Sherman: Like White House Proposal, House Bill Creates ‘TARP on Steroids’

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Thursday, October 29, 2009 at 9:58 am

Different bill; same concerns.

House Democrats introduced legislation Tuesday granting the White House broad new authority to bail out investment houses and other non-banks when their potential collapse is a threat to the larger financial system. But while the bill goes far beyond a similar White House proposal in terms of protecting taxpayers, Rep. Brad Sherman isn’t impressed. The California Democrat, who said the White House proposal represents “TARP on steroids,” issued a statement last night claiming that the House bill is little better.

“The new resolution authority,” Sherman said, “provides permanent, unlimited bailout authority” granting “unprecedented powers for the executive to decide spending and taxes, without congressional approval.”

Under the House bill, sponsored by Financial Services Committee Chairman Barney Frank (D-Mass.), the White House would have the power to swoop in and dismantle failing Wall Street institutions in order to mitigate the negative effects on the finance system as a whole — a model designed after the authority of the Federal Deposit Insurance Corporation to intervene when commercial banks are poised to topple. To protect taxpayers, Frank’s bill attempts to force the tab ultimately on failed-company shareholders, as well as on other large Wall Street institutions that would presumably benefit from the general stability created by the government intervention.

Frank said his proposal would “ensure that the industry and shareholders absorb the risk and cost of failure, not taxpayers.”

But Sherman doesn’t see it playing out that way.

The taxpayer losses are supposed to be recovered from a new tax imposed on large and medium-large financial institutions.  The statute requires the Executive Branch to recoup taxpayer funds within 60 months, but then, allows them to extend this period for as long as they want. (§1609(o)(1)).  Further, it is difficult to see how any tax on financial institutions would provide hundreds of Billions of revenue, which might be needed to repay a large bailout.

And it’s not only trouble companies that could receive help under the House bill. Indeed, it would allow the president to loan solvent institutions unlimited funds “if necessary to prevent financial instability.”

When bailout funds are lent to a solvent financial institution under §1109, the executives and shareholders lose nothing.  Executives keep their jobs and their compensation packages; shareholders retain all their rights.  In contrast, when a troubled institution receives a bailout under §1604, some executives lose their jobs, and shareholders have to stand behind taxpayers.

That creates a moral hazard problem, Sherman argues, “allow[ing] those institutions which are clearly systematically important (the top 10 to 25) to borrow at a lower cost. This will help the largest institutions get bigger, so they can pose a greater systemic risk.”

The Financial Services Committee is holding a hearing on the bill this morning, with Treasury Secretary Tim Geithner testifying. There’s been no love lost between Sherman and Geithner in the past. Should be a good show.

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