The Treasury Department and the House Financial Services Committee chairman Barney Frank (D - Mass.) last night unveiled a sweeping new bill that attempts to rein in "too big to fail" financial institutions. The proposed legislation, its authors argue, would end the era of taxpayer bailouts for failed firms.
In essence, as the blog Volatility put it, the bill would force large banks and other financial firms to contribute to a "financial superfund," so that they, instead of taxpayers, would foot the bill for the failure of immense institutions. Here's more on the proposed cost-shifting from House Financial Services Committee's website:
Costs to resolve a failing firm will be repaid first from the assets of the failed firm at the expense of shareholders and creditors, and to the extent of any shortfall, from assessments on all large financial firms. In this instance we follow the "polluter pays" model where the financial industry has to pay for their mistakes--not taxpayers...[The] Resolution Fund is structured to spread the cost over a broad range of financial companies with assets of $10 billion or more, and provides for a flexible repayment period to avoid potential procyclical effect of such assessments.
The plan would also give the Federal Reserve the power to reduce the size of of banks, hedge funds and other financial firms with more than $10 billion in assets.
Community banks and other lending institutions that may have more than $10 billion in assets, but don't pose systemic risks, will not be covered under the proposed legislation, according to Bloomberg. But the bill could cover money management firms and many larger hedge funds.
The bill gives the Federal Reserve the power to determine which firms are actually "too big to fail" and pose systemic risk to the financial system. But it also creates a new council of financial risk regulators. Here's Bloomberg:
Under the bill, the Fed would oversee the biggest financial companies, known as Tier 1, and would hold the most power on a new council of regulators, officials said. The measure gives each major market regulator such as the Fed, FDIC, other bank agencies, the Securities and Exchange Commission and Federal Housing Finance Agency a seat on the council and some authority for monitoring systemic risk.
The draft gives the council powers to impose "heightened prudential standards" on financial holding companies deemed a threat to market stability. That determination could be made on a broad range of criteria, including the degree of a company's reliance on short-term funding.
There is, however, reason to be skeptical about whether the proposed legislation would actually work. Specifically, there is concern that the Federal Reserve and FDIC, as currently constituted, don't have the resources to handle the orderly dissolution of a bank with enormous assets. Here's the Washington Post;
A handful of prominent economists, including former Fed chairmen Alan Greenspan and Paul A. Volcker, who is President Obama's top outside economic adviser, say the administration's plan would not be enough to prevent another crisis. Financiers will find loopholes in any new regulations that are set up by the government, these economists warn. Greenspan and Volcker, in particular, have advocated for splitting up big banks.
Officials at Treasury and the Fed have been skeptical that such a break-up would work in practice. Daniel K. Tarullo, a Fed governor, said last week that dividing up the biggest banks would be fraught with "conceptual and practical challenges," and is "more a provocative idea than a proposal," though he added that having the idea in circulation can help focus the debate toward containing the risks created by enormous banks.
At the Market Ticker, Karl Denninger sees a lot of good in the bill, but it's fully convinced that the Federal Reserve can handle an expanded role. And he points out the bill does nothing to break Wall Street's long standing ties with financial regulators:
I cannot endorse this as written, but I can say that it is a vast improvement over what we have now, and what has happened to date. For The Fed to have that primary seat at the table and the "final backup authority" they must be subject to regular and comprehensive audit, so as to insure that the people can see they are complying with the strictures of law - otherwise any so-called "restrictions" are nothing other than a joke.
In addition it is critical that this law include criminal penalties for violations as any failure to follow the constraints laid down will of necessity expose the taxpayer to enormous loss (as has occurred in this instance), and as there is no reasonable civil penalty available in such a circumstance, severe federal criminal penalties are appropriate.
We must not only end "too big to fail" we must also end "too bribed to give a damn", which has permeated the entirety of Washington DC over the last three decades.
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