On November 30, the Board of Governors for the Federal Reserve System approved a final rule specifying its procedures for emergency lending under Section 13(3) of the Federal Reserve Act. Since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, the Federal Reserve’s authority to engage in emergency lending has been limited to programs and facilities with “broad-based eligibility” that have been established with the approval of the Secretary of the Treasury. The Dodd-Frank Act also prohibited lending to entities that are “insolvent” and imposed certain other limitations. According to the Federal Reserve, the final rule “incorporates a number of changes from the original proposal made in response to comments received on the proposal.” In its earlier proposal, the Federal Reserve had been criticized for not being restrictive enough in determining which entities could be offered relief in the event of a crisis. Notably, Senators David Vitter and Elizabeth Warren had, in response to the Federal Reserve proposal, sponsored legislation which would require the agency to be more restrictive than the language in its original proposal contemplated. While not going as far as the Vitter-Warren legislation would have gone, the final rule did tighten the criteria for federal assistance, in what some commentators have categorized as bowing to political pressure. For its part, and while not referring to the Vitter-Warren bill, the Federal Reserve commented on changes to the proposal, stating the following:
The final rule defines “broad-based” to mean a program or facility that is not designed for the purpose of aiding any number of failing firms and in which at least five entities would be eligible to participate….[T]he final rule also broadens the definition of insolvency to cover borrowers who fail to pay undisputed debts as they become due during the 90 days prior to borrowing or who are determined by the Board or lending Reserve Bank to be insolvent.
The Federal Reserve, through Chair Janet Yellen, took the opportunity to remind the public that “[e]mergency lending is a critical tool that can be used in times of crisis to help mitigate extraordinary pressures in financial markets that would otherwise have severe adverse consequences for households, businesses and the US economy.” Notably, various critics of the agency took the position that the Federal Reserve lacked the authority to take the actions it took in 2008 under Section 13(3). The result, in part, was the more restrictive language engrafted onto current Section 13(3).
Despite the changes to the rule, it is uncertain, in the event of another financial crisis, whether the new rule will actually prevent the Federal Reserve from taking the action it deems necessary to prevent catastrophe.
The final rule will take effect January 1, 2016.
The final rule is available here.