Representative Barney Frank and Treasury Secretary Timothy Geithner introduced and defended this week new federal legislation that seeks to address the "too big to fail" financial firm problem that we've discussed on this blog several times previously. In short, the bill would create an executive branch council, the Financial Services Oversight Council, which would be delegated broad powers to oversee and promulgate regulations over firms designated as "too big to fail." This oversight council would be composed of representatives from the Treasury Department, the Federal Deposit Insurance Corp., the Securities and Exchange Commission, and other various bank regulators that would be given the power to "invoke the authority" to provide funds to "wind down" insolvent institutions.
The proposed legislation, which set off a firestorm of criticism in Congressional hearings yesterday, would give power to the Financial Services Oversight Council to establish capital asset requirements and "be responsible for identifying companies and financial activities that pose a systemic threat to the markets and subject those institutions to greater oversight, capital standards and other regulations," including winding them down if the systemic threat would damage the national and global economy. Three of the most contentious issues already raised include (1) who will pay for the winding down of the failing behemoth institutions, (2) what cap might be set as an asset figure that will make a firm "too big to fail," and (3) whether the Government's list of potential "too big to fail" firms will be made public.
As to the first issue, who will pay for the winding down, the bill proposes that "financial institutions would not be required to pay fees in advance to fund a pool of capital. Rather, the government would first borrow taxpayer dollars from the Treasury Department and afterwards recoup the costs from assessments on financial institutions with $10 billion or more in capital." This proposal has critics up in arms suggesting that regional banks will become the new "taxpayer bailout" target as regional banks with assets of $10 billion or more will foot the bill if enormous financial institutions fail. Critics argue that an up-front insurance tax on all "too big to fail" financial institutions makes much more sense than an "after the fact" taxpayer funded bailout (through the Federal Reserve) to be reimbursed later by financial firms with net assets of $10 billion or more.
As to the second issue, whether a cap on assets is necessary to properly regulate "too big to fail," a number currently debated is capping assets at $100 billion. This number is, according to critics, just one tenth the size of some already existing financial institutions. In addition, Fed Reserve chair Ben Bernanke does not seem to think that any cap is mandatory, as it might hinder the borrowing needs of global institutions.
To the third, issue, whether to make public those firms identified by the Government as potentially "too big to fail," the proposed legislation seems to be contradictory as to when and if these firms should be made public. Critics suggest that a potential public identification could have deleterious impact on financially sound firms that just happen to have an enormous amount of assets on its books and might imply to the public that these firms would assuredly be bailed out by the government in the event of overleveraging and reckless management.
As argued by Steve Ramirez yesterday, now that the bill has been proposed and defended, critics, lobbyists and opponents will no doubt line-up with great purpose in order to kill the legislation. Whatever the merit of the proposal, the amount of lobbying and money that will be spent to kill this bill will be amazing.
For more on Too Big To Fail, see:
Professor Barclift: Too Big To Fail, Too Big Not to Know
Professor Ramirez: Subprime Bailouts and the Predator State
Professor Painter: Bailouts: An Essay on Conflicts of Interest and Ethics When Government Pays the Tab