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Obama’s no-more-bailout stance may be tested

Speaking on the anniversary of the start of the meltdown, President Barack Obama warned bankers not to “expect that next time, American taxpayers will be there to break their fall.”
/ Source: The Associated Press

Speaking on the anniversary of the start of the financial meltdown, President Barack Obama warned bankers not to “expect that next time, American taxpayers will be there to break their fall.”

That’s not a serious threat.

Obama’s plan for overhauling the financial system creates a new category for the largest banks, those whose failures would threaten the wider financial system. These “Tier I” companies will face stricter rules designed to limit how much risk they can take and how much damage they would do if they fail.

But when big banks do fail, taxpayers still will be on the hook. Not rescuing these “systemically important banks” would, by definition, threaten the broader financial system.

“Big banks are always going to be too big for the government to let them go under in the middle of a big financial crisis,” said Douglas Elliott, a former investment banker and senior fellow at the Brookings Institution who supports most of the Obama plan. “All we can do is protect ourselves by making those banks stronger, so there’s a lower chance they’ll go under.”

Obama spoke at Federal Hall in the heart of Wall Street on Monday, on the first anniversary of the collapse of Lehman Brothers. A number of rules proposed by Obama would help make bank failures less likely. The banks would have to hold more capital on their books, limiting how much risk they can take.

The banks would face stricter supervision from the Federal Reserve — a proposal that faces stiff opposition from senators, including Banking Committee Chairman Christopher Dodd, D-Conn.

Banks with assets of more than $10 billion would pay more fees to regulators to finance the stepped-up oversight.

But the banks’ failures still “would pose a threat to financial stability,” the Obama regulatory plan says.

“They’ll say, ’Look, you regulated us and held us to a higher standard, and now we’re failing and it’s your job to clean it up,”’ said Simon Johnson, a former economist with the International Monetary Fund, now a professor at the Massachusetts Institute of Technology’s Sloan School of Management. “It’s the kind of regulation where government is on the hook when things go wrong.”

The administration plan does include a new way of winding down failed institutions. It will be modeled on the Federal Deposit Insurance Corp.’s practice of taking over smaller, failed banks and selling off their assets.

Under the proposal, financial companies that falter usually will be taken under the FDIC’s wing while their business relationships are dissolved. That will help minimize the disruption caused by disorderly failures like Lehman’s.

The administration’s plan would “protect the economy while imposing losses on shareholders and creditors of a troubled firm,” said Treasury Department spokesman Andrew Williams. He said the proposal requires that any money spent on bailouts be recovered through fees levied on the financial industry.

But there’s no reason to think taxpayers won’t be tapped to provide emergency financing for any bank whose failure could upend the financial system.