Why Is the House Financial Reform Bill Stalling?

Lawmakers are worried about certain aspects of the Geithner proposal to regulate risk

This morning, Politico reports that Rep. Barney Frank (D-MA) is considering postponing the Financial Services Committee's hearing of a bill to regulate risk in the financial system. Why? The bill, much of it coming from the proposals of Tim Geithner, has drawn considerable criticism for a plan to have the federal government collect money from banks to pay for bailouts. Frank himself has recently waffled on this particular point, breaking with the Obama administration's position. What's the problem?

Here's why some are worried the plan will create the wrong incentives, perpetuate TARP failures, have the government regulating its own missteps, and leave taxpayers with the bill:

• Punishes Banks That Play It Safe  Dean Baker, a think tanker writing in the Huffington Post, says that what little the bill would change in the financial system's current structure would be to give the Fed "even more power than it has now." He thinks the plan for a bailout fund is particularly half-baked: "Rather than raising a pool of money in advance from the big banks to cover the cost of a bailout, the bill proposes that large banks would be assessed a special fee only after a failure." Baker doesn't think this makes much sense:

[S]uppose Citigroup or some other major bank collapsed, requiring $100bn to pay off creditors. (We actually should not need a penny to pay off anyone other than insured depositors if we were serious about the banks not being too big to fail.) Either the failed bank was acting as a rogue institution, engaging in behaviour that was far more reckless than its peer institutions, or it was doing the same thing as everyone else.

In the first case, would it make sense to tax the other large banks $100bn because Citigroup acted recklessly? If the recklessness of one bank had led to its collapse in an environment where its competitors are sound, this would imply that there had been some serious failures of regulation. Why would we tax other large banks because the Fed, the FDIC and/or other regulatory bodies had failed in their job?

• If System Collapsed, Taxpayer Would Still Pay  The Singapore Business Times' Leon Hadar raises some other objections. If one bank fails, he points out, it's likely that the others are also in distress, and thus likely incapable of contributing money to the bailout fund. That means the taxpayer would foot the bill. Furthermore, he argues, "[a]nother problem has to do with the role that the government, including the Fed, would have in identifying and containing systemic risks. In some cases, it was the government that may have created these systemic risks." He points to government encouragement of mortgage companies. "Would government regulators be able to regulate themselves?"

• Reinforces Problems of TARP  Rep. Brad Sherman (D-CA) says about Geithner's original proposal, and Mother Jones's Andy Kroll agrees: "As bailout watchdogs have consistently pointed out, we still know very little about how TARP money was spent by institutions that received billions in bailout cash. With that in mind, do we want financial regulation that institutionalizes this opacity?"

• Only Solution Is To Cut Banks Down to Size  Bloomberg's David Reilly applauds the effort to make Wall Street pay for its own mistakes. But "[t]he practical problem," he writes, "is that the failure tab may be too steep for even the largest of the too-big-to-fail club such as JPMorgan Chase & Co. and Goldman Sachs Group Inc." He joins the many warning that taxpayers would be left to make ends meet. Ultimately, he says, "this well-intentioned fix will give a false sense that we’ve reined in too-big-to-fail firms. It would be better to make them small enough to fail on their own.