Dodd & Corker's Financial Deal: "Bipartisan"? Sure. "Creative"? Maybe. Effective? No.

Steven Pearlstein of the Washington Post waxed lyrical today [1]about the compromise deal on financial regulations proposed Sens. Dodd and Corker, calling it a "creative bipartisan proposal." It's certainly "bipartisan," and it may even be "creative." What it isn't is effective. It's not just a compromise - unfortunately, it's also compromised.

It's bad enough that consumers are likely to get the short end of the stick on this deal. What may be even worse is that it's a recipe for bureaucratic gridlock and regulatory impotence.

"You have to wonder how big a financial crisis we have to go through," writes Pearlstein, "before we get the new regulatory apparatus in place to make sure it doesn't happen again." That's the right concern, and we certainly need a regulatory structure designed to prevent future catastrophes. But, while Pearlstein mocks "liberal Democrats who insist the only solution is to micromanage the financial services industry from Washington," the Dodd/Corker alternative looks like that old definition of a camel as a horse designed by committee.

The Administration has been pressing for a new, independent agency to regulate consumer lending in all forms. According to Pearlstein, this agency has become a "litmus test" that has "assumed symbolic importance way beyond its practical significance." Enter Dodd and Corker. Pearlstein describes their solution as follows, based on what he describes as "conversations with several key players": "The compromise ... would establish a single regulator of federally chartered banks with a dual mission and an independent source of funding. One division would promulgate and enforce rules to protect consumers; the other would fulfill the traditional role of supervising banks for safety and soundness."

That's Problem #1 with Dodd/Corker: Dual missions ares a recipe for organizational disaster and an invitation for bureaucratic infighting. And when Main Street competes with Wall Street for resources, Main Street always seems to lose. Here's an example: The Federal Reserve's two organizational objectives are to create price stability and achieve full employment. [2] Nevertheless, Ben Bernanke told the Wall Street Journal that "our dual mandate ...is growth and inflation [3]." Bernanke forgot half of his organizational mission and nobody even seemed to notice, even in a period of massive unemployment.

It's funny how Main Street interests always seem to get forgotten in the hallowed halls of Washington.

True, Dodd and Corker would create a consumer protection division, but two "equal" subordinates in any organization inevitably end up competing for dominance. And ask yourself: Who's likely to win in this case - the one who's being fed predesigned arguments by high-priced consultants and lobbyists, or the one fighting for those who don't have special-interest dollars or resources to throw around?

The assurance given by Pearlstein's sources that "... any conflicts between the two would be resolved by the head of the agency" is cold comfort in a town dominated by K Street and special interest money. Do we really want the financial safety of the American consumer left to the capricious judgment of unnamed and unknown future agency heads, all of whom will be political appointees?

The only real, workable solution is a truly independent consumer agency - not because of it's a "litmus test," but because it would work. The Dodd/Corker proposal, on the other hand, is a recipe for infighting and paralysis that will leave the American consumer unprotected.

There's another problem with the Dodd/Corker proposal: its solution for institutions that are "too big to fail" is "too small to work." The House's bill would have them pay into a bailout fund and would raise their capital requirements. Pearlstein summarizes the Dodd/Corker alternative as follows:

" any time a big financial institution is threatened with insolvency, the government would be authorized to take it over and close it down in a bankruptcy-like process. The government could provide temporary loans to ensure an orderly liquidation process and prevent financial panic, but only to the extent that the loan would be repaid from proceeds of the sale of the bank's assets. '

It's not readily apparent why this would be better than current bankruptcy practices under the FDIC, but what is clear is that it lacks the most important element of the proposal passed by the House: Under the House bill, institutions that choose to endanger the nation by becoming "too big to fail" must proactively put up money for the risk, rather than leaving that responsibility to the taxpayer. It sounds good to say that loans will be repaid from the sale of bank assets, but what happens when that doesn't cover the cost? And the House proposal has the added benefit of providing a brake on excessive expansion, discouraging excessive risk-taking through a "pay as you go" approach.

In an online chat session today, Pearlstein described the breakup of "too big to fail" institutions as a "populist fantasy [4]." Sadly, he's probably right. But we can certainly ask mega-institutions to pay a form of failure insurance, both to protect the public's funds and to discourage excessively risky consolidation.

The Dodd/Corker proposal is designed to win sixty votes in the Senate. But the Senate's reconciliation rules are traditionally used for matters that affect the Federal deficit. Wars aside, what has exploded the deficit more in recent history than bank bailouts?

A better solution would be to scrap Dodd/Corker and address this issue through reconciliation, creating the CFPA while implementing new requirements for dangerously large institutions. That would protect the American consumer and the Federal piggy-bank, while at the same time providing greater financial stability than we're likely to see under the Dodd/Corker proposal.