December 9, 2009

December 9, 2009 | Factsheet on Regulation, Financial Regulation

TARP II: The Sequel Is Never Better

Paving the Road for More TARPs

  •  The Barney Frank Agenda: In an attempt to reform the financial industry, Congressman Barney Frank (D-MA) and the Obama Administration have proposed new regulatory measures that would hurt consumers, increase the likelihood of future government bailouts and interventions, and do little to address the real problems in the financial industry.
  • "Too Big to Fail": Frank's legislation would give the Federal Reserve Board and other regulators sweeping powers to control firms deemed "too big to fail," or those firms whose failure could put the entire financial system at risk. This puts a lot of faith in regulators who also missed the outset of the last financial crisis.
  • Limiting Financial Innovation: The new authorities granted under the Frank legislation would likely be used to limit the development of new products, thus depriving consumers of the real benefits of financial innovation.
  • TARP IINew Regulatory Bureaucracy: The bill would also create a new "Consumer Financial Protection Agency." Despite its name, this new regulatory bureaucracy would hurt consumers far more than it would help them. It would raise costs for consumers, reduce the number and type of products available, and greatly increase the confusion caused by conflicting consumer laws in different states.
  • The Real Life Effect: More Risk: In reality, the legislation -- and the government's new powers -- would signal to markets that the targeted firms are supported by the federal government and guaranteed against failure, thus leading them to take more undue risks, not more.

The Frank Bill Doesn't Stop at Regulation

  • Gives Government Broad Powers: It would give the FDIC broad power to seize and close failing financial institutions -- with limited court review for its actions -- and would establish a fund for the FDIC to use to resolve the affairs of firms it takes over.
  • The FDIC Can't Do the Job: While the FDIC has broad experience with resolving failing smaller banks, it has no experience with the broader financial activities that would almost certainly be part of failing larger financials. If cast in this new role, the agency would likely discover that its procedures cannot handle the challenges of such a distressed firm, and its efforts would cause the same systemic shock that the new authority is designed to prevent.
  • The Final Irony: A Permanent TARP: Rather than avoid future bailouts, the Frank proposal would facilitate them. Congress will have created a permanent TARP.

There Is an Alternative

  • Modernize Bankruptcy Laws: Current bankruptcy laws are not designed for modern financial firms. Congress should create an expedited bankruptcy process to restructure and close large and complex financial firms. Otherwise, the government will again find itself bailing financial firms when the next economic crisis hits.
  • Strengthen Capital Standards: Congress should strengthen capital standards to discourage financial firms from reaching the point that their failure could endanger the entire financial system.

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