A new bankruptcy process is the right way to deal with failing financial institutions.
It’s good news there’s now bipartisan agreement that the financial reform bill should not be a "bailout bill," and that amendments to Connecticut Sen. Chris Dodd’s draft legislation are being proposed and debated with this agreement in mind. The biggest challenge in this bailout reform debate is to avoid giving the federal government more discretionary power, whether by creating a special bailout fund or by providing more ways to bypass proven bankruptcy rules. Experience shows that such power would increase, not decrease, the likelihood of another crisis.
Some say that the government did not have enough power to intervene with certain firms during the financial crisis. But it had plenty of power and it used it, beginning with Bear Stearns. This highly discretionary power—to bail out some creditors and not others, to take over some businesses and not others, to let some firms go through bankruptcy and not others—was a major cause of the financial panic in the fall of 2008. The broad justification used for the bailout of Bear Stearns creditors led many to believe the government would again intervene if another similar institution, such as Lehman Brothers, failed.