Larry Kudlow

Surprise, surprise. Sen. Chris Dodd’s financial-regulation proposal raises the possibility of substantial progress on the road to ending “too big to fail” (TBTF) and bailout nation for banks and other financial institutions.

How the Dodd bill will play out in the final details remains to be seen. But when you read the Dodd fact sheet, there are a few key items to like.

First, under the Dodd scheme, large complex companies will have to submit plans for rapid and orderly shutdowns should they go under. These are called “funeral plans.” Then, in terms of these orderly shutdowns, the bill would create an “orderly liquidation mechanism for the FDIC to unwind failing systemically significant financial companies. Shareholders and unsecured creditors will bear losses and management will be removed.” Good.

Then comes the “liquidation procedure.” This spells out that the Treasury, FDIC, and Federal Reserve must all agree to put companies into the orderly liquidation process. “A panel of three bankruptcy judges must convene and agree -- within 24 hours -- that a company is insolvent,” the bill goes on to say. It also states that the largest financial firms will be assessed $50 billion for an upfront fund that will be used if needed for any liquidation. This is a kind of debtor-in-possession safety net for the bankruptcy-liquidation process. Also good.

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Finally, under the heading of bankruptcy, the bill stipulates that most large financial companies are expected to be resolved through the normal bankruptcy process. This is the key. However, it is not an airtight case for bankruptcy. It is possible that a government-resolution process could keep big banks alive or in conservatorship, such as with Fannie and Freddie. That would be wrong. Very wrong. In fact, one of the flaws in the Dodd bill is that there is no mention of Fannie and Freddie.

But the strict language on bankruptcy judges and shutdowns, and the line stating that most large failed financial firms are expected to be resolved through the normal bankruptcy process, is very hopeful.

The biggest flaw in the Dodd bill is that it gives the Consumer Financial Protection Agency (CFPA) far too much free reign. The agency will be housed in the Federal Reserve. But it will be independent inside the Fed, with a director appointed by the president and financed by the Fed’s own profits.


Larry Kudlow

Lawrence Kudlow is host of CNBC’s “The Kudlow Report,” which airs nightly from 7 p.m. to 8 p.m.