Fed Urged to Ensure Emergency Lending Rules Bar Bailouts

The Federal Reserve must clarify its emergency lending authority rules to foreclose the possibility of “backdoor bailouts” in a future financial crisis, a bipartisan group of lawmakers said in a letter today.

The central bank’s proposed rules for emergency lending place “no meaningful restrictions” on its lending powers in a time of crisis, inviting the prospect of assistance similar to that provided five years ago, 15 Senate and House members wrote in the letter to Federal Reserve Chair Janet Yellen.

“If the board’s emergency lending authority is left unchecked, it can once again be used to provide massive bailouts to large financial institutions without any congressional action,” the group wrote. “The board’s proposed rule fails to strike the appropriate balance between promoting financial stability and mitigating moral hazard.”

The Fed extended billions of dollars of assistance to banks and non-bank financial firms after the credit-market collapse that toppled Lehman Brothers Holdings Inc. in 2008. In response, Congress narrowed the Fed’s ability to extend a liquidity lifeline -- as was done with Bear Stearns Cos. and American International Group Inc. -- in enacting the Dodd-Frank financial regulation law in 2010.

The letter was led by Senators Elizabeth Warren, a Massachusetts Democrat, and David Vitter, a Louisiana Republican, and Representatives Scott Garrett, a New Jersey Republican, and Michael Capuano, a Massachusetts Democrat. Eleven other members signed the letter.

December Proposal

In December, the Fed proposed changes to its emergency lending authority. The proposal was written with input from the Treasury Department.

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 their letter today, the lawmakers urged the Fed to establish a time limit for financial institutions’ use of the emergency lending and duration of each lending facility as well as creation of procedures for orderly unwinding of any emergency program. They also recommended that the central bank create a penalty rate for any assistance.

They also asked the Fed to change the definition of an “insolvent” institution and “broad-based eligibility” for the program.

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