Ideas. Action. Results.

BPC Calls for Enhanced Emergency Powers During Financial Panics

Wednesday, May 20, 2015

Washington, D.C. – The following is a statement by Martin Neil Baily and Phillip L. Swagel, co-chairs of the Financial Regulatory Reform Initiative:

“We share the bipartisan commitment of Senators David Vitter (R-LA) and Elizabeth Warren (D-MA) to ending the era of backdoor bailouts. The Dodd-Frank Act has made significant progress toward addressing the problems of bailouts and too-big-to-fail financial institutions, particularly in creating new authorities to allow any financial institution to fail. Still, additional measures for financial regulatory reform would be useful.

“In a September 2014 report, the Bipartisan Policy Center’s (BPC) Systemic Risk Task Force made several recommendations to improve financial oversight and stability. BPC believes it would be better to repeal the provisions of Dodd-Frank that restrict emergency action by regulators, rather than doubling down on those restrictions, as the Vitter-Warren legislation, S. 1320, the Bailout Prevention Act, proposes. The task force called on Congress to restore the ability of the Federal Reserve to make emergency loans to individual non-depository institutions and to broaden access to the Fed’s emergency lending facilities, along with commensurately enhanced regulatory supervision. During a financial crisis, the central bank needs to be able to act quickly to avoid a potential collapse of the financial system. The Fed must have significant authority to act in case of emergency to minimize the potential for an event to have a catastrophic effect on the lives of ordinary Americans. The availability of this authority is compatible with holding individuals or institutions accountable for misdeeds, and with avoiding inappropriate risk to taxpayers. Indeed, the Fed’s emergency loans must be secured against collateral, as was the case during the financial crisis.

“Further steps must be constructive and not increase the risk of a financial sector problem having broad negative effects on the overall economy. Such a risk would be created by restricting the ability of the Federal Reserve to act as a ‘lender of last resort’ in the event of a crisis. Restrictions on the Fed’s lender of last resort authority are sometimes seen as a way to address the problem of moral hazard by which private investors take inappropriate risks because they believe that the Fed will bail them out. The solution of restricting the Fed’s ability to act, however, gets the logic of moral hazard backward by making it more difficult in a crisis for the Federal Reserve to punish badly-run firms by allowing them to fail. By requiring the Fed to lend to the full broad class of institutions on the same terms, it may force the Fed to provide more generous terms to everyone than the more punitive terms it would offer just the troubled institution. At the same time additional restrictions would have the practical effect of delaying assistance to firms facing temporary liquidity problems. As former Fed Chairman Ben Bernanke said, this legislation ‘would create an insuperable stigma problem’ for the Fed’s lender of last resort function. As a result, our financial system would be made less safe by barring use of the very tools that can help mitigate financial panics.”