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Will financial reform end big bank bailouts?

Lawmakers are pledging to end bailouts in the financial reform bill that the Senate is considering now. But many experts say bank bailouts can and will occur again.

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The Senate bill makes the task sound deceptively easy: A large firm should be liquidated, it says, "in a manner that mitigates such risk [to the economy] and minimizes moral hazard." But to achieve those twin goals may require both new tools and new fortitude from regulators.

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In Mr. Elliott's view, the Senate bill would limit regulators' options more than does the House bill approved in December.

Both bills use the "orderly liquidation" phrase. Both seek to make a bank's managers and creditors face consequences if the firm fails. The Senate bill, for example, says "management responsible for the condition of the financial company will not be retained."

The House bill calls for firms to draw up so-called funeral plans in case of failure, but it also includes language that enables the government to make loans to a failing firm, buy assets from the firm, or guarantee its debts. Senate Republicans complained in a recent report that the Dodd bill also goes easy on failing firms.

"As the receiver, the FDIC [Federal Deposit Insurance Corp.], with the consent of the Secretary of the Treasury, is explicitly authorized to pay creditors and shareholders of the company more than they would be entitled to receive in bankruptcy," they wrote on April 30.

Regardless of what the bills say about the resolution of a failing firm, they also authorize the FDIC and the Federal Reserve to provide broad support to the financial system – such as lending money or guaranteeing debts – much as they did in 2008.

In theory, the idea is to keep healthy firms from being caught in the vortex of a crisis, with asset prices being pushed downward in an investor panic. But if most banks have engaged in risky behavior, propping up "the system" is also bailing out bad actors.

In the debate over tighter regulation, complex issues can be obscured by debates that may be largely semantic. Case in point: A politically important compromise in the Senate in recent days has been to remove what Republican critics called a $50 billion "bailout fund."

Republicans' concern was that the fund's existence would make firms conclude that more bailouts are on the way. A fair point, but other provisions also may encourage banks to expect aid.

With or without the fund, the reform bills call for the industry to bear any direct bailout costs. And for taxpayers and other Americans, the real cost of a crisis is not bailouts, but recession and joblessness.

Related:

Financial reform bill 101: what it means for consumers

Financial reform bill takes shape as decision looms on 'Fed audit'

Obama to Wall Street: financial reform is in your interest

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