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Fed Proposes Limits on Emergency Lending Under Dodd-Frank

Federal Reserve Building
The Marriner S. Eccles Federal Reserve building stands in Washington, D.C. Photographer: Andrew Harrer/Bloomberg

The Federal Reserve is proposing changes required by the Dodd-Frank Act of 2010 to regulations governing its ability to extend emergency lending to struggling financial firms.

“The proposed rule is designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid an individual failing financial company,” the Fed said today in a statement issued in Washington.

The Fed will take comments until March 7 on its proposal, which meets a requirement of Dodd-Frank, the regulatory overhaul enacted after a financial crisis that saw the central bank extend billions of dollars in assistance to banks. In an effort to reduce chances that taxpayer money could be used to rescue failing companies, the law narrowed the Fed’s ability to extend a liquidity lifeline -- as was done with Bear Stearns Cos. and American International Group Inc. in 2008.

“Credit may be extended by any Reserve Bank only through a program or facility with broad-based eligibility,” according to today’s proposal. The Fed must quickly “document the justification for its authorization, including describing the unusual and exigent circumstances” for using it.

Treasury Secretary

The Fed proposal was written with input from the Treasury Department. The Treasury Secretary would have to approve any future use of the new authority, according to the proposal.

In the case of AIG, Fed General Counsel Scott Alvarez said in 2010 congressional testimony that the emergency power was used “in order to avoid the potentially devastating and destabilizing effects on the economy and the financial system that would have attended the collapse.” Dodd-Frank replaced the government’s individual-company emergency interventions with new demands on the banks to strengthen capital, reduce risky behaviors and prepare for their own hypothetical failures.

In a Nov. 14 report, the Government Accountability Office urged the Fed to finish the new emergency-lending procedures, noting the agency had “not completed its process for drafting the required procedures or set time frames for doing so.”

The study had been requested by Senators Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, who asked the GAO to examine benefits banks receive from the government.

“The nation’s four largest banks are nearly $2 trillion larger than they were in 2007 –- aided by an implicit government guarantee awarded by virtue of their ‘too big to fail’ status,” Brown said in a statement responding to the report. “If big banks want to continue risky practices, they should do so with their own equity on the line.”

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