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Dodd v. McConnell

Wishing so won't make Too Big to Fail go away.

4:11 PM, Apr 13, 2010 • By MATTHEW CONTINETTI
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Republican Senate leader Mitch McConnell isn't a fan of Chris Dodd's financial reform bill:

McConnell's criticism centers on the Resolution Authority, Dodd's mechanism to break apart large and complex financial institutions that are not banks. Many conservatives and Republicans, such as Peter Wallison and David Skeel, believe such a task is too complex for the FDIC or Treasury Department. They champion a modernized bankruptcy code instead. No new agency would be required. No $50 billion fund to repay creditors during the resolution process would be necessary.

Financial reform is ridiculously complex. But I can't help thinking the differences between a new resolution authority and an updated bankruptcy code are rather small. As I understand it, the resolution authority wouldn't perpetuate the failed institution, but would rather wind it down in a manner perhaps more favorable to creditors than bankruptcy. To call it a "permanent bailout" sounds a little like saying the FDIC is permanently bailing out failed banks, which it isn't doing. What the FDIC does is bail out depositors, up to a certain dollar amount, while shutting down the failed bank. Arguments that the FDIC isn't equipped to handle Lehman or Citi, or that a body of rules exist for the FDIC that will take years to work out for the resolution authority, seem more persuasive.

I'm also a little skeptical that bankruptcy code modernization alone (stop yawning!) would somehow rid the world of Too Big to Fail. As long as regulators feel that a capsizing institution could bring down the whole economy, they will act to save that institution and forestall financial disaster. The Resolution Authority is one way to handle that situation. "See you in bankruptcy court" might not cut it in every instance.

To call a bank Too Big to Fail is to say that its size and scope have made it enormously important to the financial system, and thus to the political system. The way to handle that is to prevent banks from becoming big in the first place. I haven't seen Republicans put forward policies that address this problem. They should try reading Arnold Kling.

Treasury Secretary Geithner seems to think regulatory reform would prevent the Great Recession from happening again. Afraid not: bubbles and panics are part of market capitalism, and market participants always find ways to work around the rules and/or capture the institutions that make the rules. So a little humility is in order. But a little humility won't be enough to convince the public that the GOP is serious about addressing the gaping holes in our financial system revealed by the panic of 2008. Instead, there's a real danger that the GOP comes away from this debate not only looking pro-Wall Street but also obstructionist for no principled reason. Not exactly a winning hand.

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