Bailout tax in new financial reform bill

Native Oregonian Greg Zerzan, former Acting Assistant Secretary of the United States Treasury, wrote an excellent review of the financial reform bill that was featured in teh Wall Street Journal.  Here is his review:

Greg Zerzan– On Monday the Senate Banking Committee passed the “Restoring American Financial Stability Act of 2010” on a 13-10, party-line vote. The legislation, drafted by committee chairman Chris Dodd, gives the Federal Reserve power to regulate any large company in America. When considered alongside similar legislation that passed the House of Representatives in December, at least part of the intent of the bills’ sponsors becomes clear. The current proposals for “financial” reform are stalking horses allowing government intervention into virtually every facet of the U.S. economy.

The bill that passed the House proposed to create a systemic risk regulator with the power to look into any company in America to determine if it poses a “threat” to the economy. If so, the bill gave the Federal Reserve power to order the company to segregate its financial dealings into a separate business to be regulated as a bank holding company. Remarkably the provision was aimed not just at financial firms like insurers or securities and investment businesses. Under its terms the bill would apply to potentially every large company in America, no matter its primary line of business.

Were there any thought that this was a mistake, or overly zealous legislative drafting, the plain language of the Senate financial reform legislation should dispel all doubts. The Senate bill is even more explicit in giving the Fed power to regulate commercial, non-financial services companies.

Under both bills a company that is deemed to be “financial” can be made subject to special examination and scrutiny by the systemic risk regulator. Whether or not a company is financial comes down to whether the company is engaged in “financial activities,” a term that comes from the Bank Holding Company Act of 1956 and includes things like lending money, holding assets of others in trust, investing in securities, trading derivatives, or even leasing real estate and offering certain consulting services. In short “financial activities” are so broadly defined as to include things non financial businesses do everyday like extending credit to customers and holding down payments on deposit, or even managing a company’s own investment portfolio.

The House bill contained an important if insufficient caveat for companies that were engaged in financial activities as part of their regular treasury operations, but even with this exception many of America’s leading manufacturers, retailers and service providers would potentially be roped into the new regulatory scheme. Under Senator Dodd’s draft the government’s reach is even less restrained: any company “substantially” engaged in financial activities can be made subject to regulation by the Federal Reserve as though it were a bank holding company. For the curious, what is “substantial” is to be determined by the Fed.

Despite non-binding staff explanations to the contrary, there is no mystery as to who is being targeted. Under the bill the Fed gets regulatory authority over bank holding companies with greater than $50 billion in assets, and “nonbank financial companies”. As the Fed already regulates bank holding companies the new twist is that non-banks become subject to Federal Reserve regulation for the first time. The language is unusually clear: if the new systemic risk regulator so chooses, any company engaged in routine business transactions can suddenly be deemed “financial” and subject to bank-like regulation.

The list of companies that might find themselves subject to new Federal Reserve regulation is as deep as the U.S. economy itself. An airplane manufacturer that holds customer down payments for future delivery, a large home improvement chain that invests its profits as part of a plan to increase revenues, and an energy firm that makes markets in derivatives are all engaged in “financial activities” and potentially subject to systemic risk regulation. Under the House bill, and even more so under the Dodd legislation, companies that had absolutely nothing to do with the financial crisis of 2008 are finding that they are the object of so-called “financial services reform”.

Why would the systemic risk regulator seek to make regular American businesses subject to bank-like regulation? No doubt in part it is the belief in some quarters that the government can stop financial crises from happening if only it has enough power and influence over the economy. Even among true believers the near-collapse of the highly regulated banking sector should call that article of faith into question. But there is a more practical reason to seek to turn Walmart, IBM, Boeing and other Fortune 500 companies into “financial” businesses. Under both the House bill and the Dodd legislation it is these companies that are to be taxed to pay for winding up a “too big to fail” firm. If a company gets deemed systemically risky it is on the hook for bailing out financial firms that took on too much risk. Such a regime is neither fair nor sensible from an economic perspective, but existing taxpayers’ money is already over-allocated; the Treasury needs the contents of new wallets to pay for the next crisis.

Senator Dodd’s systemic risk proposal would authorize the Federal Reserve to have an unprecedented role in regulating the U.S. economy. This proposition deserves more scrutiny and debate than it has thus far received.

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