Too Big To Fail, Part V: More Bailouts?

I'll end the day with one last post on the new Financial Stability Improvement Act of 2009 proposal (.pdf). But this hardly marks the end of my toils with the doc. There are at least a few more issues it addresses that I intend to tackle tomorrow including the resolution authority and securitization. Up to now, I've covered the Council, identifying risky firms, heightened regulation and capital requirements. This one will be quick. I found one section a little peculiar. I understood the spirit of this legislation to ensure that the government wouldn't have to bail out financial firms anymore. One part of the draft appears to contradict this principle.

The document contains a section that addresses "Emergency Financial Stabilization." Of course, the point of this enormous new framework is precisely to avoid the need for this. But if such a situation still arises, this legislation will have a mechanism in place. I'm not going to block quote this paragraph directly from the document, because the language is terribly cumbersome. Here's my understanding:

In a time of economic calamity, a firm might be deemed, yes, you guessed it, too big to be allowed to fail. In such a scenario, the Federal Reserve Board and Federal Deposit Insurance Corporation (FDIC) Board of Directors both need to agree, by a two-thirds vote, that the firm must be saved. The Treasury Secretary must also agree, after consulting with the President. In such a scenario, the FDIC may extend credit to or guarantee obligations of solvent firms to maintain stability. It will not, however, permit equity payments of any kind to firms.

I get why this provision is included. The government hates the fact that it had to get involved in the equity game. That's literally giving bad firms good money. This provision would still do that -- kind of. But the government would instead be guaranteeing debt or extending credit. What's the difference? Well, it's subtle. Debt is generally a more clearly defined obligation. But ultimately, you'd have the same result. These firms would acquire the capital they need to avoid collapse, courtesy of Uncle Sam.

There's another important thing to note here: Congress need not approve of this assistance. That's a stark contrast to what happened in 2008, when Congress nearly derailed the first bailout attempt. That's a lot of power for the President and a bunch of unelected officials.

So who would bear the risk for this capital? If a firm engaging in this emergency assistance still manages to fail, then what happens to the credit the government extended or the debt it guaranteed? Well, the government loses. Sort of. The draft states:

Any losses incurred by the (FDIC) pursuant to subsection (a) shall be recovered from (FDIC) assessments on large financial companies in the manner provided in section 1609(o) of the Resolution Authority for Large, Interconnected Financial Companies Act of 2009.

The Act it's talking about is the resolution authority portion of the draft. I haven't gotten there yet, but I've read enough summaries of this proposal to know that the FDIC intends to asses the identified firms in order to create a sort of insurance fund to pay for such failures. More on this tomorrow, when I get to that part of the draft.