Senate Financial Reform Plans Can’t Address Short Term Trouble

The Senate has voted 96 to 1 in favor of a program that prevents the use of government funds to bailout large financial firms the way that the TARP fund did. At the same time, many Senators have proposed that the government should be able to “liquidate” troubled firms if their collapse would cause a systematic risk to the credit markets.

What the approaches fail to contemplate is that a liquidation by its nature may require government funds and that those funds may never be returned to taxpayers.

Another possible program that may address bank failures is a fund, paid for by the banks themselves, to cover the costs of winding down institutions. The fund would be as large as $50 billion and might have other uses including paying back past losses from the TARP program. But, the pool of capital will take several years to fund, if it is derived from a levy paid for by the largest banks. That means that its effectiveness may not exist short-term

The current debate about how another credit crisis might play out does not acknowledge that some amount of taxpayer money is always necessary in these events. That was true in the S&L crisis and also the Asian credit crisis in 1997. Aside from the US capital in the IMF, which had to loan money to Asian sovereign nations, the Fed paid for a bailout of some financial institutions like Long-Term Capital Management which were likely affected by the economic crisis there. That bailout totaled $3.6 billion. The federal government provided as much as $125 billion in aid during the S&L debacle.

One of the results of most US credit crises is that the taxpayers get much of their money back, eventually. That was certainly true with the TARP fund. Even though that money  has been recouped, Americans were at risk for paying huge sums, which would cause either higher taxes short-term or in the futures as bailout ripples cause future deficits.

The Senate cannot create a failsafe system to handle another bank crisis which takes down firms like Wachovia and CountryWide. The need for capital in a similar situation would almost certainly be beyond $50 million, and the mechanism that would be created to collect that capital is set up so that it will not be appropriately funded anytime soon.

Douglas A. McIntyre