Bit by bit, bipartisan negotiations in the Senate over financial regulatory reform have broken down. Richard Shelby, the ranking Republican on the Banking Committee split with the Democratic Chairman, Chris Dodd in February. Bob Corker filled the gap, stepping in to try to hammer out a compromise on an issue in which both parties see the potential for good policy and good politics. But wary of delays after a bitter health care fight, Democrats voted the bill out of committee in March with no Republican support, and now are looking to open up the legislation to amendments and debate on the Senate floor. As recently as last month, Republican leadership was open to a deal.

In a floor speech this morning, Senate Minority Leader Mitch McConnell threw cold water on the prospects of detente, establishing a hard line of attack against the Dodd bill, and indelibly marking the party line: “We must not pass the financial reform bill that’s about to hit the floor.”

The crux of his criticism is that the bill “institutionalizes… taxpayer-funded bailouts of Wall Street banks.” He knocked the expansion of power at the Fed and Treasury, while sounding the alarm on Wall Street accountability. If the outline of his speech sounds familiar, it’s because it is the exact argument pollster Frank Luntz urged Republicans to make earlier this year in a widely publicized memo. Compare the excerpts below (emphasis mine):

Luntz: “The single best way to kill any legislation is to link it to the Big Bank Bailout.”

McConnell: “We cannot allow endless taxpayer-funded bailouts for big Wall Street banks. And that’s why we must not pass the financial reform bill that’s about to hit the floor.”

Luntz: “Taxpayers should not be held responsible for the failure of big business any longer. If a business is going to fail, not matter how big, let it fail.“

McConnell: “[The Dodd bill] gives the government a new backdoor mechanism for propping up failing or failed institutions…. We won’t solve this problem until the biggest banks are allowed to fail.“

Luntz: “Government policies caused the bubble and its ultimate crash. Fannie Mae, Freddie Mac, the Federal Reserve, and the Community Reinvestment Act all had a role in the catastrophe. The government inflated economic bubbles with easy credit policies.”

McConnell: “It also directs the Fed to oversee 35 to 50 of the biggest firms, replicating on an even larger scale the same distortions that plagued the housing market and helped trigger a massive bubble we’ll be suffering from for years. If you thought Fannie and Freddie were dangerous, how about 35 to 50 of them?”

(See “Top 10 Financial Crisis Buzzwords.”)

Thus begins the wrestling match for the populist mantle, both sides claiming their party as the champion of Main Street. The Democrats’ response to McConnell (policy-wise) will be that the tax for a “bailout fund” is levied on financial institutions that pose a risk to the system, and that such a measure would help refund taxpayers for the original cost of TARP, as well as avoid the need for Americans to foot the bill in the future. Their political response will be basically the same as McConnell’s attack: to paint the opposition as protectors of Wall Street interests and the status quo.

Though McConnell has been masterful at holding his caucus unified against the Democrats’ major legislative agenda items so far, some observers predicted the anti-bank populism easily adopted by the Dems on this issue would make it difficult for the GOP to oppose legislation outright. Not so; the battle over financial regulation has just begun.

(See “Financial Reform: Far from a Done Deal in Congress.”)

Video and text of McConnell’s speech:

[youtube=http://www.youtube.com/watch?v=V8m2QLmraW0]

“A lot of smart people have thought about how to prevent a repeat of the kind of financial crisis we saw in the fall of 2008. We’ve heard plenty of ideas. But if there’s one thing Americans agree on when it comes to financial reform, it’s this: never again should taxpayers be expected to bail out Wall Street from its own mistakes. We cannot allow endless taxpayer-funded bailouts for big Wall Street banks. And that’s why we must not pass the financial reform bill that’s about to hit the floor. The fact is, this bill wouldn’t solve the problems that led to the financial crisis. It would make them worse. “The American people have been telling us for nearly two years that any solution must do one thing — it must put an end to taxpayer funded bailouts for Wall Street banks. This bill not only allows for taxpayer-funded bailouts of Wall Street banks; it institutionalizes them. “The bill gives the Federal Reserve enhanced emergency lending authority that is far too open to abuse. It also gives the Federal Deposit Insurance Corp and the Treasury Department broad authority over troubled financial institutions without requiring them to assume real responsibility for their mistakes. In other words, it gives the government a new backdoor mechanism for propping up failing or failed institutions. “A new $50 billion fund would also be set up as a backstop for financial emergencies. But no one honestly thinks $50 billion would be enough to cover the kind of crises we’re talking about. During the last crisis, AIG alone received more than three times that from the taxpayers. Moreover, the mere existence of this fund will ensure that it gets used. And once it’s used up, taxpayers will be asked to cover the balance. This is precisely the wrong approach. “Far from protecting consumers from Wall Street excess, this bill would provide endless protection for the biggest banks on Wall Street. It also directs the Fed to oversee 35 to 50 of the biggest firms, replicating on an even larger scale the same distortions that plagued the housing market and helped trigger a massive bubble we’ll be suffering from for years. If you thought Fannie and Freddie were dangerous, how about 35 to 50 of them? “Everybody agrees on the need to protect taxpayers from being on the hook for future Wall Street bailouts. This bill would all but guarantee that the pattern continues. We need to end the worst abuses on Wall Street without forcing the taxpayer to pick up the tab. That’s what Republicans are fighting for in this debate. The taxpayers have paid a high enough price already. We’re not going to expose them to even more pain down the road. “The way to solve this problem is to let the people who make the mistakes pay for them. We won’t solve this problem until the biggest banks are allowed to fail.”

(See “The Financial Crisis One Year After.”)

UPDATE: Here’s some clarity on what the bill actually does as far as “bailouts” go:

“Roadmaps” for shutting down banks: The bill would require large institutions to periodically submit plans for systematic shutdown to be used in the event of disaster. Higher capital requirements and restricted trading activities could be be used to punish companies that failed to submit adequate “funeral plans.” These plans are supposed to help oversight agencies understand the best way to start dismantling the institution and selling assets quickly in a dire scenario — it’s an information and transparency measure, not a structural change.

Liquidation: Under the Dodd bill, the FDIC would take charge of selling off pieces of large financial institutions that go bust, but the Treasury, Fed and a panel of bankruptcy judges would have to sign off on liquidating an insolvent firm before action could be taken. (The judges aren’t a part of the Frank bill.)

(See “Top Ten Bankruptcies.”)

“Bailout” fund: The biggest financial institutions pay into what is basically a bailout insurance fund, a $50 billion pool fed by a tax on the largest financial institutions that acts as a cushion between the cost of intervention and the taxpayer. (The fund is $150 billion in the Frank bill.) This money would be used to rescue or liquidate some firms in trouble, paying for taking bad assets off the books or the operational cost of busting down the company to spare parts. The FDIC can borrow more money from the Treasury to work with while it sells off assets, but only as much as they expect to be repaid in the end. If those funds get eaten through and the government lends institutions money out of its own pocket, the feds get to be first in line for repayment. Worth noting: Current estimates put total losses from TARP at a bit under $100 billion.

So back to the issue at hand. When McConnell talks about “the tax payer,” at least for the first $50 billion, he means the banks. And when he says “let them fail,” he means don’t seize and dismantle. As far as “institutionalizing” bailouts, a more accurate characterization is probably that the bill establishes a protocol for rescue scenarios. But that doesn’t mean it incentivizes them.

(See “The Winners and Losers of the Wall Street Mess.”)