New Bill in Senate Seeks to Reduce Risk of Too Big to Fail

Last Wednesday, a bill named “Terminating Bailouts for Taxpayer FairnessAct” was introduced in the Senate by Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican.  The bill seeks to end the risk of taxpayer bailouts of the largest banks by forcing banks with assets greater than $500 billion to hold common stockholder equity of at least 15%, up from 8% currently. There are many reasons for taxpayers and regulators to like this bill.  It  would eliminate the problems of risk weighting embedded in the Basel Bank regulations, as it would not rely on credit ratings of assets to dictate how much capital a bank needs to hold against those assets.  The bill would also require banks to include all off-balance sheet assets in the capital formula, and require the banks to hold their capital in liquid assets that could absorb losses easily.  The bill would hurt the profitability of banks, as they would be less leveraged and unable to make as many loans.  Many large banks have already stated that they are opposed to the legislation on the grounds that it would lead to reductions in lending and harm the economy.   For bond holders, we feel the bill would be a net positive, as the reduced profitability would be offset by the reduction in default risk.  Seeing that Chairman Bernanke in his last press conference stated that “Too Big to Fail” is still a problem, we will be watching this bill closely.