James Pethokoukis

Politics and policy from inside Washington

3 TBTF loopholes in the Dodd bill

April 20, 2010

The wonderful Nicole Gelinas explains why she does not think the Dodd bill ends TBTF (as outlined by me):

1) Title II, which starts on p. 107, explains how “orderly liquidation authority” would work. When the Treasury and a panel of judges have determined that a financial firm is unsafe for bankruptcy, the FDIC would take over that firm. In “liquidating” the company, the FDIC would figure out who — of the firms’ lenders, other creditors, and shareholders — would get what. On the repayment list is “any amounts owed to the United States, unless the United States agrees or consents otherwise” (italics mine). That speaks for itself on whether taxpayers will be “exposed to a penny of risk of loss.”

2) More important, though, what does it mean to “liquidate” a company? … The bill does not ensure that lenders will take losses. Instead, it merely directs the FDIC to operate under a “strong presumption” (p. 131) that “creditors and shareholders will bear the losses of the financial company” (p. 132).

3) A hundred-odd pages later, the bill offers a big loophole for lenders in a crisis. It says that the FDIC, “with the approval of the [Treasury] Secretary, may make additional payments or credit additional amounts to or with respect for the account of any claimant or category of claimants of the covered financial company” — that is, to lenders — “if the [FDIC] determines that such payments or credits are necessary or appropriate to minimize losses” to the FDIC (p. 241). It wouldn’t be unreasonable for a lender to expect the government and the FDIC to use all of the discretion the bill affords them to guarantee financial firms’ debt in a future systemic financial crisis, just as happened this time around.

4) Finally, Geithner’s language — he wants to “dismember” failed financial firms “safely” — is interesting. Three months ago before Congress, Geithner had this to say about the AIG bailout: “We didn’t rescue AIG. We intervened so we could dismember it safely.” True, that was the government’s intent in the fall of 2008. But AIG is still with us; the stock trades at nearly $40.

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