Fed Moves to Bar Bailouts of Failing Firms

30 Nov 2015 | Author: | No comments yet »

Fed Adopts Dodd-Frank Bailout Limits.

WASHINGTON — 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 Federal Reserve on Monday adopted a new rule restricting its ability to lend money to financial institutions in a crisis in an attempt to ease concerns from lawmakers who worry about the central bank’s unchecked power to pump money into the financial system. 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.

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.

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. Lawmakers of both parties had objected to the Fed’s emergency aid to several big Wall Street banks and insurance giant American International Group. “Emergency lending is a critical tool that can be used in times of crisis to help mitigate extraordinary pressures in financial markets that would otherwise have severe adverse consequences for households, businesses and the U.S. economy,” Fed Chair Janet Yellen said before the vote. 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.

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. Loans would come with a penalty rate and would have to be repaid in full on an accelerated basis if borrowers are found to have misrepresented their solvency. 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. Elizabeth Warren (D., Mass.) and David Vitter (R., La.) urged the Fed in a letter last year to establish time limits for emergency lending programs, bar firms who might be “on the verge of bankruptcy” from receiving loans and ensure the loans be dispersed across the financial sector rather than concentrated among a few big firms. “The Federal Reserve has long had this authority but has used it only sparingly and only in severe financial crisis,” Ms.

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