James Pethokoukis

Politics and policy from inside Washington

The state of play for financial reform

April 26, 2010

A few observations, comments and highlights:

1) Three things can happen today, as I see it: a) Chris Dodd and Richard Shelby reach a deal; b) Dems pick off a few Rs, get cloture, and the debate on the bill proceeds; or c) no deal, Rs stay unified and negotiations continue. Of those “c’ is the likely option — and that will eventually lead to a bill that may be getting tougher by moment. On Good Morning America today, Shelby seemed supportive of tougher derivatives language. And although it will not be in the bill, Kent Conrad’s comments that a bank tax is coming is reflective of the growing anti-Wall Street mood on Capitol Hill.

2) An interesting piece in The American by economist Phil Swagel, formerly of the Paulson Treasury Department, on whether the Dodd bill is a “bailout bill.” Read the whole thing, but in this bit he uses Lehman Brothers as an example:

In the fall of 2008, the Lehman Brothers bankruptcy was followed by severe negative effects as short-term credit markets shut down. This is sometimes taken as evidence that bankruptcy is not a tenable outcome for a large financial firm. This is wrong. The disruptions that followed Lehman’s collapse were greatly magnified by the idiosyncratic problem that a large money-market mutual fund broke the buck as a result of losses on Lehman debt. This sparked a panicked flight out of money-market mutual funds, which led commercial paper markets to seize up and in turn begat TARP. This situation would have been prevented only by guaranteeing Lehman debt—that is, by a bailout that the administration says would not be allowed to occur under its financial regulatory reform proposals. This means that either the administration intends to allow bailouts or that its approach would not in fact solve the problem of Lehman’s collapse—it cannot be both ways. In fact, the Dodd bill allows two forms of a bailout, since the government can put cash directly into a failing firm or guarantee its debt. The Dodd proposal is a bailout bill, plain and simple.

3) Here is Charles Plosser, head of the Philly Fed, on Dodd and TBTF:

I believe the best approach to making such a credible commitment and thus ending TBTF is amending the bankruptcy code for nonbank financial firms and bank holding companies, rather than expanding the bank resolution process under the FDIC Improvement Act (FDICIA). While the Senate bill has tightened up the proposal with a stronger bias toward liquidating a troubled firm, the bill would still give a great deal of discretion to policymakers to avoid the discipline of a bankruptcy court.

The Senate bill’s proposal to restrict the Federal Reserve’s supervisory authority to about 35 of the largest financial firms with $50 billion or more in assets further undermines the effort to end TBTF. The markets will likely interpret this provision as signaling that these firms are unique and will continue to be treated as TBTF. Many would assume that the language in the resolution section that emphasizes bankruptcy would not apply to these firms. This provision would, de facto, make the Federal Reserve supervisor of the firms deemed TBTF.

In addition, restricting the Federal Reserve’s supervisory authority to these large firms would focus the Federal Reserve’s attention more toward Wall Street and less on Main Street.

Comments

http://en.wikipedia.org/wiki/Gold_reserv e, see item 30

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Dodd needs a job on Wall Street upon retirement, so he can’t be too aggressive

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