Damian Paletta has an informative account of the legislative history of the idea of a $50 billion fund to finance the resolution of insolvent financial institutions in the Wall Street Journal. Unfortunately, I think it’s marred by an effort to talk up the importance of this issue beyond what the facts will bear:
The details are confusing and the rhetoric is distracting, but there is no doubt that the stakes are huge. The fund is at the core of one of the most central questions facing the government in the aftermath of the financial crisis—how should the government be armed to protect taxpayers in the future if big banks start to topple?
I recommend almost everything else in the article, but the details aren’t that confusing, the states are not huge, and though the fund is at the core of a central question, the dispute over the fund is not very important.
Let me explain:
Right now, when a bank fails it goes into FDIC receivership. Insured depositors still have access to their money, the shareholders are wiped out, and the management is almost invariably fired as the bank is either sold to another bank or else directly wound-down by the FDIC. In recent decades, a lot of firms that are not banks in the relevant regulatory sense have gotten into banking (or “shadow banking”) which led us to bailouts when some of those firms failed. A key object of financial regulatory reform is to establish a resolution process for these firms comparable to what the FDIC does for traditional banks. This is very important. It’s also the case that making the resolution process work requires some money. This has led to a dispute between two different ideas about financing resolution. Under one scenario, the FDIC would borrow the needed funds from the Treasury and then get the money back later through taxes on big banks. Under another scenario, the FDIC would raise $50 billion through taxes on big banks and then if the $50 billion runs out the FDIC would borrow the needed funds from the Treasury and then get the money back later through taxes on big banks.
Realistically, these two processes are very similar. The main dispute between them is political in nature. Maybe raising the $50 billion in advance signals toughness and seriousness about cracking down on banks. Or maybe raising the $50 billion in advance signals lack of confidence in prudential regulation and can be dishonestly characterized as a “bailout fund.” In practice, the difference is not large. What’s more the incidence of taxes on banks to raise the $50 billion has not, I think, been carefully studied so it’s somewhat difficult to characterize exactly what the small difference would be.