What's the Republican alternative to bailouts?

Original Link: http://voices.washingtonpost.com/ezra-klein/2010/04/whats_the_republican_alternati.html

By Ezra Klein

"If there’s one thing Americans agree on when it comes to financial reform, it’s this," said Senate Minority Leader Mitch McConnell. "Never again should taxpayers be expected to bail out Wall Street from its own mistakes. We cannot allow endless taxpayer-funded bailouts for big Wall Street banks. And that’s why we must not pass the financial reform bill that’s about to hit the floor."

So much for that vaunted bipartisan cooperation, huh?

The Republican attack on FinReg is that it creates a "permanent bailout." This isn't a judgment on the Dodd bill. In fact, it long predates the Dodd bill. It goes back to a memo that GOP pollster Frank Luntz penned back in February. The subject? How to defeat financial regulation reform. "If there is one thing we can all agree on," Luntz said, "it's that the bad decisions and harmful policies by Washington bureaucrats that in many ways led to the economic crash must never be repeated." Note the echo in McConnell's remarks above. "Frankly," Luntz concluded, "the single best way to kill any legislation is to link it to the Big Bank Bailout."

So that's what McConnell does. But is it true? When compared to the status quo, absolutely not. The Dodd bill makes bailouts less likely by empowering regulators and increasing transparency, raises a $50 billion fund from banks to pay for future too-big-to-fail bankruptcies, and then makes the outcome a predictable punishment rather than a chaotic rescue. That last is known as "resolution authority" -- as bloodless a word as one could possibly imagine -- and it wipes out both shareholders and management. It's all there in Section 206 of the bill: "Mandatory Terms and Conditions for All Orderly Liquidation Actions." What we call "resolution" would better be described as "execution."

But there's a good argument to be made that this bill doesn't go far enough. On some level, so long as we have systemically important firms, there will be the risk of bailouts. Management and shareholders might not win out, but many creditors will do better than they should, and so too will some firms. Criticizing the Dodd bill for not entirely ending the problem of systemically-crucial firms -- and thus rescues of some form or another -- is a fair critique.

The ways to permanently end bailouts, however, are very radical: The most common suggestion is to break up large firms before they become too big to fail. Another option, put forward by Gary Gorton, is to insure the securities that banks lend to one another. Another option is to impose such enormous capital requirements on systemically important banks that they can't take many risks and can mostly cover their debts.

The way to judge whether someone is serious about ending bailouts is to see whether they propose one of these options, or some similarly radical solution. McConnell has not done that yet, and he does not do it in this speech. But the status quo, of course, is far more pro-bailout than the Dodd bill is. If that's McConnell's alternative, than he is ensuring and fighting for a future of endless bailouts. And if it's not his alternative, he needs to say what his alternative is.