Fed Limits Future Emergency Lending Programs

30 Nov 2015 | Author: | No comments yet »

Fed Adopts Dodd-Frank Bailout Limits.

The Board of Governors of the Federal Reserve System unanimously voted at an open meeting Monday to adopt a rule limiting its emergency lending powers following pressure from lawmakers following the 2008 bailout of large failing financial institutions. WASHINGTON (AP) — Federal Reserve officials have moved to prevent the central bank from bailing out failing companies, a power it exercised during the 2008 financial crisis. The new rules would allow for emergency lending only in the event of “broad-based” systemic issues affecting a number of banks rather than tailoring emergency loans to the individual needs of a single failing bank.

Under the revised authority approved in a unanimous vote Monday, the Fed would only be able to save firms in a broad-based scenario including at least five entities at the same time. Fed Chair Janet Yellen defended bailouts in certain circumstances, sayings emergency lending is a “critical tool” used to mitigate potential economic crises which has only been used sparingly. The Fed spent about $2 trillion on such a program to ease a credit crunch during the financial meltdown, aiming to spark lending to consumers and small businesses.

Many lawmakers worry the Fed was able to operate with relatively few restrictions as it tried to keep banks and other firms afloat during the last financial crisis. The changes stem from legislation passed in 2010 under the sweeping Dodd-Frank banking reform bill, which was created in an effort to ward off another financial crisis and to avoid another massive taxpayer financed bailout of the financial industry. Lawmakers from both parties including Democratic Senator Elizabeth Warren complained that an initial proposal released almost two years ago didn’t go far enough and left regulators too much wiggle room to orchestrate backdoor bailouts. Fed officials said the final rule was intended to allow the injection of liquidity into an entire market or sector of the economy rather than to specific firms. The new rule traces its legal origin back to the Dodd-Frank Act, which President Obama signed into law to enforce new regulations on Wall Street and expand federal oversight in the wake of the Great Recession.

David Vitter to introduce legislation last May in an attempt to limit the Fed’s lending authority by requiring a minimum of five banks that meet the criteria to be involved in any central bank lending program — a provision set to be implemented under the finalized rule. “The Dodd-Frank Act amendments eliminated the authority to lend for the purpose of aiding a failing firm or preventing a firm from entering bankruptcy or another resolution process, such as was done with loans to Bear Stearns and AIG,” Yellen said in her opening statement. The issue of limits on the government’s power in responding to financial catastrophe came to the fore in an unusual legal case over the Fed’s $85 billion bailout in September 2008 of then-teetering AIG. The feeling at the time was that executives at so-called ‘too big to fail’ banks knew the government would have to bail them out so they cavalierly took on dangerous amounts of risk in order to increase their firms’ profits and their own paychecks in the process. In addition, emergency loans can only be made at a “penalty rate” that is higher than the market rate, and the Fed will be required to review every six months whether a loan program should be ended.

The bailout violated the Constitution’s Fifth Amendment by taking control of AIG with 80 percent of the stock without “just compensation,” Greenberg’s suit alleged. The government insisted that its actions in the AIG bailout were legal, proper and effective, and that the terms were as tough as needed to protect taxpayers from the risk of AIG failing to repay the loan. As credit markets froze up in 2008 following the collapse of the U.S. housing market, several huge lenders and financial institutions including Bear Stearns, AIG (NYSE: AIG) and Citigroup (NYSE: C) teetered on brink of collapse, prompting the Fed to open its little-used “emergency lending window.” The move may have averted a much larger crisis but critics have argued that the big banks were bailed out by the government despite their risky behaviors brining on the crisis in the first place. Yellen said. “The ability to engage in emergency lending through broad-based facilities to ensure liquidity in the financial system is a critical tool for responding to broad and unusual market stresses.”

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