Senators David Vitter (R-La) and Elizabeth Warren (D-Mass), members of the Senate Banking Committee, have introduced the Bailout Prevention Act (S. 1320), legislation intended to halt megabank bailouts during a financial crisis by responsibly limiting the Federal Reserve’s lending authority. It would also close a loophole that creates risk-taking exemptions for megabanks Goldman Sachs and Morgan Stanley. The senators had previously called for stronger limitations on the Federal Reserve’s use of its emergency lending powers in an August 2014 letter to the Fed.
“It’s no secret that Too Big to Fail is still around. If another financial crisis happened tomorrow—and that’s still a real risk—nobody doubts that megabanks would be calling on the federal government to bail them out again,” Vitter said. “Our legislation makes common sense reforms to the Fed’s emergency lending powers to protect taxpayers the next time the megabanks lead us into another crisis.” Warren added that financial institutions will have a greater incentive to manage their risks carefully if they know that they will be unable to get cheap cash from the Fed in a crisis.
Legislation. According to the bill's sponsors, the Bailout Prevention Act would improve market discipline by responsibly limiting the Fed’s emergency lending authority. Specifically, the act would limit emergency lending by:
- requiring lending programs to be truly broad-based—the Fed may only create facilities or programs that allow five or more institutions to participate in a significant manner;
- restricting lending to only those institutions that are not insolvent. The Fed and all other banking regulators with jurisdiction over an institution that wishes to participate in a lending program must certify—based on analysis of assets and liabilities over the preceding four-month period—that the borrower is not insolvent, and must provide a contemporaneous written explanation of their analysis;
- requiring lending to be provided at a penalty rate—the Fed may only offer loans that are 500 basis points or more above the cost of borrowing for the U.S. Treasury for a similar loan term; and
- reducing the risk of future bailouts and market manipulation by closing the loophole that allows two megabanks to engage in nearly unrestricted activities with physical commodities.
The Bailout Prevention Act would explicitly permit the Fed to create a program that does not satisfy the broad-based requirement or the penalty rate requirement, but the Fed must obtain congressional approval for that program within 30 days under expedited procedures spelled out in the Act. If the Fed fails to obtain congressional approval within that time period, it must terminate the program
This story previously appeared in the Banking and Finance Law Daily.
