FOR IMMEDIATE RELEASE: Dec. 1, 2015

CONTACT: Marcus Stanley, Americans for Financial Reform
Marcus@ourfinancialsecurity.org / 202-466-1885

During the financial crisis of 2007-2009, the Federal Reserve used its emergency lending powers on an unprecedented scale, providing trillions of dollars in loans and guarantees to major financial institutions over an extended period of time. These emergency lending programs were a major source of assistance to “too big to fail” insiders on Wall Street, even as the rest of the economy suffered.

The experience of the financial crisis showed definitively that reform of emergency lending powers was needed. The Dodd-Frank Act required the Federal Reserve to place new limits on these powers to ensure that they were only used in broad-based programs providing temporary liquidity support to solvent institutions. Unfortunately, the Federal Reserve’s initial proposal for implementing these new limits was extremely weak, and did not do enough to actually fulfill the requirements of the law.

Yesterday the Federal Reserve issued its final rule on emergency lending. In response to bipartisan criticism of the 2013 proposal from, among others, Senators Elizabeth Warren and David Vitter, Representative Jeb Hensarling, and Americans for Financial Reform, the Federal Reserve has significantly modified its initial proposal.

Many of these changes – including the commitment to charge a penalty rate for emergency loans, the toughening of standards for borrower solvency, the imposition of a one year time limit for emergency lending, and the more specific definition of “broad based” in the final rule – respond directly to our critique of the proposed rule. These changes mean that the final rule is a significant improvement over the original proposal. They indicate that the Federal Reserve is taking the need to place advance controls on its emergency lending powers more seriously.

However, this stronger final rule still leaves extensive and in some cases excessive discretion for the Federal Reserve to provide emergency lending that could violate the Dodd-Frank requirement that such lending be limited to solvent borrowers in need of temporary liquidity assistance. For example, borrowers are still permitted to self-certify their own solvency. The Federal Reserve may dispute such self-certification, but it is not actually required to certify the solvency of borrowers itself, even in cases where it directly supervises the borrower and knows its operations well. Further, the standard for such solvency (recent ability to “generally” pay undisputed debts) remains weak, since a financial institution must pay all its undisputed debts to stay in business.

To take another example, while the final rule places a one-year time limit on the use of emergency loans, this already generous one-year limit can be extended indefinitely by a vote of the Federal Reserve Board and the approval of the Treasury Secretary, with no need for Congressional action.

The proper control of emergency lending is a critical issue. Inadequate controls on emergency lending can lead to excessive risk-taking by financial institutions who expect a public backstop, and of course create the risk of taxpayer loss. AFR will remain active in seeking ways to address remaining issues in the Federal Reserve use of its emergency lending powers.