How Dems Provide Wall Street Allies With Permanent Bailouts – With Or Without $50B Slush Fund

There are conflicting reports as to whether Washington Democrats will remove a $50 billion bailout slush fund from their Wall Street bailout bill, but it’s a moot point. With or without the fund, Senate Banking Chairman Chris Dodd’s (D-CT) 1,408-page regulatory reform bill would empower the federal government to provide Wall Street with permanent bailouts, courtesy of American taxpayers.

Under the Dodd bill, the nation’s largest financial firms – including Goldman Sachs, President Obama’s top Wall Street ally – would be eligible for special treatment at the highest levels of government, including resolution authorities and resources unavailable to smaller financial firms. This includes exclusive access to a pre-existing bailout fund, a Treasury-backed line of credit, the ability to have debt guaranteed by the government, and much more.

To put it in perspective, the bailout resources this bill provides far surpass those that were available to bail out Fannie Mae and Freddie Mac, the government mortgage companies that sparked the meltdown by giving high-risk loans to people who couldn’t afford it. As Rep. Brad Sherman (D-CA), a member of the House Financial Services Committee, told Politico yesterday, “The Dodd bill has unlimited executive bailout authority. … The bill contains permanent, unlimited bailout authority.”

• A Pre-Existing $50 Billion Bailout Slush Fund. Sen. Dodd’s financial bailout bill would create a $50 billion ‘orderly resolution fund’ ($150 billion in Rep. Barney Frank’s bill) that could be repeatedly replenished from industry assessment. Despite its technical title, the fund’s purpose is not difficult to discern. It is not needed for people who have FDIC (Federal Deposit Insurance Corporation) or SIPC (Securities Investor Protection Corporation) insurance or for people whose insurance policies are protected under state law, as they are covered by other funds and resources. This would be bailout money for firms deemed ‘too big to fail,’ and investors will recognize it that way.

• A Treasury-Backed Credit Line. In addition to the $50 billion bailout fund, the FDIC would be authorized to borrow from Treasury up to the amount of cash left in the ‘resolution fund’ plus 90% of the value of the assets of any and all too-big-to-fail firms in its control. These borrowed funds, like the funds collected through assessments, would be available to bail out creditors. This could include the exchange of cash and other liquid instruments for illiquid assets of a failing firm.

• Government-Guaranteed Debt. In addition to the funds and authority noted above, the FDIC would be given the authority to guarantee the debt of any solvent bank, bank holding company, or affiliate in any amount subject only to an aggregate debt limit set by the Treasury Department.

It is reasonable to expect that the largest firms will be the primary beneficiaries of such a program. The experience of the current FDIC’s debt guarantee program is instructive: as of December 31, 2009, the cumulative debt of all banks under $10 billion in assets that was guaranteed comprised only approximately one-half of one percent of all the debt guaranteed. Codifying the FDIC’s authority to provide additional debt guarantees thus will be just one more way in which the government will make it clear that the largest financial firms could be kept afloat during times of stress.

• Institutionalized, Unlimited Bailouts. The FDIC, as the resolution agency for too-big-to-fail firms, would be given wide latitude to use resources to make payments to anyone in any amounts, at their own discretion. For instance:

o Section 204(d) of the bill would give the FDIC broad authority to use the resolution fund in whatever way the FDIC determines, in its discretion, to be “necessary or appropriate.”

o This discretion would extend to the payment both of secured and unsecured creditors. Section 210(b)(4) would provide the FDIC with the discretion to treat unsecured creditors in a dissimilar manner – including making payments to some but not all – if the FDIC deems it necessary to do so.

o Section 210(d), after discussing the maximum amounts that may be paid to creditors, states that the FDIC “may make additional payments or credit additional amounts to or with respect to or for the account of any claimant or category of claimants of the covered financial company, if the Corporation determines that such payments or credits are necessary or appropriate to minimize losses to the Corporation as receiver from the orderly liquidation of the covered financial company under this section.”

• Bridge Bank Authority. The bill would authorize the FDIC to create a bridge institution as part of resolving a covered institution and would vest the FDIC with comparably broad authority to use the orderly resolution fund in connection with the bridge institution. Under section 210(h), assets and liabilities could be transferred to the bridge institution, the FDIC may pay creditors in whole or in part, and the bridge company may be sold to or merged with another company at the FDIC’s discretion. The FDIC also could provide funding to facilitate the sale or merger of a bridge company. Thus, creditors of firms that could be resolved through this bridge authority can do business with such firms confident that the government will make the creditors whole either directly (through payments) or indirectly (through facilitating a sale of the business to a stronger company.)

As we saw for decades with Fannie Mae and Freddie Mac, perceptions that the government can bail out a firm or its creditors will create significant unfair advantages for that firm, making it easier for the firm to attract more funding, at lower rates, than otherwise would be available. This special treatment will make these large firms more attractive to investors than the smaller financial firms. More broadly, it results in the mispricing of risk, which lays the foundation for later economic and financial problems.

Republicans believe any efforts to protect taxpayers should begin with reforming Fannie Mae and Freddie Mac, the government mortgage companies that sparked the meltdown by giving high-risk loans to people who couldn’t afford it. For more information on the House Republican plan, click here.