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Proposed Bank Regulations Raise Concerns About Preferred Treatment

Republicans say White House-backed legislation to oversee the financial industry would lead to more government bailouts. Democrats say that won't happen. So who's right?

No one can be sure. But in this case, some key Republican arguments are supported by many on the left, right and center.

The GOP's position was once raised by none other than Obama's own treasury secretary, Timothy Geithner, and by some liberal critics of the Democrats' proposed overhaul of Wall Street oversight -- as well as by nonpartisan analysts.

Central to the criticism spearheaded by Senate Republican leader Mitch McConnell is a proposed $50 billion fund that big banks would finance and that the Federal Deposit Insurance Corp. would use to liquidate giant, interconnected financial firms on the verge of collapse.

McConnell, R-Ky., said the very existence of the fund "would of course immediately signal to everyone that the government is ready to bail out large banks."

In October, Geithner made a similar argument to House lawmakers, saying that instead of creating a fund in advance, the costs of liquidating a large firm should be assessed to other large financial institutions after the FDIC dismantles a company. "A standing fund would create expectations that the government would step in to protect shareholders and creditors from losses," he said then.

McConnell also maintains that the Democrats' bill would sustain a cadre of financial behemoths considered "too big to fail" by singling them out for special attention by a Financial Stability Oversight Council. "So a new government board based in Washington would determine which institutions would qualify for special treatment -- giving unaccountable bureaucrats and self-appointed wise men in Washington even more power to protect, promote or punish companies at whim," he said.

Simon Johnson, former chief economist for the International Monetary Fund and a professor at the Massachusetts Institute of Technology, and others have argued from the left that Obama and the Democrats have done nothing to get rid of "too big to fail" firms.

Unlike McConnell, however, Johnson would impose strict size limits on financial institutions and separate the activities of commercial and investment banks. Republicans propose that failing firms, no matter what size, go through bankruptcy court.

In addition to creating a mechanism for liquidating large firms and the oversight council to detect systemwide financial threats, the House and Senate bills would bring previously unregulated financial products under government oversight and establish a consumer protection agency to police lending, credit cards and other bank-customer transactions.

The debate over financial regulations has been misleading on a variety of fronts, from both sides:

-- McConnell on Tuesday said his views on the financial regulation package have been most influenced by the comments of community bankers in Kentucky, his home state. Yet such bankers are represented by the industry group that most favored setting up an advance, pre-financed liquidation fund for large institutions -- the Independent Community Bankers Association.

-- McConnell also said the Democrats' decision to continue the Federal Reserve's emergency lending authority -- the same authority that allowed the Fed to extend a $60 billion line of credit to troubled insurance conglomerate American International Group -- "gives the government a backdoor mechanism for bailouts." The legislation, however, imposes new restrictions on the Fed's ability to use that authority, including a requirement that it seek approval from the Treasury Department ahead of the loan and that it inform Congress.

-- In arguing that the legislation addresses concerns over firms becoming too big to fail, the administration and congressional Democrats say it would prohibit commercial banks or bank holding companies that have depository subsidiaries from speculative trading on their own accounts. That prohibition has been promoted by former Federal Reserve Chairman Paul Volcker and has come to be known as the Volcker Rule.

"It restricts -- and this was the important point that former Fed Chairman Paul Volcker has stressed -- it restricts the so-called proprietary trading activities, some of the most risky activities of these institutions," Larry Summers, head of the White House National Economic Council, said on ABC earlier this month.

But the Senate legislation is far less specific than that. It merely calls for a study by the Financial Stability Oversight Council to make recommendations on how to implement such restrictions. It would be up to the oversight council to decide what to restrict and how.

McConnell also has complained that the Democratic bill is partisan and the White House intervened to stop Democratic-Republican negotiations.

To be sure, administration officials dissuaded Sen. Blanche Lincoln, D-Ark., chairwoman of the Senate Agriculture Committee, from moving forward with a compromise bill she was drafting with the committee's top Republican, Sen. Saxby Chambliss of Georgia.

But Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, negotiated for months with leading Republicans and found much common ground, only to see the vote in his committee unfold along party lines after provisions opposed by Republicans were not stripped out.