Will Dodd’s Financial Reform Bill End Too-Big-To-Fail?

AP090319056942Yesterday, Senate Banking Committee Chairman Chris Dodd (D-CT) released the latest version of his financial regulatory reform legislation, after he decided last week that negotiations with Republican members of the committee were taking far too long. Of course, one of the biggest issues that the bill is meant to address is that of financial firms that are “too big to fail.” And already, Senate Republicans are claiming that Dodd’s bill doesn’t do away with them:

“This bill does nothing to change the expectations in the market that some firms are too big to fail,” said Senator David Vitter, a Louisiana Republican who serves on the Banking Committee. “I’m disappointed that Senator Dodd has decided to abandon any sort of bipartisan approach in favor of political posturing on behalf of the Obama administration.”

This hews closely to the advice that GOP pollster Frank Luntz gave to Republicans earlier this year, which was to portray financial reform as inevitably leading to more big bank bailouts, no matter what the legislation actually says. House Republicans also used this tactic incessantly during the regulatory reform debate last year, falsely claiming that Rep. Barney Frank’s (D-MA) bill created a “permanent bailout fund.”

However, Dodd’s actual legislation tells a very different story. For one thing, it bars financial firms from owning more than 10 percent of the assets in the financial system, while creating a Financial Stability Oversight Council (formed by the Treasury Secretary and the heads of the regulators) that will recommend stricter capital and leverage standards for firms as they grow. It also includes the option for regulators to implement bans on proprietary trading (although it doesn’t mandate such bans). These provisions will discourage excessive growth and make it more expensive for companies to expand to an outlandish size.

Under the bill, financial firms would also have to craft a plan for “rapid and orderly resolution in the event of material financial distress or failure.” Basically, firms will have to write living wills, laying out their interconnectedness and liabilities in the event that they fail. It also envisions using the bankruptcy court for all but the biggest firms, with the Treasury, FDIC and Federal Reserve needing to act affirmatively to use resolution authority on a failing firm, instead of simply letting it go into bankruptcy court.

Plus, just like the House version, Dodd’s bill would levy a fee on big financial institutions (those with more than $50 billion in assets, as well as those deemed systemically risky) to build up a fund that will be tapped in the event that resolution needs to occur. The Senate bill also explicitly states that the fund can only be used to liquidate a firm, and “not for the purpose of preserving the covered financial company.” Even CNBC’s Larry Kudlow — who thinks that everything Congress does preserves too-big-to-failis impressed by Dodd’s work.

Now, at the end of the day, all of this is meaningless if regulators aren’t willing to pull the trigger and actually use resolution authority when faced with the impending failure of a big firm. But that’s going to be true no matter what the bill says. Dodd’s legislation isn’t perfect, but on this piece, he does seem to have thought through a workable way to ensure that firms have a hard time becoming gigantic, and have no expectation of a taxpayer funded bailout, regardless of their size.