Taxpayers and the Dodd Bill

Last Thursday, at New York's Cooper Union, President Obama promoted the Senate financial reform bill while castigating its opponents. "Now, there's a legitimate debate taking place about how best to ensure taxpayers are held harmless," he said of Sen. Chris Dodd's legislation. "But what's not legitimate is to suggest that somehow the legislation being proposed is going to encourage future taxpayer bailouts, as some have claimed. That makes for a good sound bite, but it's not factually accurate. It is not true. . . . And nobody should be fooled in this debate."

Who is actually fooling the taxpayers about bailouts?

Last week, the Congressional Budget Office reported on the costs of the Dodd bill. It reviewed the budgetary effects of the bill's $50 billion resolution fund for the large nonbank financial firms--insurance companies, securities firms, hedge funds, bank holding companies, finance companies and others--that are considered "systemically important" and thus too big to fail. These firms, among others, would be assessed for the $50 billion fund, which Mr. Obama apparently believes will not be a cost to the taxpayers.

But in a footnote the CBO reported that "such assessments would become an additional business expense for the companies required to pay them." This means the assessments will be tax deductible, and place additional costs on other U.S. taxpayers to make up the difference in government revenue. Thus, even on the face of it, taxpayers will not completely escape the tax costs that are associated with this fund.

That is merely the beginning. The footnote goes on to say, somewhat elliptically, that "those additional expenses would result in decreases in taxable income somewhere in the economy, which would produce a loss of government revenue from income and payroll taxes." The meaning? A loss of government revenue from income and payroll taxes means a loss of the things that produce income and payroll taxes--that is, jobs.

This will occur simply because of the size of the fund. It doesn't account for the jobs that will be lost if large U.S. financial firms are priced out of foreign markets because of the costs of the resolution fund. Nor does it include the added costs that will be built into the products that taxpayers--as consumers--will buy. Thus the $50 billion resolution fund is not cost-free to the taxpayers.

If the Dodd-Obama resolution plan is ever actually put to use, the direct or indirect costs could be many times greater. For example, the bill authorizes the Federal Deposit Insurance Corporation to borrow from the Treasury "up to 90 percent of the fair value of assets" of any company the FDIC is resolving. Yet one institution alone--Citigroup--has assets currently valued at about $1.8 trillion. The potential costs of resolving it (not to mention others) would be spectacularly higher than $50 billion. In short, the $50 billion in the resolution fund is a political number--a fraction of what the FDIC is authorized to borrow and spend.

Why would this vast sum be necessary? The Dodd bill has one answer. It says that the FDIC "may make additional payments," over and above what a claimant might be entitled to in bankruptcy, if these payments are necessary "to minimize losses" to the FDIC "from the orderly liquidation" of the failing firm.

In other words, the agency would be able to borrow huge sums so that it could make more generous payments to creditors than they would receive in a bankruptcy. Generous payments to creditors would certainly make unwinding a firm "orderly"--but it would also encourage lending to the too-big-to-fail financial institutions while disadvantaging smaller, less favored institutions. This in itself will have a profound and destructive effect on competition.

Another possible purpose for the FDIC's borrowing power is to enable the agency to provide what it calls "open bank assistance." Here, instead of liquidating a failed bank, the agency keeps it in operation by paying off its creditors and avoiding the disruption a bank closing might entail. This practice is a straightforward bailout of all creditors, and it has been criticized extensively by Congress over the years. Yet here it is, back again, in the guise of an innocuous power to make additional payments to some creditors, coupled with virtually unlimited authority to borrow from the Treasury.

The FDIC certainly knows what to do with a failed bank, but it has no experience taking control of a giant financial institution like Lehman Brothers. It is authorized to borrow against the assets of the failed firm because eventually, in theory, the assets could be sold to repay the Treasury. However, the FDIC's operation of the failed firm could easily be unsuccessful, with losses quickly diminishing the value of its assets.

If that happens, the FDIC would have to impose an additional assessment on the financial industry--again adversely affecting the solvency and stability of those firms and causing the loss in employment, tax revenue and competitive position outlined above. Or the taxpayers would have to bear the loss, which could be enormous. Congress, accordingly, by passing the Dodd bill, will be courting serious taxpayer costs in the event of another financial panic.

These are only a few of the land mines that litter this 1,400-page bill, which Senate Democrats are seeking to rush to judgment with a cloture vote today. Does anyone really know what's in this bill, or what other unintended consequences will flow from its adoption? The American people may detest Wall Street, but imagine what they'll think of senators who vote for this bill because Mr. Obama has told them it will not impose any costs on taxpayers.

Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at AEI.

Photo Credit: Flickr user Randy Bayne/Creative Commons

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