The timing of the Securities and Exchange Commission’s suit against Goldman Sachs may sway a few doubters. But U.S. financial reform is still partly a matter of faith. That’s one reason for the partisan bickering. Preventing future government bank bailouts relies heavily on Wall Street believing new rules will be enforced and failures will be allowed. For skeptics, though, the current Senate bill leaves enough wiggle room to induce doubt.
On paper, Democrats have a case to support their convictions. Their bill gives regulators new authority to wind down non-bank financial institutions. Tougher new capital and leverage requirements, as well as limits on risky activities, are supposed to make failures much less likely. A $50 billion bank-financed pool would fund resolution costs — though this whole idea may yet be dropped.
The trouble is, teetering banks and their creditors might still assume that while not too big to sue — as Goldman can attest — Uncle Sam would still think them too big and interconnected to fail. And that’s the problem for many Republicans. The bill tends to favor discretion over hard and fast rules. While the feds would have the authority to shut down institutions, for instance, they wouldn’tbe required to do it. History hints that regulators and politicians will continue to be tempted to rescue banks in a crisis, a point made by several regional Federal Reserve Bank presidents who doubt the efficacy of the Dodd bill.
And those new rules on capital, leverage and risky activities will be spelled out only later by a new systemic risk council. The government would be able to guarantee financial firms’ debt without any automatic triggering of the resolution process. And it’s still fuzzy how the challenge of winding down cross-border obligations and operations would be met.
There’s an argument for leaving less to officials’ discretion. If the threat of liquidation isn’t credible, banks will operate — and investors will treat them — as if a government backstop still existed.
If the Democrats’ reform bill passes in its current form, believers might then look for signs that it’s working. One would be that big banks can no longer fund themselves so cheaply. Especially since the recent crisis, big banks — with, say, more than $100 billion in assets — have been paying less interest on deposits and debt than smaller brethren.
If that too-big-to-fail subsidy doesn’t narrow significantly, Republicans would be justified in calling for a reform revival.