Perhaps nothing angered the average American more during the financial crisis than the idea that they would have to bear the cost of keeping alive giant financial firms that should have failed. Policymakers, including former Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, said that bailouts were undesirable but necessary. They asserted that the entire financial system would collapse if the government did not intervene. It's impossible to know if that claim was true, but Congress wants to make sure that the question of whether to bail out a firm never has to be asked again.
Yet, Republicans are unconvinced that the financial reform legislation offered by Senate Banking Committee Chairman Christopher Dodd (D-CT) would really end bailouts. In a fiery exchange of floor speeches this week, he and Senate Minority Leader Mitch McConnell (R-KY) debated this point. Dodd asserts that his bill will put an end to bailouts, while McConnell and other Republicans say it leaves the door open for the government to prop up firms in perpetuity. Who's right? They both are.
Dodd's bill seeks to create a mechanism for winding down firms that are so large or interconnected that their failure could cause the financial system to collapse. The so-called too-big-to-fail problem was the basis for rescuing firms like AIG and Fannie Mae. Such institutions enduring regular bankruptcy proceeds would have taken too long, creating an extended period of uncertainty and market turmoil. The creation of a non-bank resolution authority -- with a similar role to that the FDIC plays with troubled depository institutions -- could help.