With additional reporting by Sam Stein
When it comes to opposing the Democratic Wall Street reform plan, Republican leadership has a logic problem: If the Democratic idea to wind down and liquidate banks that are currently deemed "too big to fail" is no good, then what's the alternative?
The obvious answer, of course, is to break the banks down in size so that failure doesn't jeopardize the entire system. That might sound like an unusual position for the GOP to adopt but, slowly, Republican senators are beginning to embrace it.
The GOP faces an uphill battle to defeat the plan -- Senate Minority Leader Mitch McConnell (R-Ky.) does not have the votes to block Majority Leader Harry Reid (D-Nev.) from going to the floor with reform legislation next week, because Sen. Susan Collins (R-Maine) is refusing to sign a letter committing to block any bill Reid puts forward, reports The Hill.
A senior Senate Democratic aide confirmed the report to the Huffington Post. A top-ranking party strategist, meanwhile, relayed plans by the White House to make McConnell's position all the more untenable by launching a tough new attack accusing him of parroting talking points authored by noted GOP strategist Frank Luntz.
"We're not about to let them get away with planting the seeds of these bogus claims with the public the way they did for a time on health reform," the source said. "McConnell's arguments that the Democrat's plan for Wall Street reform will perpetuate bailouts is pure fantasy cooked up by Frank Luntz in a right-wing focus group... If Mitch McConnell wants to look foolish and to look like the bag man for big banks that he and his colleagues are - we're glad to help."
The first piece of "help" came Thursday evening when the Democratic National Committee put out a web ad titled "Luntz Led."
Even earlier in the day, however, an onslaught against McConnell was taking place on the Senate floor, where Banking Committee Chairman Chris Dodd (D-Conn.) ripped Republicans who sign the Minority Leader's letter, saying they did so for purely political reasons without having read it.
Last week, Sen. John Cornyn (R-Texas) and Minority Leader Mitch McConnell (R-Ky.) met with 25 top Wall Street executives in New York City to hear their concerns regarding reform. Both say they oppose the Democratic plan as a perpetual bailout. "By creating a fund, that's an invitation to Congress to spend that money just as we have in the highway trust fund and the surplus in Social Security," Cornyn said.
HuffPost asked Cornyn what his alternative solution to the Democratic plan would be. "I think we need to look at the concentration of banking in just a handful of entities that threaten our economy if they go under," Cornyn said. "They need to be smaller in order to avoid that problem and I would support efforts to move in that direction."
At a press conference Wednesday afternoon, McConnell described it as "a permanent taxpayer bailout of Wall Street banks," "an endless taxpayer bailout of Wall Street banks" and "a perpetual taxpayer bailout of Wall Street banks."
Making those banks smaller, said Cornyn, would reduce the risk. "Sixty percent of all the banking assets are concentrated in ten banks in the country," said Cornyn. HuffPost asked if he'd support what's known as the Volcker Rule, an administration plan to split off risky trading done by banks for their own gain from standard commercial banking activities.
"Yes," he said, "I think that's one approach."
Without prompting, he added: "Glass-Steagall, we need to look at that."
The repeal of Glass-Steagall in the late 1990s, which allowed banks to greatly expand in size and scope of operations, is often cited as a cause of the crisis, as banks used insured deposits for risky investments that went bad.
"We all -- I say we all, but almost all of us -- made the mistake of repealing Glass-Steagall in 1999," Sen. Johnny Isakson (R-Ga.) told HuffPost. "Some of the problems of the big banks were brought about by the blurring of the restrictions on where they could go. And they went into brokerage and they went into derivatives they went into lots of other things. Maybe we need to look back to that, but it's hard to put the genie back in the bottle."
The suggestion to break up banks has been called "very radical," but it's embraced by mainstream economists, including three presidents of Federal Reserve regional banks. On Thursday, James Bullard, president and chief executive of the Federal Reserve Bank of St. Louis, joined Kansas City Fed President Thomas Hoenig and Dallas Fed President Richard Fisher in pressing for a break-up of big banks.
The GOP, in pushing for tougher bank regulation, should be careful what they wish for, Sen. Charles Schumer (D-N.Y.) said on Thursday. "He wants to toughen up the provisions so the taxpayer isn't on the hook? Good. We welcome it," said Schumer of McConnell's objections.
Sen. Richard Shelby, the highest-ranking Republican on the Banking Committee, was asked to explain this week just how it is that the Democratic plan amounts to a perpetual bailout. He said that regardless of how the bill is written, if there is a perception that a big bank will be bailed out, then the "too big to fail" problem continues.
"Well, I could sit down with you if we had a couple of hours and had the sheets spread out you know, a lot of pages, but I think any perception -- not just reality, but the perception -- that you're creating a fund here to be used, could be used or misused for bailouts is a mistake," said Shelby of Alabama.
How do you eliminate that possibility as long as big banks exist, Shelby was asked. "I think as Dr. Volcker has said, if they're too big to regulate properly, maybe they're too big to exist. I know there's a lot of talk on both sides of the Atlantic to deal with that. I never thought that being too big by itself was bad but I believe that being too big and believing that you're going to be bailed out is horrible. And you've got to remember, the government never bails out the small and medium-sized banks or companies, it's always the huge" banks, Shelby said.
Sensing news in the water, reporters continued to circle: Should they be broken up? "That is an argument and I think they're talking about it. Merv King has talked about it on the other side of the Atlantic," he said.
Is it an argument Shelby agrees with?
Shelby smiled broadly. "You're looking at somebody [who was] the only Republican who voted against the repeal of Glass-Steagall," he said.
Don Stewart, a spokesman for McConnell, said that McConnell objects specifically to the creation of a $50 billion fund that would be used to wind down big banks. "Rather than letting banks know that they'll be bailed out no matter what, they need to be disincentivized from getting themselves in that position in the first place -- part of that is taking away the potential of a bailout," he said.
Stewart cited testimony from Treasury Secretary Tim Geithner a few months ago:
The third element of effective reform is making sure that taxpayers are not on the hook for any losses that might result from the failure and subsequent resolution of a large financial firm.
The government should have the authority to recoup any such losses by assessing a fee on large financial firms. These assessments should be stretched out over time, as necessary, to avoid adding to the pressure induced by the crisis.
Such an ex-post funding mechanism has several advantages over an ex-ante fund. Most notably, it would generate less moral hazard because a standing fund would create expectations that the government would step in to protect shareholders and creditors from losses. In essence, a standing fund would be viewed as a form of insurance for those stakeholders.
Sen. Bob Corker (R-Tenn.), who, with Sen. Mark Warner (D-Va.), negotiated the provision that McConnell calls a permanent bailout, told HuffPost Thursday that he would be okay with eliminating the $50 billion pre-fund. "Whether it's a pre-fund or post-fund is not central to the resolution," he said. "What I've said is, 'Let's do away with it. Let's just post-fund everything if that's a problem, if that's what everybody thinks is problematic."
House Republicans, meanwhile, say their alternative to breaking up the banks is to make big institutions go through the bankruptcy code.
"Republicans are proposing a new chapter to the bankruptcy code to make it more efficient and better suited for resolving large non-bank financial institutions," said a spokeswoman for House Minority Leader John Boehner (R-Ohio.). "The proposed chapter will facilitate coordination between the regulators of these institutions and the bankruptcy system to allow regulators to provide technical assistance and specialized expertise about financial institutions. Bankruptcy judges would also have the power to stay claims by creditors and counterparties to prevent runs on troubled institutions."
While that may not be remarkably different than what Corker and Warner agreed to, it might not end the possibility of bailouts either.
"In ordinary bankruptcy you can get debtor-in-possession money if companies have assets, and through a bankruptcy court or through a resolution court, they can do that," Shelby noted.
Senate Republicans will find a receptive audience in Sen. Blanche Lincoln (D-Ark.) for their proposal to break up banks.
"Our hopes are that banks will be able to separate the risky aspects of what they do from the vulnerability [of the system]," Lincoln said Thursday, adding that she may have legislative language ready by Friday morning. Lincoln, chair of the Agriculture Committee, has jurisdiction over derivatives regulation. "I'm going to certainly make sure that people understand that when there's risky business, there's going to be regulation."
The White House is pushing hard. Chief of Staff Rahm Emanuel, leaving the Capitol on Thursday, told HuffPost he is happy to have Republican support for a tougher bill.
"There's a bipartisan bill to be had here. And the fact is it's all about whether we're going to be comprehensive, even with the derivatives section," he said. "Warren Buffet spoke about it: 'This is where, in fact, future crises can occur.' And whether we're going to have a tough, comprehensive, transparent... section on derivatives, is where, in fact, the whole issue is at."
This story has been updated