Monday, November 19, 2012

The Politics Of Preventing Future Bank Bailouts

This is the first of several posts that I will make that were informed by Sheila Bair's new book Bull By The Horns.  The Dodd-Frank reform bill proposed a new resolution trust that would be established to deal with problem banks.  The question was about how the resolution trust would be funded.  Bair wanted the banks and hedge funds to pay a risk weighted premium to fund the trust.  That is how the FDIC funded deposit insurance for state chartered banks.  The banks paid premiums to fund the insurance.  The alternatives were to have the trust funded by the Fed with the use of taxpayer funds.  Another alternative was proposed by the Treasury.  It would provide a line of credit to banks that had a liquidity problem.  That also would require taxpayer funding.

The Treasury, under Tim Geithner, did not want to prefund the trust by assessing the large banks and hedge funds with an insurance premium weighted by risk.  They were in the business of using leverage to increase potential payouts, and they also funded their operations with short term debt.  That made them riskier, and subject to higher premiums.  President Obama's Chief of Staff told Bair that the administration favored her proposal for a prefunded trust.

Senator Shelby, a GOP member of the financial services committee wrote a letter to Geithner claiming that the trust would be a "slush fund" that could be used to bailout the banks.  Bair was surprised that Shelby wrote the letter to Geithner instead of to Dodd who was the Chairman of the Senate Finance Committee.  She suspected that he did that because Geithner and Larry Summers, who had ties to hedge funds, had made the same criticism of the trust.  Mitch McConnell, the GOP's Senate minority leader was also critical of the trust for the same reason.  He was asked by a reporter on a Sunday TV show why he believed that an industry trust, funded by the industry, could be called a bailout fund.  He told the reporter that Obama should talk to his Treasury Secretary who also objected to the trust for the same reason.  In other words, Tim Geithner was working behind the scenes to undermine the administration's position on the resolution trust.  Moreover, calling an industry funded trust a bailout was right out George Orwell. 

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