National Public Radio put your tax dollars to good use this week:
We at Planet Money did an informal survey of economists and regulatory experts on the left and the right. We couldn’t find any who fully endorse the reforms backed by President Obama and Democrats in Congress. Everyone thinks the reforms just aren’t enough to solve the problem.
Take, for example, “too big to fail” — the idea that if one of the largest banks in the country gets into trouble, the government will save it with taxpayer money.↓ Continue Reading Below
“A vote for reform is a vote to put a stop to taxpayer-funded bailouts,” Obama said in his speech in New York on Thursday.
I cannot find any experts — of any party — who are willing to agree with Obama on this one.
Why don’t the experts agree with Obama? Because he’s wrong.
The issues surrounding the financial reform bill are very complicated, but here’s a shorthand explanation for this business of “too big to fail.” There are basically two ways of dealing with large, failing financial institutions. One is through bankruptcy, where there is a transparent process and a paper trail and iron-clad rules about who gets paid and who doesn’t. Usually, everyone ends up getting a haircut of some kind.
The other way is the AIG way, in which the government jumps in, provides money to prop up the firm, then starts handing out cash in a very non-transparent process, in order to prevent further market consequences. Months afterward, we finally find out who got the money.
Republicans proposed a financial reform bill last July that simply modernizes the bankruptcy code to deal with the large firms in question. The Dodd bill, on the other hand, creates a process that looks more like the AIG bailout. The government (this time the FDIC instead of the Fed) would sweep in, prop up, and then bail out some creditors, with some degree of “flexibility” to decide which ones.
Is this just an extension of the FDIC’s current role of insuring bank customers? Or is it an institutionalization of “too big to fail” that will facilitate moral hazard and careless decisions by bad bankers? Your answer to that question probably depends on whether you think the AIG bailout was a bailout, and/or whether it was a good thing.