Last week the federal government initiated another government takeover: this time on the banking industry. Giving up on efforts to get a bipartisan deal on financial regulation, Senate Financial Services Committee chair Chris Dodd has his own plan for fixing the financial system. The goal, according to the plan, is to create a financial system that will not only prevent another financial crisis, but one that works for and protects Americans. Its a fine sentiment, but there’s one problem: the new regulations being proposed will make the financial system worse, not better. And while claiming to make financial bailouts a thing of the past, it would actually make them more likely, in effect creating a permanent TARP program.
Among the key provisions of Dodd’s plan:
1. A new Consumer Financial Protection Bureau, to be located within the Federal Reserve Board bureaucracy. While not technically independent, the new agency would be largely autonomous, virtually guaranteeing conflict with other regulators focused on the safety and soundness of financial markets. Moreover, the new agency would do little to actually help consumers, instead limiting their options and increasing their costs.
2. A new $50 billion fund that is to be used in emergencies to settle the affairs of failing financial institutions. This fund is virtually certain to be used for bailing out politically significant financial institutions, and is nothing less than a permanent TARP program. And, although Dodd argues that this fund will be financed by fees on financial firms, not taxpayers, the real cost will doubtless be passed on to American consumers.
3. The bill would establish a powerful Financial Stability Oversight Council. It would be made up of nine existing agencies, with almost unlimited regulatory powers over firms considered “systemically important.” Not only is such open-ended power dangerous, it also institutionalizes the notion of too big to fail. By designing certain firms as systemically important, regulators in effect would be telling investors that the government would not allow them to go under. In effect, these firms would enjoy an implicit federal guarantee, protected from the full consequences of risk-taking.
This is the wrong approach to fixing our financial markets. Bigger government and pre-funded bailouts won’t fix the system. Instead, the focus should be on establishing an effective bankruptcy system for large financial firms to allow failures to be addressed in the same way failure is addressed in other industries.
For most industries, the bankruptcy laws have long provided a way for failing firms to reorganize or liquidate under established rules of law and with independent nonpolitical supervision by courts. There is no reason, with perhaps a few modifications to take into account the special characteristics of large financial firms, that it can’t work here as well.
Despite its flaws, Mr. Dodd’s 1,300-page bill cleared a Senate committee in 22 minutes. This is a landmark piece of legislation that will affect anyone with a checking account. Instead of hurriedly pushing this bill through, serious thought and consideration needs to be taken to fix our financial system once and for all.
To hear a full explanation of the issue by Heritage financial reform expert David John listen to The Heritage Foundation’s latest podcast here.