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Obama Presses for Financial Overhaul as Senate Fight Looms

April 14, 2010 at 12:00 AM EDT
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President Obama made a case for overhauling the nation's financial system today, in an attempt to win action in the Senate. Jeffrey Brown talks to financial experts for more on a reform bill's prospects.

JIM LEHRER: The president stepped up the pressure today for major reforms in regulating the financial industry. He called in congressional leaders in an effort to win action on a Senate bill.

Jeffrey Brown has our story.

JEFFREY BROWN: The White House was the setting this morning, as President Obama shifted focus from health care and nuclear security back to financial reform. He told the assembled congressional leaders the issue remains urgent.

U.S. PRESIDENT BARACK OBAMA: I think all of us recognize that we cannot have a circumstance in which a meltdown in the financial sector once again puts the entire economy in peril, and that if there’s one lesson that we’ve learned it’s that an unfettered market where people are taking huge risks and expecting taxpayers to bail them out when things go sour is simply not acceptable.

JEFFREY BROWN: With the Senate preparing to debate a reform bill, the president insisted that the measure on the table and a House bill that already passed would put an end to federal rescues.

BARACK OBAMA: I am absolutely confident that the bill that emerges is going to be a bill that prevents bailouts.

JEFFREY BROWN: But Republicans at the meeting were unmoved. And, afterwards, Senate Republican Leader Mitch McConnell claimed the bill would do just the opposite.

SEN. MITCH MCCONNELL, R-Ky., minority leader: If you look at it carefully, it will lead to endless taxpayer bailouts of Wall Street banks. That is clearly not the direction the American people would like for us to go, and also not the direction Senate Republicans would like to go.

JEFFREY BROWN: As written, the Senate legislation creates a resolution authority designed to wind down failing financial firms. Banks would contribute to a $50 billion fund to cover those costs. It would also toughen oversight of banks and capital markets, and it would increase consumer financial protection.

The president called especially for strong new regulation of derivatives, the complex financial products that triggered huge losses that rocked insurance giant AIG and major banks, when the housing market collapsed. And he voiced continued hope of passing a bipartisan package this year.

But, back at the Capitol, Democratic Senator Chris Dodd, a chief writer of the proposed new rules, charged Republicans are spreading outright falsehoods.

SEN. CHRISTOPHER DODD, D-Conn: My patience is running out. I have extended the hand. I have written provisions in this bill to accommodate various interests. But I’m not going to continue doing this if all I’m getting from the other side is a suggestion, somehow, that this is a partisan effort.

JEFFREY BROWN: For his part, without offering new details of potential compromise, Republican Leader McConnell said his side is willing to work on the issue.

SEN. MITCH MCCONNELL: So, I think the solution to this is for the bipartisan talks to resume between Chairman Dodd and Ranking Member Shelby and others, and hope that we can get back together and address this very important issue on a bipartisan basis.

JEFFREY BROWN: Despite the tension, Treasury Secretary Timothy Geithner predicted, ultimately, the bill will find broad support.

TIMOTHY GEITHNER, U.S. treasury secretary: I think we’re very close. We’re, as I said, open to ideas. Our test is going to be, though, what’s going to work, what’s going to be in the public interest.

JEFFREY BROWN: Senate Democratic leaders said they will try to pass a final bill in the coming weeks, if necessary, without Republican help.

And we have our own analysis and debate now.

Felix Salmon writes a finance and economics blog for Reuters. Peter Wallison of the American Enterprise Institute worked on deregulation issues during the Reagan administration. He’s now a member of the Financial Crisis Inquiry Commission, but is expressing his own views tonight.

Let’s focus first on this issue upon of limiting bailouts or creating them.

Felix Salmon, what do you see here that would help prevent future federal bailouts?

FELIX SALMON, Reuters: There’s a whole series of things which will prevent bailouts. For one thing, there’s a new council which is charged with making sure that there are no big systemic risks to the financial system and to economy from the banking and financial sector.

For another thing, the biggest banks and financial institutions are going to have much higher capital levels, which they need to have, and much lower leverage. They need to be inherently much less dangerous than they were before this crisis.

And, then, finally, all of those big banks are going to be paying into the $50 billion fund, which will exist in case anyone does get close to failing to wind them down in a way which won’t cause horrible dominoes, like we saw in the wake of the Lehman Brothers collapse, which was very chaotic, and will instead be a relatively orderly resolution, where the investors in that company and the bondholders in that company take the pain, and everyone else is more or less OK.

JEFFREY BROWN: Well, so, Peter Wallison, and the Republican argument seems to be that there is still some kind of implicit federal guarantee of government support that could lead to more bailouts. What do you see?

PETER WALLISON, American Enterprise Institute: Well, the issue isn’t really where the money is coming from. It’s not whether it comes from the taxpayer or not. It’s whether the government has a fund with which to bail out very large financial institutions.

And the Dodd bill contains a $50 billion fund that is intended to do exactly that. So, what happens here is that, when creditors look at a very large financial institution, they will say, well, I’m much more likely to be repaid if there’s a $50 billion fund than if this thing has to go to bankruptcy.

So, they will prefer to lend to these very large institutions. And that is what is very dangerous about this.

JEFFREY BROWN: But if the fund is being — is coming from the financial institutions themselves, doesn’t that create the kind of disincentive to…


JEFFREY BROWN: … pick it up from there. I mean, that’s who’s paying, instead of the taxpayers, this time.

PETER WALLISON: Well, it’s not — see, that’s the point that I think Senator Dodd has been focusing on. And that is that this is not bailout because the money isn’t coming from the taxpayers.

But the important question is not whether the fund is taxpayer money or not. It’s what it says to the creditors of these institutions about whether they are going to be bailed out if the institution is taken over.

And if the fund exists, no matter who creates that fund, that’s what it will be used for. And once it exists, of course, there will be pressure on the government to rescue everybody who is in trouble, because people will say, well, you have the fund. Why didn’t you rescue this institution?

And, so, we will have this continuous process of bailing out large financial companies.

JEFFREY BROWN: Mr. Salmon, what is your response?

FELIX SALMON: My — my — this is just not true.

The — the fund doesn’t bail out creditors. Creditors have to take losses, and the fund is there to make sure that it backstops the — the creditor losses in case there are losses over and above that. And of course it matters that the fund is coming from the financial institutions.

And the whole point of the fund is that it is a wind-down situation. It’s only used when the bank or the financial institution is failing and is going to be closed and is going to disappear from the face of the earth, and all of the management is going to be fired. That is not a bailout.

That is — no one is going to say, come in and use your fund to bail us out, if it involves the institution being closed and the management being fired.

JEFFREY BROWN: What is the — the — the bailout or not a bailout, I mean, partly, this is a terminology thing.


JEFFREY BROWN: But what’s the alternative to having some sort of controlled unwinding, somebody watching it to allow it to fail in a controlled way?

PETER WALLISON: Well, if you — if you want to have it fail in a controlled way, you set up a fund, and you use the money to pay off the creditors.

The whole point about not sending these institutions to bankruptcy is that you will be able to pay off the creditors, because, if you don’t pay off the creditors, then the chaos that everyone is afraid of will occur. The creditors have to be paid. And that’s the bailout part.

Now, once the creditors are paid, then the market understands the game. And the game is that the very large financial institutions will be bailed out; the smaller ones will not be. And that will change our financial system.

JEFFREY BROWN: What about the other part that Mr. Salmon started with, the — before we get to the problem point…


JEFFREY BROWN: … new regulations that are — that would be put in place, the Federal Reserve would have more oversight to — to prevent institutions from getting into trouble in the first place?

PETER WALLISON: That’s actually the most dangerous part of this bill.

JEFFREY BROWN: The most dangerous?

PETER WALLISON: The most dangerous, yes, because what it does is, it suggests that these companies are too big to fail.

Senator Dodd says they’re trying to eliminate too big to fail, but once you establish that these companies are going to be regulated by the Fed, for what reason? Because, if they fail, there will be some sort of chaotic result. But what that really says is, they’re too big to fail. And so they will be bailed out.

JEFFREY BROWN: So, it’s better to have not — no regulation?

PETER WALLISON: Sure. It’s better to send these institutions to bankruptcy. That’s been the — the central problem here, that government has been trying to set up a resolution process that evades bankruptcy.

Bankruptcy is the way these institutions are made not too big to fail.

JEFFREY BROWN: Mr. Salmon, you see these regulations in a different light.


Well, for one thing, there’s no such thing as a bankrupt bank, because banks are leveraged institutions by their very nature. No one is going to lend to a bankrupt bank. Banks have to be liquidated. They can’t operate in bankruptcy. You could have General Motors operating in bankruptcy, but you can’t have Bank of America operating in bankruptcy.

So, you need some kind of a resolution authority. You need to be able to step in and take them over. And, in general, you need to have an ability to keep the financial system from sinking.

It’s all well and good to say that the Federal Reserve oversight means — is an admission that banks are too big or too interconnected to fail. And, to a certain extent, that’s true. But, as long as you have a way of dealing with it which doesn’t involve massive taxpayer bailouts and doesn’t involve huge systemic consequences for the economy as a whole, that’s a pretty good way of going forwards, I think.

JEFFREY BROWN: Mr. Wallison, I mean, there are many other parts of this. We can’t — we can’t go through each one…


JEFFREY BROWN: … but the derivatives, a clearinghouse to create derivatives, a consumer agency. Are they all wrapped up in — in your sense of over-regulating these institutions and keeping them from innovation or — or holding down credit, ways that would affect them that way?

PETER WALLISON: No. Actually, the most important issues are this question of federal regulation, Federal Reserve regulation of these large financial institutions.

And, incidentally, we’re not talking about banks, per se, that is, the deposit-taking institutions. We’re talking about non-bank financial institutions, like investment banks, securities firms, insurance companies, hedge funds. Those are the institutions that are now not subject to this kind of regulation and would be made subject to it.

We know what happens when a bank fails. The FDIC has the power to take it over and resolve it. We’re talking about all kinds of other institutions throughout our society.

JEFFREY BROWN: I’m wondering, though, because you’re here in Washington, and you’ve been part of this — the politics of all this.


JEFFREY BROWN: Is there a compromise that one can see between the two sides right now?

PETER WALLISON: Yes, I — personally, I would say that there is a possible compromise here. There can be some sort of consumer financial protection agency in some sort of form.

But the things that strike me as most significant to the Republicans are the two issues that I have talked about. And that is setting up a resolution process that really proposes to bail out or take over all these institutions over time, setting up a continuous process of doing that, and the Federal Reserve’s regulation of what are called systemically significant companies.


PETER WALLISON: If that were eliminated, then I think this bill could move.

But these are the things, I think, the administration wants most.

JEFFREY BROWN: And, Mr. Salmon, in our last minute, what — what — how do you see the politics and potential for compromise?

FELIX SALMON: Well, if what Mr. Wallison is saying, then there’s very little — is true, then there’s very little potential for compromise, because, clearly, you need regulation of the financial system, because the financial system, as even someone like Alan Greenspan has admitted many times now, is obviously incapable of regulating itself.

And if the Republicans are refusing to admit that any kind of regulation is necessary or desirable, then I don’t think that negotiations are going to get very far.

JEFFREY BROWN: All right, well, we will leave it there and watch.

JEFFREY BROWN: Felix Salmon and Peter Wallison, thank you both very much.