The Bad Politics of the Liquidation Fund.

Today, the Senate is set to approve an agreement between Sens. Chris Dodd and Richard Shelby, the top Democrat and Republican, respectively, on the Senate Banking committee, to remove a $50 billion liquidation fund from the financial reform bill. While this may pave the way for Republican votes, it's worrying politics for the Democrats. Just look at this, from The Washington Post:

The tentative agreement to limit the chances of future bailouts came as the Senate delayed for another day its initial votes on amendments to legislation to address the causes of the 2008 financial crisis.

But, as we've discussed, the liquidation fund was not a bailout fund, and this move changes nothing about the legislation's mechanism for resolving to "too big to fail." Financial firms that fail will be taken over by the FDIC and liquidated. The fund simply gave the FDIC resources, just like the assessment it levels on smaller banks, to safely put big firms out of business. Now, the FDIC will use the exact same mechanisms to get rid of dying banks but use money borrowed from taxpayers instead of from banks. That's today's Republican victory.

"I think that some of the hypocrisy of the criticism is, if you had zero [initial funding for resolution], there would have been a critique: 'That means, oh my God, the Treasury's borrowing, the taxpayers won't get repaid,'" Sen. Mark Warner, who helped design the mechanism, told me last week. "You've got to keep the lights on long enough to put the institution into receivership and put it out of business, otherwise you'll have the equivalent of a financial run on the institution.

In conceding the measure, Democrats have opened themselves up to Republican claims that it was the GOP that saved the bill from becoming a permanent bailout, and judging by the Post's reporting, journalists aren't going to understand why that's wrong. It may be the deal that gets this legislation passed, but this concession could spell trouble for Democrats who hope to campaign on the strength of the financial-reform bill -- and Republican opposition to the same -- this fall.

-- Tim Fernholz

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