Obama Administration Tells Senate Democrats: No Bailout Fund in Regulatory Reform Bill $GS $JPM

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The Obama administration told Senate Democrats Friday to drop a proposed $50 billion fund designed to finance the liquidation of a big financial institution facing collapse, a victory for Senate Republicans who opposed government-supervised and government-funded corporate bailouts.

"The fund was not in our original proposal we announced almost a year ago and we don't feel it is an essential part of final legislation," a senior administration source told Fox. "The President will only sign a bill if it passes the test of putting an end to bailouts."

President Obama also issued a veto threat on regulatory reform, saying he will reject legislation that "does not bring the derivatives market under control in some sort of regulatory framework."

The Senate Republican leader, Mitch McConnell of Kentucky, offered mute praise for the administration's formal dismissal of a so-called bailout fund.

"I appreciate the Obama administration's recognition of the need to substantively improve this bill," McConnell said from Louisville. "And I hope we can work with them to close the remaining bailout loopholes that put American taxpayers on the hook for financial institutions that become 'too big to fail.'"

The administration has never been a fan of the bailout reserve fund, a mechanism in both the House-passed bill and legislation passed out of the Senate Banking Committee.

The House passed it as a populist move to tax big financial firms up front in case there is a need to finance a liquidation. Sen. Chris Dodd, Connecticut Democrat, included a version of the fund in his bill. Dodd has aggressively defended the fund against GOP charges that it amounted to institutionalizing bailouts at taxpayer expense.

UPDATE: Late Friday, Deputy White House Communications Director Jen Psaki ,   in an apparent effort to soften the blow of the administration issuing an out-right rejection of the liquidation fund,  said the following about Dodd's legislation.

"What is important is that we have a mechanism that allows us to wind down failing firms at no cost to the taxpayer," Psaki said in an e-mail. "The Dodd bill does that and we will work with Congress to make sure we achieve that objective."

Treasury Secretary Geithner testified before the House Financial Services Committee on Oct. 26, 2009 that big Wall Street firms should finance liquidations after they happen (through what's called an ex-post fund), not build up a rainy day fund (known as an ex-ante fund) in case a failure occurs.

"Such an ex-post funding mechanism has several advantages over an ex-ante fund," Geithner said. "Most notably, it would generate less moral hazard because a standing fund would create expectations that the government would step in to protect shareholders and creditors from losses. In essence, a standing fund would be viewed as a form of insurance for those stakeholders."

The Senate is moving toward floor debate on its massive regulation bill, but many of its components remain subject to negotiation and the administration's call to drop a pre-set bailout fund changes the political dynamic.

The move takes away a key Republican line of criticism and may improve prospects for a bi-partisan compromise. FULL STORY