Congressional leaders and the Obama administration are seeking to limit the Fed’s authority to make emergency loans to any corporations in “unusual and exigent circumstances,” a Depression-era power the Fed used to save Bear Stearns Cos. and American International Group Inc. from disorderly collapse.
“That type of lending is ultimately putting taxpayers at risk,” Lawrence Summers, director of the President Barack Obama’s National Economic Council, said in an interview with Bloomberg Television today. “There should be some democratic accountability.”
Chairman Ben S. Bernanke and Fed governors have also invoked the authority to support the commercial paper and asset- backed securities markets, and to loan to government bond dealers. Total credit extended under section 13.3 of the Federal Reserve Act amounted to $309.2 billion as of June 10.
The Obama administration will use the worst financial crisis since the 1930s to try to push through a broad redesign of financial regulation. Under the proposals released today, the Fed would also gain authority over financial institutions deemed too big to fail. The central bank would have power to set capital and liquidity standards, force firms to develop an emergency-resolution plan, and scrutinize subsidiaries.
The plan also orders an internal review of the Fed’s governance structure, with input from “a wide range of external experts.”
Senate Opposition
Proposals to make the Fed the regulator for systemic risks met with bipartisan opposition on the Senate Banking Committee. Senator Christopher Dodd, the Connecticut Democrat who chairs the panel, said in an interview that it should be “an open question” which agency assumes the role.
The central bank “utterly failed the American people as a regulator,” Senator Richard Shelby of Alabama, the committee’s ranking Republican, said in a Bloomberg Television interview. “Now you want to pile more and more responsibility on them? We better not do this.’
Fed spokeswoman Michelle Smith said “the administration’s financial regulatory reform proposal represents an important contribution to a critical national debate,” and that “we look forward to working with the administration and the Congress in coming months.”
Agreement on 13.3
Where lawmakers signaled convergence with the administration was in limiting the Fed’s unilateral ability to lend to troubled non-bank institutions under the Section 13.3 powers.
There is “some agreement that the broad powers the Federal Reserve got from Herbert Hoover in 1932 to lend” to non-bank corporations “need to be somewhat curtailed,” said Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee.
A plan presented by Representative Spencer Bachus, the ranking Republican on the House panel, proposes to prohibit Fed bailouts of financial institutions. Loans to non-banks would require Treasury approval, and confer veto power to the Congress.
The plan released by the Treasury said the Fed would need “prior written approval” to make emergency loans to non-bank corporations.
Flexibility Threat
Former central bankers saw pitfalls in the proposals because they reduce the Fed’s independence and flexibility. Many of the emergency loans were conducted under urgent circumstances when no other agency, or even Congress, had the immediate ability to prevent failures that could have worsened the financial crisis.
Treasury Secretary Timothy Geithner participated in most of the decisions in his former capacity as president of the Fed Bank of New York.
The administration’s proposal “is essentially saying that we don’t want the Federal Reserve having the discretion to intervene in a financial crisis to the extent that they did,” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. and former research director at the Atlanta Fed. “It is a slap on the wrist, and it takes away some independence.”
Representative Marcy Kaptur, an Ohio Democrat elected in 1982, said she favors two major changes for Fed governance: nomination and confirmation of the 12 district bank presidents, and giving each a permanent vote on the FOMC. The New York Fed is the only bank with a vote that doesn’t rotate every two or three years.
“I am not for giving more power to the Fed,” Kaptur said in an interview. “I’m about making it more democratic in its governance structure and more representative of the financial regions of the country. New York has too much dominance.”
In a June 3 House Budget Committee hearing, Kaptur asked Bernanke if he supported the idea of subjecting Fed presidents to Senate approval. “No,” the chairman replied.
To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net, Scott Lanman in Washington at slanman@bloomberg.net.
Last Updated: June 17, 2009 18:16 EDT