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"Death Panels for Banks"

October 26, 2009 - by Donny Shaw

More information about Congress’ legislation for dealing with the “too big to fail” issue in the financial industry is beginning to filter out. McClatchy:

Lawmakers won’t give the independent Federal Reserve as many powers as President Barack Obama had proposed, according to a senior congressional staffer, sharing details with McClatchy on the condition of anonymity because the emerging bill hasn’t been made public. The measure, which tackles some of the thorniest issues of bank oversight, is intended to rewrite seven decades of financial regulation.

Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, worked over the weekend and throughout Monday to draft the legislation. It would provide the government with first-ever authority to shut down large globally interconnected financial institutions.

Under this authority, jokingly referred to as “Death Panels for Banks,” the Federal Deposit Insurance Corp. would oversee the dismantling of large financial firms much as it does now when it intervenes in commercial banks that are at risk of insolvency.

Decisions about which institutions are so large that they pose a system-wide risk and must be monitored would be made by a Council of Regulators, comprised of leaders from the Fed, the Treasury Department, the FDIC, and other bank-oversight agencies.

Even though former Fed Chairmen Paul Volker and Alan Greenspan have both recently come out hard against too-big-to-fail banking, there is a perception that the current Chairman, Ben Bernanke, is a softy on the issue. For example, last week in response to a question from Mervyn King, the former deputy governor of the Bank of England, on breaking up the biggest banks, Bernanke said that he prefers “a more subtle approach without losing the economic benefit of multifunction, international firms.”

Congress’ choice to go with a panel of regulators for judging systemic risk instead of giving the power solely to the Fed is a big deal. Some of the other regulators that will have a say in the matter, like the FDIC that is headed by Sheila Bair, have been much more outspoken about the need to address systemic risks in the financial sector. “We need to end ‘too big to fail,’” Bair said flatly on Monday. In the past she’s shown her independence from the bailout mentality that has dominated Washington’s approach to the financial crisis. In November of 2008 Bair came out strong against the Bush/Paulsen TARP plan. “We’re attacking it at the institution level as opposed to the borrower level, and it’s the borrowers defaulting. That is what’s causing the distress at the institution level,” she said. “So why not tackle the borrower problem?” She floated a proposal to bailout the homeowners who are at risk of foreclosure instead of the big banks, but her idea was rejected by then Treasury Secretary Henry Paulsen.

The legislation isn’t public yet. We’ll be blogging more on it when it is. From here, things could move in almost any direction. The tougher “break up the banks” mentality seems to actually have some legs, and we know that the weakening forces from the banks’ lobbying efforts will be very powerful. This is an issue that does not divide easily down party lines. We’ll likely see some strange far left-far right coalitions form on this issue that could really introduce an interesting dynamic. Nate Silver is already calling too big to fail resolution authority the “public option of 2010.” Stay tuned.

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