Congress celebrated Cinco de Mayo on Capitol Hill with two deals to guarantee that the American people will never, ever, ever bail out another financial institution.

In the morning, Sens. Dodd and Shelby agreed to scrap the $50 billion resolution fund in exchange for a plan to liquidate failing financial institutions through the FDIC. In the afternoon, the Senate voted overwhelmingly (96-1) for an amendment to "ensure that taxpayer funds will never be used to bail out financial institutions."

Here's the language:

Purpose: To prohibit taxpayers from ever having to bail out the financial sector.

SEC. 212. PROHIBITION ON TAXPAYER FUNDING.

(a) LIQUIDATION REQUIRED.--All financial companies put into receivership under this title shall be liquidated. No taxpayer funds shall be used to prevent the liquidation of any financial company under this title.

(b) RECOVERY OF FUND. - All funds expended in the liquidation of a financial company under this title shall be recovered from the disposition of assets of such financial company, or shall be the responsibility of the financial sector, through assessments.

(c) NO LOSSES TO TAXPAYERS. - Taxpayers shall bear no losses from the exercise of any authority under this title.

There are two oddities about the today's developments. The first is that some Democrats are running away from a bank tax even after voting for an amendment (above) that might necessitate a bank tax.

You see, Part B of the amendment (and the Dodd-Shelby compromise) says that when we spend money to wind down a failing company (that means paying the employees, keeping the lights on), we have to make it back by selling assets, forcing some creditors to take losses, and administering a tax on other banks to get the money back.

But today, moderate Democrats are reportedly nervous about administering, well, a tax on other banks to get the TARP money back. How bizarre: 96 senators just said they will tax banks to recover future money spent to liquidate them. But today some senators are reluctant to tax banks to recover current money spent to bail them out? Tim Fernholz fleshes out the irony.

Here's the second, deeper concern. The new liquidation plan, like the old liquidation plan, is harsh. That's the point. We don't want anybody to think that large banks have implicit government backing. We want to make their failure orderly and painful. But what happens in the once-every-few-generations event that where many large and systemically important banks fail together?

We'd bail them out, of course.

"I don't think that the government's going to be able to use this fund [in catastrophic events]," Doug Elliott of the Brookings Institution said. "If they had to take down Citibank and Bank of America in 2008 and the law required them to liquidate these guys, it would have been a disaster. Creditors would be running around to avoid the haircuts. So we would have created the TARP."

What you're saying, I responded, is essentially that there are times when bailouts are simply the right public policy.

"Yes," he said. "There are going to be situations where bailouts make sense."

That doesn't the plan hopeless, and it certainly doesn't obviate financial reform. It only means we need front-end provisions to ensure that bank failures are less likely and less devastating, such as derivatives reform and leverage requirements. "Let's give the government a good tool box, and not be so paranoid of the potential for bailouts," he said. "There can be situations like the one we just went through where the right act of the government is to bail out the institution."


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