Nightmare On Wall Street

Regulation: Washington is quietly preparing a hostile takeover of Wall Street with a new bill that would put regulators in control of managing asset prices.

While all eyes are fixed on the cobra poised to strike the health care industry, a python is wending its way through Hill banking panels that would squeeze the life from the whole economy.

By Christmas, House Financial Services Committee Chairman Barney Frank hopes to pass legislation that would create an uber-regulatory body called the Financial Services Oversight Council.

It would give the Treasury secretary power to pick which large finance firms are "systemically critical," or too big to fail. He'd have the final call when the government steps in to save or unwind a troubled firm.

The bill would "essentially turn over control of the financial system to the government and seriously impair competition in all areas of finance," says former Treasury official Peter J. Wallison. It would put the government permanently in the business of picking winners and losers, he adds, creating a kind of permanent TARP.

The Kansas City Fed agrees. In a rare public rebuke, the branch issued a study concluding the bill "could lead to greater political interference." Indeed, such heavy-handed regulation would breed corruption, loopholes, lobbying and the very kind of perverse incentives and distortions in the market that led to Fannie and Freddie securitizing $1 trillion in bad social loans. "It's Fannie Mae and Freddie Mac all over again," said Wallison.

The new regulatory agency can regulate banks, bank holding companies, insurance companies, hedge funds, finance companies and any other kind of company that might be designated too big to fail.

"The existence of these designated companies will impair competition in every market they are allowed to enter," says Wallison, "and will force the consolidation of competitors so that markets become dominated by government-backed giants like themselves."

Under the new regime, designated companies will not be able to finance their affiliates' sales, putting them at a severe disadvantage against foreign competitors. GE Capital, for example, would not be able to finance GE sales of aircraft engines.

In effect, designated companies will fall under the control of the feds, unable to start new activities or enter new markets or perhaps even open new offices without federal approval. "This is a degree of political control of business that has never been attempted before," Wallison says.

And with politics comes favoritism. Bailouts and preferences will go to favored firms, and healthy companies will pay for the cost of propping up their sick competitors. Bad decisions will be rewarded, draining taxpayers. And once the market comes to expect that government takeovers and bailouts will occur, they will have to go forward, lest surprises trigger market crashes.