By PHILLIP SWAGEL
Imagine a future in which Sen. Chris Dodd’s financial reform bill was law and a firm like AIG or Lehman Brothers failed. Without a vote of Congress, the government could guarantee the firm’s debts or put money into the failing firm to keep it afloat and reduce the hit taken by creditors such as banks and pension funds that lent the firm money.
The temptation will be huge; after all, no government official will want to be blamed for allowing another post-Lehman meltdown. But so is the danger that risky behavior and bailouts will become more common.
This scenario is a key defect in the Dodd bill that the Senate has begun to debate. True, the shareholders of a failed financial firm would be wiped out, but creditors—the people who lent it the money that got it in trouble in the first place—will be bailed out. And this has real consequences, because if market participants know they can be rescued for imprudent behavior, they will likely behave more imprudently.
In coming days and weeks, as amendments to the Dodd bill are publicly offered and private negotiations proceed, removing the $50 billion bailout fund would be a good start.
