Economy & Trade, Financial Crisis, Headlines, North America

U.S.: Secret Bailouts for Giant Failing Banks of the Future?

Adrianne Appel

BOSTON, Oct 30 2009 (IPS) - Big banks will not be forced to downsize and the public will be the last to know when they fail, a controversial bill unveiled by U.S. Treasury Secretary Timothy Geithner and Congressman Barney Frank proposes.

The long-awaited “too big to fail” legislation was roundly criticised during a congressional hearing Thursday as a nod to the biggest financial firms in the U.S.

“This is TARP on steroids,” said Rep. Brad Sherman, a Democrat, referring to the U.S. Treasury programme that gave trillions to financial companies.

The legislation was called for by Congress and President Barack Obama in the wake of the trillions recently spent by the U.S. government to rescue behemoth financial institutions like AIG and Bank of America, out of fear that their failure would bring down the whole financial system.

“Taxpayers simply must not be put in the position of paying for losses incurred by private institutions,” Obama said in a letter to Frank this week praising the legislation. “When major financial firms fail, government must have the ability to dissolve them in an orderly way, with losses absorbed by equity holders and creditors.”

Leading up to the bill, many economists on the left and the right said the only way to protect the finance system and consumers is to break up the gargantuan finance companies that now exist. Former Federal Reserve chairmen Paul Volker and Alan Greenspan, and former labour secretary Robert Reich all favour this approach.

As a result of the mergers and acquisitions during the past 18 months, Bank of America, CitiGroup and J.P. Morgan Chase now control about one-third of U.S. finance and bank business, analysts say.

“The Wall Street giants should be split up – and soon,” Reich said.

But the bill does not propose breakups, and instead takes a more “subtle” approach, current Federal Reserve Chairman Ben Bernanke told reporters.

Reich says this is a mistake. U. S. Treasury Secretary Timothy Geithner and financial advisor Lawrence Summers “continue to bend over backwards to make Wall Street happy, and in doing so continue to risk the credibility of the president, as well as the long-term financial stability of the system,” Reich said.

The bill probably will not be sorted out in time for the next round of bailouts. GMAC, the former financial arm of General Motors, is in line for its third government handout and CitiGroup is reportedly still on shaky ground. GMAC has already received 12.5 billion dollars from Uncle Sam and CitiGroup, 45 billion dollars.

GMAC, like other businesses, made itself eligible for a government bailout by purchasing a bank last year, and becoming a bank holding company.

The bill was criticised at a Thursday hearing by Frank’s House Finance and Banking Committee, by Democrats and Republicans, and even an Obama administration official.

Sherman said the bill would grant the Federal Reserve and U.S. Treasury the authority to bail out institutions in unlimited amounts without the approval of Congress.

“We are given no authority to limit the biggest institutions but we are allowed to help them when they fail?” said Democrat Rep. Paul Kanjorski, calling for the bill to allow downsizing of big financial firms.

Under the bill, sprawling bank-holding companies would continue business as usual, unless in trouble. The bill would not allow any new bank holding companies to be created.

A new government oversight council, led by the Treasury secretary, would watch for danger signs in the finance system as a whole, and identify firms at risk of failure, referred to as “the list” by Frank. The firms would be subject to heightened regulation, and monitored closely by the Federal Reserve. Investors and other business parties, and possibly Congress, would be alerted to firms on “the list”, but not the public.

“Even a cursory reading shows that the administration has chosen to continue its failed policy of costly taxpayer bailouts orchestrated behind closed doors by officials at the Treasury and the Federal Reserve,” said Republican Rep. Spencer Bachus.

“The legislation keeps the names of the ‘too big to fail’ firms secret. It allows the picking of winners and losers behind closed doors,” said Republican Rep. Randy Neugebauer.

If a firm fails and can’t pay back its loan, the FDIC would step in and attempt to dismantle it in an orderly way, outside of bankruptcy. Solvent firms of 10 billion dollars or greater would be assessed a tax to pay for the cost of the failed institution.

Sheila Bair, chief of the Federal Deposit Insurance Corporation, the entity that regulates community banks, criticised the bill.

“The oversight council described in the proposal currently lacks sufficient authority to effectively address systemic risks,” Bair said at the hearing. It should be led by a presidential appointee, not the Treasury secretary, she said.

A very controversial part of the bill is the authority that would be granted to the Federal Reserve to act apart from the council and Congress, and to bail out troubled firms or solvent firms with unlimited amounts of U.S. government funds, with quiet approval from the Treasury.

The Federal Reserve is a quasi-government entity, that helps direct U.S. monetary policy but is governed by its members – private banks and financial firms. It operates with great secrecy, and is not required to disclose the loans it makes to firms, estimated to be in the trillions during the past two years.

Americans for Financial Reform, a broad coalition of labour and consumer organisations, opposes the bill because of the greater autonomy granted to the Fed, Richard Trumka, president of AFL-CIO trade union, told Frank. The Fed was in charge during the meltdown of the past 18 months, Trumka said.

“Instead of repeating and deepening the mistakes associated with the bank bailout, Congress should be looking to create transparent, fully publicly accountable mechanisms for regulating systemic risk and for acting to protect our economy in any future financial crises,” Trumka said.

The committee may vote on the bill next week, though no similar legislation has yet been drafted in the Senate.