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Investor's Business Daily


Wall St. Bailouts Would Be Invited, Not Prevented, Under Dodd's Bill

April 16, 2010

By Nicole Gelinas

President Obama castigated Senate Republicans last week for opposing Sen. Chris Dodd’s Wall Street “reform bill.” Democrats say Republicans’ main argument — that the bill won’t prevent future bailouts — is false. The bill itself, though, is irrefutable evidence that the Republicans are dead on.

Senate Minority Leader Mitch McConnell started the fight earlier in the week when he said the bill “not only allows for taxpayer funded bailouts for Wall Street banks, it actually institutionalizes them.”

The White House and congressional Democrats have hit back hard. “I am absolutely confident that the bill that emerges is going to be a bill that prevents bailouts,” Obama said.

His Treasury chief, Tim Geithner, was even stronger. The bill will ensure that “if a major institution manages itself to the edge of the abyss, we’re able to ... dismember them safely without taxpayers being exposed to a penny of loss,” he said.

Dodd was the bluntest: “The bill as drafted ends bailouts. Nothing could be more clear.”

As for whether the bill puts taxpayers at risk: failed firms must repay “any amounts owed to the United States, unless the United States agrees or consents otherwise” (italics mine).

Why would the financial firm owe Uncle Sam money in the first place? Partly because of something else in the bill: an “orderly liquidation fund.” Big or complex financial firms would have to pay upfront into a Treasury-controlled $50 billion pot of money that would bear the cost of liquidating a future AIG.

The FDIC would have the authority to use this money as it sees fit, including guaranteeing bondholders, uninsured lenders, counterparties and other creditors to a failed company just as the government did with AIG and Citigroup in 2008.

The idea that the financial industry can pre-fund its next arbitrary bailout with $50 billion is a pleasant fiction. How much would an “orderly liquidation fund” have needed to stem investor panic starting in 2008? Try $20 trillion.

The true tab is not the retroactive cost. Rather, it’s what investors demand at the time of an acute crisis so as not to flee the unknowable risks of a financial system in meltdown, precipitating depression.

Think about everything that Washington has done in the past two years. TARP was $700 billion; that’s easy. Outside of TARP, the Treasury said it would guarantee $3.4 trillion worth of money-market funds in the fall of 2008. The Fed has purchased $1.25 trillion in mortgage-backed securities over the past year or so — providing a floor to avoid deeper housing-price declines and bank losses. It also offered $1.8 trillion to commercial-paper markets.

The FDIC guaranteed up to $940 billion in financial-firm bonds and committed another $700 billion in expanded deposit guarantees, which allowed banks to avoid selling off assets at crisis-level prices. Taking Fannie and Freddie into conservatorship and guaranteeing other housing agencies and their debt? Another $7 trillion. Other sundry programs add up quickly (see table).

Democrats can’t really believe that a $50 billion fund could avert the kind of investor panic we saw in 2008 — and if they do believe that, we’re in real trouble.

The answer is not to make the bailout fund bigger. Even if the financial industry could suck enough resources up from its customers and the economy to pay into a $2 trillion fund — a mere down payment — that fund itself would represent a systemic risk to the nation.

The feds could not invest $2 trillion in any financial markets — Treasury bond markets, global stock markets, real estate or some combination � without distorting them. And in a crisis, global investors would expect the bailout fund to dump some assets to pay for its rescues. This expectation would exacerbate price declines.

The only regulation that would better protect the economy from future financial failures is a set of predictable rules — including consistent borrowing limits and trading rules across financial firms and securities — like those we had before the 1980s.

The Dodd bill doesn’t propose such rules — and Republicans should point out that the mere idea of those rules is what really annoys the too-big-to-fail financial firms.

Original Source:



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