Federal Reserve officials voted Monday morning to limit their ability to extend emergency loans to troubled financial firms, a power that many outsiders criticized when it was used in the 2008 financial crisis to bail out AIG and several large banks.
The agency’s final rule, which is mandated by the 2010 Dodd-Frank law, includes several provisions limiting the Fed’s bailout power that were left out of a version of the rule proposed in late 2013. Critics alleged then that rule did the minimum required by Dodd-Frank law, and would allowthe Fed to offer bailouts to specific big banks or other large financial firms in the future.
Specifically, the rule would prohibit the Fed from launching any emergency lending programs unless at least five firms met the criteria for participating in the program. That measure is intended to rule out a program to bail out a particular company.
To ensure that the Fed does not give emergency loans to insolvent firms that should be shuttered, the rule would also prohibit loans from going to businesses that have failed to pay debts in the past three months. It would also restrict loans to solvent firms that would be passed on to insolvent ones.
The re-proposal, Fed chairwoman Janet Yellen said, contains other “significant” changes “to ensure that our rule will be applied in a manner that aligns with the intent of the Congress and the Dodd-Frank Act.”
The Fed’s emergency lending power has been the subject of controversy since the financial crisis, when regulators launched massive programs to stabilize the financial crisis.
Congressional critics, including Sens. Elizabeth Warren, D-Mass., and David Vitter, R-La., have maintained that the Dodd-Frank rule did not go far enough to prevent future bailouts. They introduced legislation this year that would, among other requirements, set the same five-firm minimum for any lending program.
Former top officials such as former Fed chairman Ben Bernanke and former Treasury Secretary Tim Geithner, however, have defended the Fed’s bailout powers as essential to maintaining the government’s ability to prevent future financial crises that could threaten the economy.
Speaking at Monday’s meeting, Fed Gov. Daniel Tarullo said Monday’s version of the rule did a “much better job of balancing the trade-offs” between the moral hazard created by the prospect of bailouts and the need to provide liquidity during a crisis.
