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Getting Serious About Ending Bailouts

April 13, 2010 - by Donny Shaw

Senate Minority Leader Mitch McConnell [R, KY] went before the Senate this morning and repeated a line from Frank Luntz’s financial reform talking points memo that the Democrats’ financial reform bill would lead to endless taxpayer bailouts of the big financial firms. Ezra Klein does a good, realistic debunking:

The Dodd bill makes bailouts less likely by empowering regulators and increasing transparency, raises a $50 billion fund from banks to pay for future too-big-to-fail bankruptcies, and then makes the outcome a predictable punishment rather than a chaotic rescue.

The “resolution authority” — as bloodless a word as one could possibly imagine — wipes out both shareholders and management. It’s all there in Section 206 of the bill: “Mandatory Terms and Conditions for All Orderly Liquidation Actions.” What we call “resolution” would better be described as “execution.”

But there’s a good argument to be made that this bill doesn’t go far enough. On some level, so long as we have systemically important firms, there will be the risk of bailouts. Management and shareholders might not win out, but many creditors will do better than they should. The ways to permanently end bailouts, however, are very radical: The most common suggestion is to break up large firms before they become too big to fail. Another option, put forward by Gary Gorton, is to insure the securities that banks lend to one another. Another option is to impose such enormous capital requirements on systemically important banks that they can’t take many risks and can mostly cover their debts.

The way to judge whether someone is serious about ending bailouts is to see whether they propose one of these options, or some similarly radical solution. McConnell has not done that yet, and he does not do it in this speech. But the status quo, of course, is far more pro-bailout than the Dodd bill is. If that’s McConnell’s alternative, than he is ensuring and fighting for a future of endless bailouts. And if it’s not his alternative, he needs to say what his alternative is.

The Republican “let them fail” attitude is, in fact, the status quo. The bailouts were never in the law. They required an act of Congress and they were necessitated by the status quo that allowed a few firms to get so big and systemically important that their failure would cause too much damage to the broader economy and there was no good way to wind them down. The Dodd bill would make some progress towards fixing this, but just promoting an environment of letting failing financial firms actually fail is meaningless without some other action, like limiting bank size and interconnectedness. If there are no changes to the rules that brought us the too big to fail problem, there is no reason to think that another bailout wouldn’t happen again. In fact, since the big bailed-out banks have gotten bigger since they were first determined to be “too big to fail,” it’s probably even more likely now.

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