"The biggest beneficiary of [financial] reform is Wall Street itself."  --Lloyd Blankfein, chairman of Goldman Sachs, April 27, 2010

BACKGROUND:

On May 20, 2010, the Senate voted to approve its version of TARP II.  After claiming that Republicans were waging a "misinformation" campaign by pointing out that the bill would make bailouts permanent, the Democrats dropped the bill's $50 billion bailout fund.  However, the bill is still worthy of its name-TARP II.  Rather than an objective standard regarding the treatment of creditors, TARP II authorizes the FDIC to determine how creditors of a failed firm would be paid.  Additionally, TARP II requires Congressional approval of FDIC and Treasury debt guarantee programs, and Treasury approval of the Fed's use of its 13(3) emergency lending powers.  Such approval processes allows the political class, legislators and bureaucrats, to continue to determine the fate of politically connected firms.  For example, in 2008, Congress approved the original $700 billion TARP at the request of the Treasury Department.  Also, according to a July 2009 Bloomberg article, Neil Barofsky, the Special Inspector General for TARP, reported that the Fed provided approximately $6.8 trillion in aid during the latest recession.  Treasury did not object to the Fed's actions.  In other words, nothing would change with the Senate's TARP II, except bureaucrats would get more power, Washington politicians would get more influence, and the "too big to fail" status of large Wall Street firms would get codified.  As a result, the partnership between big government and Wall Street would be strengthened.  The only real solution is to allow firms that fail to be liquidated in an orderly manner through an efficient bankruptcy. 

HOUSE REPUBLICAN SOLUTION:

Protects the Taxpayers and Restores Market Discipline:  Bankruptcy would put an end to taxpayer bailouts and restore market discipline.  Large Wall Street firms would no longer benefit from privatized profits and burden the taxpayers with socialized losses.  The fate of Wall Street firms would be determined by their management and the free market, rather than by the political elite in Washington, D.C.  Bankruptcy is a well-known process that creditors understand and take into consideration on a regular basis when investing in firms of small and mid-sized firms.

Does Not Empower Government:  TARP II would provide the FDIC and the Fed with significant latitude to treat counter-parties and creditors as they determine to be appropriate.  FDIC's assistance would be outside of bankruptcy and would be based on the assertion that creditors and counterparties to a failed firm could get into liquidity problems while waiting in the bankruptcy process.  The bill allows the FDIC to determine when and how creditors would be paid and how a failed firm would be liquidated.  Such discretion given to government bureaucrats with pressure from Washington politicians provides an incentive for the FDIC to make politically motivated decisions.  Bankruptcy would remove the partiality that government agencies and politicians have brazenly displayed during the current recession and replace them with sound, objective and predictable legal principles.

No Implicit Government Guarantee:  The market viewed Fannie Mae and Freddie Mac as having an implicit guarantee of the US government because of the government created benefits the GSEs received.  Members of Congress and previous administrations often stated that Fannie and Freddie were not backed by the government, but despite what they said, the market recognized Fannie and Freddie as having an implicit guarantee.  As soon as Washington politicians and government bureaucrats determined a "crisis" existed, taxpayer funds were generously provided to these troubled firms.  Bankruptcy would make it clear to all creditors that they can no longer expect taxpayer funded bailouts, and they will have to be more prudent with their investment decisions.

Liquidates Insolvent Firms:  House Republicans call for creating a new chapter of the bankruptcy code to make it more efficient and better suited for resolving insolvent non-bank financial institutions, no matter how large.  Bankruptcy judges would also have the power to stay claims by creditors and counterparties to prevent runs on troubled institutions.