In the wake of the recent financial meltdown, it sounds like a reasonable idea: A proposal granting the White House broad new authority to take over when a failing institution threatens to drag others — perhaps the whole economy — down with it.
Yet that proposal, included as a part of wide-ranging finance reform legislation moving through the House this month, is also sparking bouts of indignation on Capitol Hill, where at least one vocal Democrat says the provision represents an executive-branch power grab that would prop up too-big-to-fail institutions at the expense of smaller banks.
[Congress1]Rep. Brad Sherman (D-Calif.), a former accountant and member of the House Financial Services Committee, says the proposed new bailout authority would create a kind-of mutant extension of the Wall Street bailout — the differences being, he maintains, that the $700 billion Troubled Asset Relief Program at least had a cap on spending, an expiration date, congressional approval, independent oversight and some executive pay limits for the banks on the receiving end of the taxpayers’ largesse. The California Democrat is calling the bailout authority requested by the White House, which lacks most of those safeguards, “TARP on steroids.”
“The key thing is that the executive branch have the power to commit, not just $700 billion, but $1 trillion or more without having to have Congress be involved at the time of the crisis,” Sherman charged last month during a hearing on finance reform.
The criticisms highlight the pickle facing Democratic leaders as they take steps to regulate the powerful financial services industry in the wake of the worst economic turmoil since the Great Depression — a downturn caused largely by the failure of Wall Street firms to leverage their exposure to risk. On one hand, the Democrats want to rein in the most complex and abusive industry practices in order to protect consumers from companies teetering beneath the weight of their own bad decisions. On the other, they don’t want their safeguards to prop up monster institutions that might require bailing out because they’ve become too big to fail. How to balance those goals will be no easy task — particularly with conservatives in one ear urging less government intervention and liberals in the other pushing for stricter consumer protections.
The Democrats’ proposals — one was introduced by the White House earlier in the year, and another was unveiled Tuesday by House Financial Services Committee Chairman Barney Frank (D-Mass.) — would grant the president new “resolution authority” allowing the government to swoop in and overtake investment houses and other non-bank institutions when their potential failure would put the larger financial system at risk – much like the current authority of the Federal Deposit Insurance Corporation to take over commercial banks when similar risks exist. The idea is to have the government escort the failed company into oblivion in ways that soften the blow on the larger marketplace.
The push to expand the president’s bailout authority gained steam last year, after Bush administration officials found themselves with few tools to manage the near failure of American International Groups and the actual collapse of Lehman Bros. — two firms falling outside of the FDIC’s regulatory umbrella.
After the fall of Lehman Bros., the perception that some institutions couldn’t be allowed to fail for fear of simultaneously pulling down the financial system led lawmakers to jump in with hundreds of billions of taxpayer dollars to prop up those companies.
The House bill is designed to remove the burden from taxpayers, proposing instead that shareholders — as well as financial institutions with assets exceeding $10 billion — ultimately pick up the tab when the government is forced to bail out a company for the sake of stabilizing the financial system on the whole. Still, that taxpayer safeguard does nothing to tackle the issue of moral hazard. That is, the nation’s largest financial institutions would still be insulated from certain risks, critics say, leaving them with distinct business advantages over smaller competitors.
David Min, financial markets expert at the Center for American Progress, said the resolution authority, by definition, has to be unlimited in order to maintain the government’s credibility as an effective backstop. But such a system, he added, will lower the capital costs for the largest institutions, making it more difficult for smaller banks to compete.
“The whole scheme of systemic stability really favors larger institutions and encourages them to become too big to fail,” Min said.
Sherman agrees. “That is a huge gravy train to the top 20 [financial institutions] because it allows them to borrow money at a lower rate,” Sherman said by phone last week. “Think of what this does to moral hazard.”
No stranger to taking on the finance industry, Sherman was a lonely voice in the push earlier in the year to apply more stringent executive compensation limits to bailed out Wall Street firms — a push that went precisely nowhere in the face of White House opposition.
Some economists, notably Paul Volcker, former chairman of the Federal Reserve and now head of the White House Economic Recovery Advisory Board, have an alternative solution to the too-big-to-fail problem. They want to put back the firewalls between commercial and investment banking — firewalls dismantled in 1999 with the repeal of the Glass-Steagle Act. But that proposal has gained little traction on Capitol Hill, where the finance industry remains a hugely influential player despite its role igniting the recent recession. Min said the Obama administration took a look through its “political lens” and decided to tackle finance reforms without reinstalling Glass-Steagle.
Frank’s panel will hold a hearing on the House legislation Thursday, with Treasury Secretary Tim Geithner testifying.
Expect some fireworks. At a Financial Services hearing last month, Sherman pressed Geithner to apply some limits to his request for new bailout powers. “Would great harm be done to this statute,” Sherman asked, “if we limited the executive branch’s authority to a mere $1 trillion?”
An annoyed Geithner eluded the question before reaching the conclusion that Sherman was “fundamentally mischaracterizing” the provision. The Treasury Department did not respond to requests for comment.
Sherman said he intends to offer a series of amendments addressing the issue during the Financial Services panel’s markup of the bill, which has yet to be scheduled. Included will be a provision to cap the president’s bailout authority at $1 trillion, and another to strip out the resolution authority language entirely. A potential third proposal — to create an oversight panel like that monitoring TARP funds — is one he’s leaning against.
“I’m not looking for a TARP on steroids with oversight,” Sherman said. “I’m looking for an end of TARP.”
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