Whats wrong with “The Wall Street Reform and Consumer Protection Act of 2009,” which the House passed Friday?
The biggest problem so far Im only up to page 436 is that despite Rep. Barney Franks boast that the bill will “end taxpayer bailouts and too big to fail,” it would instead institutionalize the government-created arbitrariness and uncertainty that currently shadows financial markets.
The various random bailouts of 2008 showed that our financial system was missing a vital free-market element: a consistent, predictable way in which big or complex financial firms could fail, with their shareholders, uninsured lenders, and other creditors taking their warranted losses.
Losses shouldnt be randomly determined by the government. Instead, if theres not enough of the failed company left to cover all investors claims, shareholders take the first losses, and then junior bondholders, and so on up the line.
These rules known in advance are important. Investors in a company know or should know that they take risk. But they should be able to assess that risk within a clear set of rules that govern failure rather than try to game the government for a bailout during a crisis.
The House bill doesnt solve this problem.
To be sure, the bill would create a “dissolution authority” for big or complex financial firms. A new “Financial Services Oversight Council” could throw a failing bank, insurer, or investment firm into FDIC-controlled receivership and liquidate it.
The bill then directs the FDIC to ensure that investors bear their losses under a detailed process that seemingly fits the bill for predictability and consistency.
But the bill offers several opportunities for future regulators to throw all of the neatly detailed new rules out the window.
Consider this passage, from page 370:
The [FDIC] may . . . with the approval of the [Treasury] Secretary, make additional payments or credit additional amounts to . . . the account of any claimant or category of claimants of a [failed] financial company if the [FDIC] determines that such payments or credits are necessary or appropriate to . . . prevent or mitigate serious adverse effects to financial stability or the United States economy.”
Thats not the only loophole. Elsewhere, on page 324, the bill directs the FDIC to collect from the failed company “any amounts owed to the United States, unless the United States agrees or consents otherwise.”
And why would the failed company owe Uncle Sam money?
The FDICs new powers of “emergency stabilization” would allow it to take actions including “making loans to . . . the [failed] financial company” and “assuming or guaranteeing the obligations of the covered financial company.”
That is, it could arbitrarily guarantee uninsured lenders just as weve been doing under “too big to fail.”
Who is supposed to pay when the government bails out investors under the new regime? Other big financial firms are, through a new $150 billion “systemic dissolution fund” that will replenish taxpayer funds.
But the problem with this strategy is that Washington would depend on Wall Street to self-insure its own systemic risk. Finances own experiments in the unregulated credit-default swap market have shown that this way doesnt work. In the 2008 meltdown, for example, a $150 billion fund would not have been enough to avoid the $700 billion TARP program.
This bill, then, fails on two crucial fronts.
First, lawyers for big financial firms and their lenders will read it and inform their clients that the government still cant credibly threaten to let the firms fail. And so we still have a financial industry thats immune from consistent, predictable market discipline.
Second, financial firms cant make good decisions in an environment of uncertainty. The bill would enshrine uncertainty into law.
Original Source: http://corner.nationalreview.com/post/?q=YTQxMjQyNjI5YzA4NDVmZGZiMmQ5ODE2ZTEyMzRlZjM=