Will the New Senate Compromise End 'Too Big to Fail'?

The bank liquidation plan that Republicans took to calling a "bailout fund" is getting a makeover.

Sens. Chris Dodd and Richard Shelby have reached a deal to scuttle the bank liquidation fund, which would tax banks to create a $50 billion insurance pool to pay for the costs of winding down failing financial institutions. In the new deal, the FDIC would finance the liquidation with money from the Treasury Department. We would make up the losses by selling bank assets, forcing harsh losses on shareholders and creditors, and possibly taxing other banks.

What's the difference? The old plan would try to pay for banks' failures before they failed. The new plan would pay for banks' failures after they fail. The old plan winds down banks with an insurance fund. The new plan winds down banks with a line of credit from Treasury.

Sen. Barbara Boxer has also proposed an amendment that is expected to win bipartisan approval, which would state that taxpayers will never ever pay for future bailouts. That would force the government in treat all future banks failures through a FDIC liquidation process. The purpose of these provisions is to put a nail in the coffin of Too-Big-to-Fail by writing a law that says, as unequivocally as possible, if you fail, you will fail: no more bailouts.

But the new plan leaves open the same question: what happens when lots of banks start to fail together? The liquidation process will be so onerous and ugly that in future severe crises where we've got widespread problems in the industry with multiple systemically crucial banks -- the once-every-three-generations kind of catastrophes -- the government might not have the stomach for widespread liquidation.

"Think about it this time around," says Brookings' Doug Elliott. "If they had to take down Citi and Bank of America and the law required them to liquidate these guys, it would have been a disaster. And we would have created TARP."

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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