Fed Adopts Emergency Loan Limits Banning AIG-Style Bailouts

James Tisch: Fed Should Have Raised Rates Years Ago
  • Rule calls for future rescues to involve at least five firms
  • Dodd-Frank dictated changes amid furor over AIG, Bear Stearns

The Federal Reserve took the final step to ensure it can’t repeat the extraordinary measures taken to rescue American International Group Inc. and Bear Stearns Cos. in 2008, adopting formal restrictions on its ability to help failing financial firms.

Under the revised authority approved in a 5-0 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 changes are designed to reflect Congress’ intention in the 2010 Dodd-Frank Act to prevent the central bank from bailing out individual companies.

“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 stress,” Fed Chair Janet Yellen said before the vote at a meeting in Washington. The final rule included “significant changes” reflecting public comments on an initial proposal the Fed released almost two years ago, Yellen said.

That wasn’t enough to satisfy critics such as Representative Jeb Hensarling, the Texas Republican who leads the House Financial Services Committee. 

‘Vague Rules’

“Too big to fail is unfortunately alive and well, and this rule from the Federal Reserve doesn’t change that,” Jeb Hensarling said in a statement. “Vague rules and bureaucratic discretion are not the answer -- they are the problem.”

The Fed has been on the defensive as some members of Congress seek to rein in its influence over the U.S. economy. Lawmakers are trying to shrink the number of banks subject to heightened Fed supervision and are threatening to boost congressional authority over the Federal Reserve Bank of New York, which oversees giant U.S. lenders such as JPMorgan Chase & Co. and Citigroup Inc.

Lawmakers from both parties including senators Elizabeth Warren, a Massachusetts Democrat, and David Vitter, a Louisiana Republican, complained that the Fed’s original proposal didn’t go far enough and left regulators too much wiggle room to orchestrate backdoor bailouts. In a statement after Monday’s vote, Vitter said “more needs to be done,” though he didn’t specify what additional measures he would like to see.

In letters to Warren and Vitter, Yellen detailed changes the Fed made to five “key aspects” of the rule.

The final version defines a “broad-based” lending program as “requiring that at least five persons be eligible to participate,” according to a Fed memo. It also says solvent firms can’t borrow to pass the proceeds of emergency loans to insolvent firms.

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. Under the final rule, emergency credit can initially be made and renewed for a maximum of one year.

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