Federal Reserve Places Restriction on Future Bank Bailouts

Published January 14, 2016

The Federal Reserve has adopted new rules restricting its ability to bail out financially strained banks, complying with provisions in the Dodd–Frank Wall Street Reform and Consumer Protection Act.

The new rule limits the Federal Reserve’s emergency lending powers to “broad-based” programs, as opposed to targeted lending to individual banks.

Escaping Accountability

Norbert Michel, a financial regulatory research fellow with The Heritage Foundation, says the Fed’s self-imposed rules amount to little more than tinkering around the edge of a big accountability problem.

“These regulations only apply to the Fed,” Michel said. “Congress still has the power to come up with something like TARP, and that’s really the only way to hold them politically accountable. The Fed’s [Section] 13(3) power allows Congress to escape accountability.”

‘Moral Hazard and Distortions’

Michel says taxpayers always lose when big banks get bailed out by the nation’s central bank.

“People say things like, ‘The government made money on this deal,’ but that’s only a static cash flow result that we get when Congress decides to allocate tax dollars to particular firms,” Michel said. “Same sort of thing when the Fed uses money it creates, at zero cost, to make ‘loans’ that earn interest. … That doesn’t have much of a budget impact at all. The problem is the moral hazard and distortions that these policies cause in the economy.”

Savior or Villain?

Vern McKinley, a visiting scholar at the George Washington University School of Law, says the federal government causes the economic crises it attempts to solve.

“In my experience, the economy is most in need of being saved after the Fed or another part of the government first intervenes and makes a mess of things,” McKinley said. “That was the case here, first with government housing policy creating the housing bubble, which was followed by the ad hoc bailout policy led by the Fed and the Treasury Department.”

Leviathan Theory

McKinley says the Fed is a quasi-governmental institution with an urge to expand its authority and power.

“This is mostly driven by the Fed,” McKinley said. “It is very clear that the Fed wants plenary and unimpeded authority to lend to any institution they deem as appropriate.”

In December 2013, lawmakers rejected as insufficient a proposed rule similar to the one the Fed has now adopted. McKinley says the new rule is still designed to be weak.

“Their initial draft rule did not really impose material limitations on their emergency lending authority,” McKinley said. “Although there was some tightening up in their revised version, it did not move very far off that mark, and they still have a great deal of discretion to lend as broadly as they did during the recent crisis.”

Dustin Siggins ([email protected]) writes from Washington, DC.