The Senate passed financial “reform” last night. One willful omission in — or rather, not in — the bill shows how unserious Congress remains about ending “too big to fail.”

Earlier this week, New Hampshire’s Judd Gregg proposed an amendment to prevent Washington from ever using federal funds to bail out the bondholders of state and local governments (except in catastrophes like Hurricane Katrina). The Senate shot down the provision, 47–50.

In doing so, the Senate broadcast to markets that it wants to keep its options open when it comes to arbitrary bailouts of bondholders, provided those bondholders have made their “investments” in politically favored areas of the economy.

Politics, then, not markets, will continue to govern the nation’s allocation of finite financial resources, weakening the nation’s productive capacity.

Congress cannot “reform” the financial world without making it crystal-clear that bondholders run the consistent, predictable threat of losses when they make unwise investments, whether those investments are in the bonds of reckless banks or those of profligate state governments.

Please read a little bit more about this here.