Wall Street reform: Ending the bailouts

WASHINGTON (CNNMoney.com) -- Everyone in Washington says they hate Wall Street bailouts.

So when it comes to legislation reforming Wall Street, part of the mission is to avoid the kinds of bailouts that occurred during the financial crisis. Whether the bills currently before Congress accomplish that is the latest battle to roil Washington.

Democrats, in separate Senate and House bills, say their proposals would prohibit bank bailouts from ever happening again. Many Republicans say the bills would lead to even more bailouts.

Three areas of contention in the bills underline the bailout dispute.

Resolution authority: In the Wall Street overhaul bills, lawmakers would create a pot of money funded from a tax on the largest banks - a $50 million fund in the Senate bill and a $150 billion fund in the House measure passed in December. Federal regulators would use the money to pay the costs of breaking up or liquidating giant financial firms whose collapse threatens the financial system - solving the so-called "too big to fail" problem.

Democrats say that because banks - and not taxpayers - pay into the fund, any action taken is a winding down of a company and not a bailout.

"The idea of requiring these institutions to put up money in advance, so that if they fail, they end up paying for the cost of unwinding it," said Sen. Christopher Dodd, D-Conn., who runs the banking committee. "Who would object to that? Who is objecting to this?"

But many Republicans scoff at this idea. They say any government action, no matter what the funding source, is a bailout, since it allows government to even temporarily prop up failing firms that should fail on their own.

"Some people think that as long as the government doesn't end up paying for it, it's not a bailout. I think that's just wrong," said Philip Swagel, a visiting professor at Georgetown University, who was an assistant Treasury secretary during the George W. Bush administration.

Conservatives worry that creating a big new federal power to intervene on Wall Street will create an implicit government guarantee of help. So Wall Street banks may continue to make risky bets, working on the assumption that they may get something out of it.

"What you're trying to do is give the government enough power to intervene when it needs to, without making it seem so likely that they'll intervene," said Doug Elliott of the Brookings Institution, a research organization. Elliott believes the Dodd bill strikes the right balance.

Paying creditors: Lawmakers want creditors and shareholders to bear the brunt of losses when a firm is going through a government-imposed wind down.

In the Democrats' Senate and House bills, the federal government gets first crack at any money from assets sold in the unwinding process. And creditors aren't supposed to recover any more of their losses in a government action than they would in a bankruptcy, according to Raj Date, executive director of the Cambridge Winter Center for Financial Institutions Policy, a financial think tank.

But the legislation allows regulators to pay some creditors more if that would prove beneficial to the government. The FDIC says it needs this discretion, and uses it all the time when it takes over commercial banks.

Regulators want to be able to set up "bridge banks" to pay technology service providers, property upkeep and others to keep the lights on at the Wall Street firm, to "maintain the franchise value as the institution is resolved," said Andrew Gray, an FDIC spokesman.

Conservatives say that Wall Street banks are fundamentally different from commercial banks that take deposits. They believe Wall Street assets and liabilities are too big and too complicated for a government regulator. And they don't want any life breathed back into them, even temporarily.

The banking industry, in particular, would prefer a judge be the one making special exceptions and using discretion, rather than a federal regulator who could be susceptible to political pressure.

"Our view is that pressure of various kinds could result in funds finding their way to bailout creditors or others," American Bankers Association spokesman Wayne Abernathy said.

Sen. Bob Corker, R-Tenn., who crafted much of the unwinding legislation, has called such exceptions "loopholes," although he has also said they can be fixed "in about five minutes."

Emergency loans from the Fed: The Democrats' bills would curtail, but not eliminate, the Federal Reserve's ability to make emergency loans. Some consider this lending power a way to bail out firms, but others believe the Fed's role as lender of last resort is key to the nation's financial security.

Both the House and Senate bills would greatly narrow the emergency lending powers, installing new checks such as getting approval from the Treasury Secretary and preventing loans to prop up a single failing company.

However, the Federal Reserve can still make loans "for the purpose of providing liquidity to the financial system," according to the Senate bill - language that triggered Republican criticism, led by Senate Minority Leader Mitch McConnell, R-Ky.

Republicans think the bill gives the Fed too much leeway to make loans to sectors of the economy or groups of companies that are faltering. Key GOP congressional aides explained Thursday that they recognize the Fed needs some emergency powers, but they believe the Senate bill is too generous.

Even FDIC Chairman Sheila Bair, who generally supports the reform bills before Congress, has some concerns that the Fed's emergency powers are not limited enough and that they should be "subject to the same heightened standards as the FDIC's emergency support program," FDIC spokesman Gray said.

Sen. Mark Warner, D-Va., stressed on the Senate floor Wednesday that the Fed could no longer help specific institutions. He added that some aspects of the Fed's loan-making powers are "an important tool," because they can prevent turning a situation that inhibits loan making into one that threatens the survival of the financial system.

Next step: Senate Majority Leader Harry Reid, D-Nev., said he plans to bring the Wall Street overhaul bill to the Senate floor next week. Top Republicans are counting their members to see if can muster 41 votes to delay the bill.

In the meantime, Dodd and the ranking Republican on that panel, Sen. Richard Shelby, R-Ala., are deep in negotiations over differences.