According to a Reuters report, French economy minister Christine Lagarde today applauded President Obama’s call for more regulation of the U.S. financial sector. “I am delighted that [the] president of the United States is following our lead,” she added.

In a possibly related story, the Dow Jones yesterday dropped by 213 points, the largest one day drop since last October.

As early as today, the House is set to approve Rep. Barney Frank’s (D-MA) financial regulation bill intended to prevent future Wall Street bailouts by granting regulators sweeping new powers to control firms deemed “too big to fail.” But as Heritage Senior Research Fellow David John explains below, the Frank bill actually encourages future bailouts by signaling to markets that the targeted firms guaranteed against failure, thus enabling risky business decisions. Worse, by empowering the FDIC to seize and close failing financial institutions, while also establishing a fund enabling the FDIC to accomplish these tasks, the Frank bill does not end TARP, it creates a permanent TARP. Watch:

There is a better alternative: add a new chapter to the bankruptcy code that is explicitly designed to meet the special circumstances of “too big to fail” financial institutions.

The financial reform bill that is currently before the House would give regulators virtually unlimited power over “too big to fail” financial institutions. Those are large, complex and usually international entities whose failure could cause such a shock to the interconnected financial system that others would be endangered. Under the House bill, if one of them does get into trouble, the FDIC would step in to reorganize and run the financial institution until it could be closed or sold. The FDIC has done an acceptable job closing small and medium banks, but does not have the expertise necessary to deal with such complex companies.

A better approach – described here and here — would be to add a new chapter to the bankruptcy code that is explicitly designed to meet the special circumstances of “too big to fail” financial institutions. Properly structured, the new chapter would make it easier for large financial firms to be closed in an orderly way that reduces the potential for systemic risk. It would not give regulators virtually unlimited powers and would free the process from political interference by giving control to an unbiased court system that already has extensive experience with complex modern firms. By creating an open process controlled by an impartial judiciary guided by established statutory rules, financial firms, investors, taxpayers, and others would have the advance knowledge that large financial firms that were once known as “too big to fail” can now be closed if necessary without risking disaster.

This is one of several interesting ideas contained in a substitute to the House financial reform bill that will be proposed by Rep. Spencer Bachus (R-AL) and several other legislators. Bankruptcy is a far better way to deal with “too big to fail” financial institutions than any other alternative.

Creating a new “Consumer Financial Protection Agency” (CFPA), as proposed in the financial regulation bill now before the House, would raise costs for consumers, reduce the number and type of products available to them, increase the micro-management of financial services firms, and greatly increase the confusion caused by differing and conflicting consumer laws in the different states.

A far better approach has been proposed as an amendment by Rep. Walter Minnick (D-ID). His amendment would coordinate the consumer activities of existing state and federal financial regulators by creating a coordinating council designed to promote equal standards of consumer protection.

Critics of the current regulatory system justify the need for a CFPA by citing instances where different agencies applied different regulatory standards to similar products, and pointing to misleading products or unregulated entities that took advantage of consumers. But these problems could just as easily be solved by a coordinating council as by creating a massive new regulator. The council would be managed and staffed by the agencies with an oversight panel of outside experts to monitor its activities and ensure that coverage is universal.

As we have written in the past, the CFPA proposal is filled with poorly considered departures from existing law and practice that are as likely to damage consumers’ interests as improve them. Giving any agency such wide powers makes little sense, and encouraging the individual states to create their own higher standards will damage the national market in financial services. Congress should avoid the bad policies contained in the proposed CFPA. The same goals supported by those who propose the creation of a new agency can be better achieved through a coordinating council of existing regulatory agencies. There is no need for a massive new agency when existing agencies could work better, faster, and at little additional cost.

Just as the housing market is showing definite signs that it is stabilizing after a lengthy drop in housing prices, the House of Representatives is about to vote on proposal that would destabilize it once again while also raising the cost of mortgages for future home buyers.

The proposal – to be offered by Rep. John Conyers (D-MI) as an amendment to the financial regulation bill now before the House -would allow bankruptcy judges to reduce the principal owed on a mortgage, a practice often referred to as a “cramdown.” Judges would also be able to reduce interest rates or lengthen the term of the mortgage.

This is a huge policy mistake that would help only a few people while raising the cost of borrowing for thousands of moderate-income and first-time homebuyers. As we warned back in February, and expanded upon in April, when the Senate debated and ultimately defeated similar language that limited cramdowns to specific situations:

…no matter how strict those limits seem, they do not alter the fundamental problems caused by mortgage cramdowns. Even with these limits, this proposal would still increase the cost of homeownership and especially hurt both first-time homebuyers and families with low to moderate incomes. It would also deal a blow to banks and other lenders at a time when many are faltering. Worst of all, allowing bankruptcy judges to rewrite mortgages would prevent few foreclosures while imposing high costs on many who tried this approach.

Mortgage cramdowns were bad policy in both February and April. They are still bad policy, and would end up hurting the very people that supporters claim to want to help.

It’s been used to buy one car company, give another to union allies, punish non-union workers, undermine the bankruptcy code, enrich Wall Street at the expense of Main Street, keep unionized Zombie firms from dying, and generally terrorize the world economy. Now the left in Congress wants to use it again, this time as a slush fund for a third round of stimulus funding. The AP reports:

Democrats are looking to tap as much as $70 billion in unused funds from the Wall Street bailout to pay for new spending on roads and bridges and to save the jobs of firefighters, teachers and other public employees, officials said Thursday.

After talks with the administration officials such as Treasury Secretary Timothy Geithner, Democratic lawmakers are eyeing what remains from last year’s $700 billion financial rescue package as a way to finance job-related legislation. Two House Democratic aides said the figure could be as high as $70 billion.

The economic crisis that led to the adoption of TARP is over. Rather than serves as a necessary tool to avoid an systemic collapse of the financial system, TARP has become at best just another source of stimulus spending, and at worst a slush fund providing ready cash, with little or no accountability, to whatever industry or firm the Treasury Department chooses to support. The continued existence of TARP does nothing but enable the completely undemocratic and unaccountable Obama Czar State.

It is far past time to end TARP.

The House Financial Services Committee yesterday OK’d a key part of Barney Frank’s agenda for reform of the financial industry yesterday, voting to 31-27 to adopt his plan for so-called “too-big-to-fail” banks. The measure has been widely touted as providing a way to avoid future budget-busting bailouts of the industry.

That would be welcome. After a year of seemingly endless TARP bailouts and abuses, most taxpayers want to make sure that we never go down that road again. The problem: far from making future TARPs less likely, the Frank plan actually paves the road for more.

The bill would give financial regulators sweeping powers to control firms deemed “too big to fail” — those whose messy failure would put the entire financial system at risk. But this puts quite a lot of faith in regulators, who — having missed the last crisis — clearly have no magic ball for determining risk. As Heritage senior fellow David John points out, the authority will likely be used to limit newer lines of business instead of traditional ones, depriving consumers of the real benefits of financial innovation.

Making things even worse, the real life effect of the new powers will be to signal to markets that the targeted firms are supported by the federal government, and guaranteed against failure — thus leading them to take more undue risks, not more.

American Enterprise Institute scholar Peter Wallison summed it up well, saying: “Regulation doesn’t work,” adding: “And now they’re proposing regulation that doesn’t work for the entire financial industry.”

But the Frank bill doesn’t stop at regulation. It also would give the FDIC broad power to seize and close failing financial institutions, with limited court review of its actions. And most disturbingly, it would establish a fund for FDIC to use to resolve the affairs of firms it takes over. This is the final irony: Rather than avoid future bailouts, the proposal would facilitate them. As Wallison put it, Congress will have created a permanent TARP.

There is an alternative: bankruptcy, the time-tested procedure for dealing with economic failure. With a few minor changes, the bankruptcy code could be more effectively used by failing financial firms to allow them to fail in an orderly fashion, without threatening the broader financial system.

Congress should rethink its rush to regulation and more bailouts, and instead work to make failure a real option for financial firms. This is a task which is too big to get wrong.

In an era when legislation routinely exceeds 1,000 pages, the bill introduced by Sen. John Thune yesterday — at seven lines — doesn’t look like much. But looks can be deceptive. If adopted, those seven lines would guarantee the end of the Troubled Asset Relief Program (TARP), a critical first step toward putting federal finances, and the economy, back on the right track.

Under current law, TARP, which provided up to $700 billion to support troubled financial institutions, is scheduled to expire on December 31 of this year, but can be extended until October of next year if Treasury Secretary Tim Geithner call for an extension. Geithner hasn’t made any final decision yet, but all indications are that he will so request. The Thune bill, S. 2787, would take away this authority, ensuring that the program will end this year.

The Administration has argued that more time would be useful, giving them the flexibility to extend taxpayer support to troubled financial institutions (and auto manufacturers) if necessary. That’s not good enough. The economic crisis that led to the adoption of TARP is over. Rather than a necessary tool to avoid an systemic collapse of the financial system, TARP has become at best just another source of stimulus spending, and at worst a slush fund providing ready cash, with little or no accountability, to whatever industry or firm the Treasury Department
chooses to support.

It should be ended.

The Wall Street Journal reports:

The Obama administration, under pressure to show it is serious about tackling the budget deficit, is seizing on an unusual target to showcase fiscal responsibility: the $700 billion financial rescue.

The administration wants to keep some of the unspent funds available for emergencies, but is considering setting aside a chunk for debt reduction, according to people familiar with the matter. … On the $700 billion Troubled Asset Relief Program, the administration is considering a change that may appear to improve the fiscal situation. Agreeing not to spend a certain amount of TARP money will enable the White House, in its budget projections, to assume less money out the door and, therefore, less debt issued.

Foregoing any chunk of the remaining TARP funds would be a blessing. But budgeting rules aside, pledging not to spend additional money is not a real reduction spending. These promises are completely worthless if the administration insists on keeping “some of the unspent funds available for emergencies.” TARP was not created to be a White House slush fund.

End TARP. All of it.