As the 2008 financial crisis erupted, the government faced an urgent task: It had to quell fears that big banks might collapse. Such failures would have worsened the crisis and punished financial markets. So the government injected billions into Wall Street banks — infuriating taxpayers.
Now, everyone agrees on the need to avoid more taxpayer bailouts.
The overhaul of financial rules Congress is finalizing would more strictly monitor companies whose failures could put the system at risk. And it creates a way to dismantle such companies using industry money.
Here are some questions and answers about how the bill addresses bailouts:
Q: How would the bill make taxpayer-funded bailouts less likely?
A: It establishes a system for having the industry pay to close failing institutions — eventually. The House bill would tax big banks in advance. The Senate bill would recapture some money from bondholders and stockholders while a company was being shut down.
Yet under the Senate version, Treasury would use taxpayer money to help pay the costs initially. The industry would be taxed to repay Treasury.
These changes would apply to any company deemed so big or interconnected with other institutions that its failure could threaten the system. A council of regulators would decide which companies belong in this category and subject them to tighter regulation. It also would decide when a company was so weak it had to be closed.
Lawmakers agree the government can't let a financial giant collapse. Instead, they favor shutting it down in a way that avoids spreading fear. But doing so is hugely expensive. The company's financial obligations must be paid. Otherwise, other banks could panic.
Q: What would the changes mean for financial companies?
A: No matter how big, a failing bank could no longer necessarily expect a government bailout to keep it afloat. The bill aims to ensure that executives, shareholders and bondholders would share the financial pain if a bank failed.
The biggest banks would face tighter regulation by the council. So would big nonbank financial companies, which have avoided much federal oversight. These include hedge funds and insurers like American International Group Inc. Regulators would limit how much borrowed money these companies could risk. And they couldn't bet too much on any one type of investment.
Yet the banks would still enjoy favorable treatment. Regulators won't likely impose rules that would significantly shrink banks' profits. They would be reluctant, for instance, to limit the banks' size or force them to set aside much more money to cushion losses.
Some, like former Federal Reserve Chairman Paul Volcker, still think a financial crisis would lead the government to bail out banks.
Q: What would all this mean for ordinary people?
A: Taxpayers would be less likely to have to bail out banks. But the government would still have to risk taxpayer dollars under the Senate bill. And investors and pension funds would likely receive smaller dividends from big banks. Banks say the rules would reduce their profits, so they would have less money to return to shareholders.
Q: Where does the bill fall short?
A: It doesn't deal with foreign subsidiaries of failing banks. Uncertainty about such subsidiaries ignited panic after Lehman Brothers sought bankruptcy protection in 2008. The same could happen the next time a big bank teeters, even with the new rules in place.
There's no way to predict where the next bubble will inflate. If banks' bets sour all at once, a crisis is likely. Officials would do whatever they felt necessary to stop it — including giving more taxpayer-funded aid to banks. And if one bank failed, the government might have to hand money to other big banks, too, to keep a crisis from spreading.
The bill wouldn't end bailouts. It would make them less likely. And when they do occur, there's a better chance they would be paid for, at least in part, by the industry.
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