WASHINGTON — The cost of future government rescues of huge financial institutions would be paid by their surviving rivals while the troubled firms' management would be fired, their unsecured creditors would face losses and their shareholders could be wiped out, according to a proposal released Tuesday by the Obama administration and a key House panel chairman.
The legislation tries to address the issue of large bank holding companies and other complex financial firms, such as American International Group Inc., that have been deemed "too big to fail" because of the damaging effect that a bankruptcy filing by one of them could have on the overall economy.
The proposal would seek, in effect, to allow such firms to fail but in a controlled manner that would minimize the collateral damage -- and not leave the government with the tab.
The legislation would "ensure that the industry and shareholders absorb the risk and cost of failure, not taxpayers," according to a statement released late Tuesday along with the legislation by the Treasury Department and Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee.
By putting a financial firm's shareholders, creditors and executives at risk, the legislation also is designed to discourage companies from taking excessive risks and from becoming too large in the first place.
Such incentives could diminish the concern expressed by many economists and government officials that last fall's bailouts had set a precedent for the government to bail out "too big to fail" firms with taxpayer money, creating a "moral hazard" and encouraging them to engage in risky behavior.
The 258-page bill, which also would provide for increased oversight of the economy to look for signs of "systemic risk," is a major component of the Obama administration's proposed sweeping overhaul of financial regulations, which is working its way through Congress.
Scott Talbott, a lobbyist for the Financial Services Roundtable, which represents about 90 large financial firms, said it had concerns about some provisions in the bill but supported its overall goals, including the idea of assessing firms to pay for the failure of rivals.
"There are plenty of instances of asking the industry to cover the costs of others," Talbott said.
