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New York Post

 

A Rotten 'Reform'

June 28, 2010

By Nicole Gelinas

PRINTER FRIENDLY

Finance bill penalizes prudence

The Dodd-Frank Act to “reform” Wall Street isn’t yet a sure thing, votes-wise. New York’s congressional delegation can still do the right thing for the city and state -- and should vote against this bad bill.

The measure would bring New York’s strongest banks and investment firms down to the level of the weakest, and turn Gotham’s premier industry into a collectivist monolith with no incentive to control risk.

And, in a move that’s guaranteed to push jobs out of New York, the feds want big investment firms, insurers and hedge funds to front $20 billion in two years for a “financial crisis special assessment fund.” All this does is give funds time to send assets abroad to escape the fee.

The compromises hammered out by Sen. Chris Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.) and others don’t address their bill’s fatal flaws -- starting with the bill’s disastrous effort to end taxpayer bailouts.

The obvious -- and correct -- way to end Wall Street rescues is to let a failed financial firm go bankrupt. That is, the people who invested in a failed company -- including bondholders, people owed money on derivatives and other lenders -- should take the losses.

Instead, Congress would “end” bailouts by directing the feds to rescue the creditors to any failed “too big to fail” financial company. Later, the feds would make the failed firm’s competitors pay the cost.

Don’t buy the claim that this is similar to our 80-year-old system of deposit insurance. Deposit insurance is meant to protect mom-and-pop savers, not sophisticated global investors. And because there are only so many small-scale American savers with a finite amount of cash saved up, any single bank’s risk of having to make good on a failed firms’ FDIC-insured deposits is limited, and roughly predictable.

By contrast, Dodd-Frank would force financial institutions to shoulder an unknowable and unpredictable risk -- but one that stands a good change of being huge.

Worse, the approach encourages wild risk-taking -- and penalizes prudence.

Say you’re the CEO of Downtown Investment Bank, and you spend a lot of time worrying about the next financial crisis:

* You sacrifice some profits now by keeping lots of cash on hand in case investors demand it one day.

* You borrow debt that doesn’t mature for a few years, rather than debt that matures every night. It costs more, but “cheaper” short-term lenders could pull all their money out in a panic.

* When you suspect a bubble’s going to pop, you pull back a little -- even as your competitors chase after every last dollar.

Under Frank-Dodd, Downtown Investment Bank gets no reward for this. Indeed, its massive cash stash is at risk of being grabbed by the feds to pay for the bailout of its profligate competitor Midtown Investment Bank.

Meanwhile, no one has to worry about trusting their money to Midtown’s madmen, because the feds will likely make good on it, courtesy of the saps at Downtown.

The penalties for good behavior don’t end there. Frank-Dodd’s system will inflate the size of the bailout, too -- because the government would be in charge.

The feds would arbitrarily determine how much they’d front to rescue global investors to a failed bank -- and then hand the bill to the bank’s competitors. In the midst of a panic, eager to mute the chaos, they’re going to err on the side of paying investors in a bad bank too much. They’re not going to worry about the economic impact of the bill they later hand to the surviving banks.

The result: Every firm will take more risks, guaranteeing another crisis down the line, and more taxpayer bailouts.

To avoid that, Congress needs a bill that focuses on helping the economy to withstand financial-company bankruptcies, by:

* Limiting debt across the board, even debt at a firm that seems to be making “safe” investments. That way, a financial company’s bankruptcy wouldn’t bankrupt the rest of the economy.

* Forcing financial firms to trade their trillions of dollars’ worth of derivatives openly, on public exchanges. Investors would know their derivatives were safe if one firm goes bankrupt, because the exchange would have collected money in advance from all firms, to minimize the risk of any one going under.

Congress hasn’t done any of that. Its new derivatives rules are shot through with exemptions. And its new “financial stability oversight council” will replace the infamous ratings agencies in pretending to determine what kind of debt is “safe” -- ensuring that everyone will again make the same mistake at the same time.

Democrats don’t want to hand President Obama a legislative defeat before November elections. But that would be far better than the current alternative -- voting for a bill that would slowly suffocate New York’s successful financial companies by shouldering them with failed firms’ losses.

Original Source: http://www.nypost.com/p/news/opinion/opedcolumnists/rotten_reform_LOEzv2SW7w5JTWThXLIYHJ

 

 
 
 

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