‘Tough’ reform prevents a bubble

In financial reform, the industry must pay for its own failures.

Last week, the Federal Deposit Insurance Corporation closed eight small, insolvent banks, bringing the yearâÄôs total to 50. They sold most parts to healthier banks; losses were covered by banking industry insurance payments to the FDIC. The closed banksâÄô owners were wiped out and management was fired. Such efficient action to protect depositors and taxpayers stands in stark contrast to the treatment of the largest financial institutions. In the fall of 2008, with markets in a tailspin and regulators blushing, the only options available were to let them fail or to bail them out. Seeing the wreckage caused by the relatively small collapse of Lehman, they chose the latter. There is a third option, akin to the FDICâÄôs power to shutter failing deposit banks. This option would allow regulators, the Federal Reserve and a panel of bankruptcy judges to methodically wind down large firms teetering on insolvency. Republicans pushed back, erroneously calling it a âÄúpermanent bailout fund.âÄù At first glance, itâÄôs a believable claim: In the past decade, Washington, D.C., has absorbed $5 billion in financial sector influence. But the âÄúwind downâÄù money comes from the banks this time, not Uncle Sam. Chairman of the Senate Banking Committee Sen. Chris Dodd, D-N.H., rebutted, saying, âÄúOur bill stops bailouts by imposing … tough new requirements on Wall Street firms.âÄù âÄúToughâÄù reform must also force Wall Street to abide by sane capital requirements: To avoid more bailouts, avoid another bubble; to avoid a bubble, require financials to keep a realistic ratio of debt to wealth. A capital requirement of 10:1 might not be much fun, but it prevents default when assets lose up to 10 percent in value.