannie Mae and Freddie Mac, perceptions that the government can bail out a firm or its creditors will create significant unfair advantages for that firm, making it easier for the firm to attract more funding, at lower rates, than otherwise would be available,” the memo continued. “This special treatment will make these large firms more attractive to investors than the smaller financial firms.”
The House GOP plan, said Boehner spokesman Kevin Smith, “makes enhancements to the existing bankruptcy process to insure coordination between regulators and courts to provide technical and specialized expertise when dealing with the winding down of complex financial institutions.”
Thomas Jackson, a University of Rochester professor and president emeritus whose paper on bankruptcy reform was endorsed by Taylor, said government bailouts of large financial firms will probably never fully be eliminated.
“The government can always intervene,” Jackson wrote in a recent paper titled, “A Proposal for the Use of Bankruptcy to Resolve (Restructure, Sell or Liquidate) Financial Institutions.”
“But a system of established rules, judicial oversight (including appeals to Article 3 courts), and full public disclosure, has a better chance of both reducing bailouts — and making the costs of them known — than does a nonbankruptcy resolution authority,” he said.
Corker and Shelby both indicated that bankruptcy reform will not be a part of the final regulatory reform package.
Corker said that while he wants to update the bankruptcy laws, “because it’s in a whole another jurisdiction, the Judiciary Committee, that makes it very difficult.”