Dodd-Frank called for the Fed to limit emergency lending to “broad-based” programs rather than to a select few institutions, excluding insolvent institutions from the loans and demanding enough collateral to protect taxpayers.
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Dodd-Frank took away the Fed’s authority “to lend for the goal of aiding a failing firm or preventing a firm from entering bankruptcy or another resolution process, such as was done with loans to Bear Stearns and AIG”, Fed Chair Janet Yellen said before the meeting.
“The Fed and other federal agencies have been telling us for quite some time that Dodd-Frank legislation was meant to eliminate the scenario of “Too Big to Fail, ‘ but apparently it did not, or the Fed simply wouldn’t see the need to introduce a final rule on emergency lending”, Five Star President and CEO Ed Delgado said”.
The upshot: Banks likely will be able to rely on the Fed to provide relief in a crisis.
The final rule, unanimously approved by the Fed, made several changes from a previously proposed rule that had come under heavy congressional scrutiny. It can only conduct emergency lending when it would be considered “broad based”, which is when at least five firms meet the criteria for participating in the program. The final regulations define insolvent companies as those that had failed to pay “undisputed debts” in the previous 90 days.
Under the new rule, the Fed will no longer conduct “emergency lending” to specific companies.
“The FORM Act places needed constraints on the Fed’s emergency lending powers”.
Of note, the Fed published a draft version of the new rule in 2013, but that version met a frosty reception in Congress as many said it still left way too much latitude for the Fed.
“It’s very hard to judge in real time whether a firm is insolvent or just having liquidity problems because it becomes impossible to price assets”, says Paul Ashworth, chief USA economist at Capital Economics, a research firm.
As the financial crisis intensified in 2008, the Fed invoked its little-used emergency lending power to help stave off the failure of AIG.
Dodd-Frank limited the Fed’s ability to engage in emergency lending to programs and facilities with “broad-based eligibility” as approved by the Secretary of the Department of Treasury. As the financial crisis deepened in 2008, the Federal Reserve stepped in with multibillion-dollar loans to struggling corporations that had invested too heavily in residential mortgage-backed securities to survive the securities’ nearly total loss of value.
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Warren, the most prominent liberal U.S. Democrat on financial issues, said the action “will help promote market discipline and make the financial system safer”.
