Frank-Dodd reform: the second time as farce.

It’s said that all history occurs twice, first as tragedy and second as farce. That bears repeating with at least one element of the proposed “financial overhaul,” the Dodd-Frank Wall Street Reform Act. That element, writes Eugene White, is the “Financial Crisis Fund,” a fund in which Sens. Dodd and Frank propose strong banks will pony up for a $19 billion “war chest” to be reserved for the next banking crisis, supposedly also aimed to “protect the taxpayers.” Aren’t Misters Dodd and Frank so kind… if only they’d apply that same thinking to the Bush tax cuts scheduled to expire in 2011, creating the single largest tax increase in American history.

The problem facing Dodd and Frank Democrats, says White, is that we tried this before, in 1893, and the same economic arguments that lead to its defeat then have not been solved today.

When [William Jennings] Bryan [(D, Neb)] presented his bill to the House committee, he was met with skepticism from both Democrats and Republicans. One critic, Nils P. Haugen (R., Wis.) quickly pointed out that many recent bank failures were quite large, “and that would be a great draft upon the fund in the case of a failure of two or three large banks,” easily exhausting it.

One of Bryan’s most telling exchanges was with Nicholas N. Cox (D., Tenn.):

Cox: “Now, the fund becomes exhausted and you have to assess another tax to make it good, and then after that is exhausted you have to assess another?”

Bryan: “Yes.”

Cox: “Then how can you arrive at any certainly about [the $10,000,000 figure]? Take this panic on hand now, and six, eight or 10 banks have broken in a technical sense and the depositors closed out, and they want their money, now it does not strike you that you would have to be continually assessing the solvent banks to supply those which have broken?”

Bryan: “A greater [one] than I has said that you can only judge the future by the past, and judging by the past, I do not think the danger of which you speak is a proximate one at all.”

Cox: “If it does not go to that extent, does it not result in the end that the good banks, that the well-managed banks, stand as a guard for the badly managed banks?”

With distaste for taxing safer banks to protect risky ones and distrust about the seemingly modest sum required by Bryan, the committee dismissed the bill. When the next big panic hit in 1907, fewer banks suspended business than in 1893. But as Bryan’s critics had correctly guessed, failing financial institutions were larger and outside the safety net that he had originally proposed. They were trust companies that had engineered their operations around the existing system of state and federal regulations and were now at the epicenter of the crisis. The fund would have been inadequate and perhaps have engendered a complacency that might well have made the 1907 crisis even worse.

Wondering what $10 million meant in 1893? It was 0.065% of GDP in 1893, while $20 billion is 0.132% of 2009 GDP. The ante has been roughly doubled by the Dodd-Frank bill, but the criticism of the bewhiskered men in starched collars is still on the mark.