The Agenda

Chuck Grassley Does the Right Thing

There is much to dislike in the Dodd bill, as Nicole Gelinas has argued at Investor’s Business Daily and here at NRO

The bill does not ensure that lenders will take losses. Instead, it merely directs the FDIC to operate under a “strong presumption” (p. 131) that “creditors and shareholders will bear the losses of the financial company” (p. 132).

A hundred-odd pages later, the bill offers a big loophole for lenders in a crisis. It says that the FDIC, “with the approval of the [Treasury] Secretary, may make additional payments or credit additional amounts to or with respect for the account of any claimant or category of claimants of the covered financial company” — that is, to lenders — “if the [FDIC] determines that such payments or credits are necessary or appropriate to minimize losses” to the FDIC (p. 241).
It wouldn’t be unreasonable for a lender to expect the government and the FDIC to use all of the discretion the bill affords them to guarantee financial firms’ debt in a future systemic financial crisis, just as happened this time around.

This conclusion would help create the next systemic crisis. 

One clear result of this legislation will be that major financial institutions will intensify their efforts to shape the regulatory environment.

But the flaws in the Dodd bill don’t change the fact that at the very least Congress needs to revamp the regulation of derivatives. Senator Lincoln has produced a strong proposal, and Senator Grassley was the only Republican on the Senate Agriculture Committee to vote for it. The following is from Edward Wyatt and David Herszenhorn in the NYT:

In a statement after the vote, Mr. Grassley said that he still might oppose the larger financial regulation bill. “I am disappointed that the legislation presented for committee action was not bipartisan,” Mr. Grassley said. “I hope the floor debate on a larger financial reform package is different, and that good policy is put ahead of politics.”

This sounds like the right move to me. The liquidation authority is an entirely different kettle of fish. Reforming derivatives regulation is controversial, but it’s a necessary step. Once again, Gelinas has done the most lucid and persuasive writing on this subject, as in this City Journal column from January:

If the Financial Crisis Inquiry Commission can get the American public to grasp just one thing, it should be that properly applying old rules to new financial instruments goes a long way toward solving the “too big to fail” problem that infects our economy and is at the root of public anxiety. AIG could not fail in 2008, because if it had, its unregulated derivatives would have blown up the financial system from the inside. The FCIC needs Congress, which has offered up a loophole-ridden derivatives fix, to get this, too. Otherwise, Wall Street will one day take on such mammoth liabilities that it overwhelms even Washington’s ability to bail it out.

She’s continued in this vein over at The Corner

This reminds me of Ross’s terrific post on the openness with which post-Bush conservatives have been approaching big domestic policy questions. The trouble, of course, is that conservatives in Congress and in the states don’t seem to have caught up with the fact that new economic circumstances demand a new approach — in some respects, a more strenuous emphasis on Goldwaterite basics (there ain’t no such thing as a free lunch is a time-tested principle that we badly need) and in other respects a willingness to embrace policy innovations that can make markets work more transparently and efficiently. 

P.S. Robert Litan has written a terrific primer on the formidable barriers to derivatives markets reform.

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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