Back to drawing board for financial reform

 The same is true for financial reform legislation being rushed through the House Financial Services Committee. The Financial Stability Improvement Act of 2009 (to be reported as H.R. 3996) is a central part of Democrats’ plan to revamp America’s financial system. The only problem is that no one is in agreement on whether this bill will help or hurt the economy. Stakeholders and outside experts are still expressing concerns with the proposal.

In fact, the only agreement to come from this proposal has been the unlikely alliance between congressional Republicans and the editorial boards for The New York Times and The Washington Post. Each has made the point that the Obama administration and Financial Services Democrats should not rush this poorly conceived financial reform bill through Congress.   

Despite the massive changes to our financial system proposed by this legislation, recent news reports indicate that the bill could be on the House floor as early as mid-December. Two “in session” weeks is simply not enough time to fix this bill.

Before enacting legislation that causes the next financial meltdown, Congress should take a long look at the 2008 collapse and learn from the mistakes of the past.

For example, consider the question of how to handle collapsing institutions that allegedly are “too big to fail.” Economists and legal experts point to this mentality as the culprit that laid the groundwork for the September 2008 near-meltdown of our financial system.

Providing taxpayer-funded bailouts to collapsing institutions only encourages risky behavior. If Congress bails out Wall Street every time a gamble doesn’t pay off, what will serve as a deterrent for bad business decisions in the future?

But rather than putting an end to billion-dollar bailouts, Democrats’ proposal makes the “too big to fail” mentality a cornerstone of their financial reform legislation. The proposal gives special treatment to big firms, encourages risk, and gives government agencies the power to determine which firms live or die. In other words, the bill institutionalizes the mistakes that led to the 2008 financial collapse.

So why continue to reward bad behavior with taxpayer-funded bailouts? The authors of H.R. 3996 rest their approach on the myth that Lehman Brothers’ declaration of bankruptcy catalyzed the September 2008 crisis. They reject bankruptcy as a way to resolve troubled institutions and leap to institutionalize a federal bailout regime.

But leading economists and academics have concluded that it was not Lehman Brothers’ bankruptcy that caused the markets to panic.

Rather, it was the actions of the federal government that were at the root of the crisis.

The lesson of this history is not that America should avoid bankruptcy as a means to resolve failed financial institutions. It is that America should renounce government authority that lets federal agencies and government employees determine who lives and dies in our economy. There is a better way to reform our financial system.

In July, House Republicans introduced the Consumer Protection and Regulatory Enhancement Act (H.R. 3310), which puts an end to billion-dollar bailouts and establishes a new chapter of the Bankruptcy Code to resolve failed non-bank financial institutions. The Republican proposal prevents backroom political favoritism toward struggling institutions by putting responsibility in the hands of non-partisan bankruptcy courts. It also adds special provisions to help courts better handle the bankruptcies of these institutions so that future crises may be better averted.

To their credit, House Judiciary Committee Democrats have held two recent hearings at which Republicans and Democrats have begun to explore, side-by-side, the competing claims of House Republicans’ bankruptcy approach and the administration’s alternative ideas.

Regrettably, House Financial Services Committee Democrats have not agreed to join in the deliberations.  Instead, they have forged ahead with a premature markup of H.R. 3996, a bill that needs to go back to the drawing board.

Rather than overhauling America’s financial system overnight, we should first look for ways to improve the current system one carefully considered step at a time.
Smith is the ranking member of the House Judiciary Committee.