Protecting taxpayers from bank bailouts: It's a long way from law

While reports today indicate that GMAC is in talks for a third round of bailout money from the government, Congress and the Treasury Department finally developed draft legislation to make sure that "the taxpayers are never again called upon to take responsibility for Wall Street's business decisions." At least that's what they say in a press release announcing the draft legislation to address systemic risk for "too big too fail" institutions.

We can only believe those words when we see the final version of the bill that passes Congress. As I've previously written, the bill does give the federal government the right to seize control of troubled financial institutions that are deemed "too big to fail," fire their top executives, wipe out shareholders and rewrite the institution's loan agreements, but I suspect that won't last through the legislative process. It's too drastic a change from current bankruptcy law, and you can be certain that bondholders and other interested parties will quickly tone it down.Another key provision to protect taxpayers is the creation of a Resolution Fund to spread the cost of bailing out a large financial institution with assets over $10 billion among a broad range of financial companies, rather than having the taxpayer foot the bill. This fund will be built using assessments on financial companies with assets over $10 billion.

Another big change will be the creation of the Financial Services Oversight Council to monitor systemic risks. At first the Federal Reserve wanted that power, but Federal Reserve Chairman Ben Bernanke gave up that fight at the beginning of October when he announced support for the council, as well as the consumer financial protection agency. Once that internal battle was over, Treasury got to work with House Committee on Financial Services Chairman Barney Frank to jointly draft a fix for monitoring, and acting when necessary, to deal with banks that are too big to fail.

The council will identify financial companies and financial activities that pose a threat to financial stability. These companies will be subject to heightened oversight, standards and regulation. The council will also be responsible for greater scrutiny of systemically important financial market utilities and payment, clearing and settlement activities.

Another critical area that will be addressed is removal of the loopholes in regulations that allow financial institutions to shop for the easiest watchdog. The council will improve communication among regulators and make sure to close these loopholes. Current nonbank banks, industrial loan companies and similar companies that engage in commercial activities but are not currently subject to bank holding company regulation will not have to divest. But they will have to restructure, creating a bank holding company to house all financial activities. They'll also face limits on transactions between the bank holding company and any commercial affiliates.

You can review the full bill at the House Committee on Financial Services website, but don't get too attached to any of its provisions. The legislative process is just starting, and I can guarantee that lobbying for changes will be intense among financial institutions and all interested parties. We can only hope that in the end taxpayers are truly protected from ever having to bail out Wall Street again.

Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies.

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