Federal Reserve moves to bar bailouts of failing firms

WASHINGTON: Federal Reserve officials have moved to prevent the central bank from bailing out failing companies, a power it exercised during the 2008 financial crisis. The Fed governors voted 5-0 on Monday to downsize the Fed's emergency lending powers.

Only broad lending programmes designed to revive frozen markets -not loans to individual firms -will be allowed. The Fed spent about $2 trillion on such a programme to ease a credit crunch during the financial meltdown, aiming to spark lending to consumers and small businesses.

The 2010 law enacted by Congress overhauling financial regulation required the Fed to impose the restraints. Lawmakers of both parties had objected to the Fed's emergency aid to several big Wall Street banks and insurance giant American International Group.

The 2010 Dodd-Frank financial reform law instructed the Fed to curtail emergency loans to individual companies and prohibited it from lending to firms that were insolvent.

While some at the Fed worry the new rules will hamper the central bank's re sponse in future crises, some politicians have said the proposed regulations are too mprecise, example in defining insolvency , o prevent the types of deals done in 2008.

The final regulations approved on Monday tried to address some of those concerns. Under the proposal, at least five irms would have to be eligible to participate in any future crisis lending program.

To avoid lending to insoltvent companies, the regutlations also said no loans would be made to firms that had failed to pay “undisputed debts" in the pretvious 90 days.

Fed Governor Daniel Tas rullo said during the meeting that the regulations would provide better bali ance between the Fed's need to respond in a crisis and the concern that helping specific companies cons sidered "too big to fail" cres ated the wrong incentives for managers at companies t expecting to be bailed out.

There has been "a longstanding tension of confronting moral hazard with want ng to retain flexibility," said Tarullo, the Fed's point person on regulatory issues.

As the financial crisis intensified in 2008, the Fed invoked its little-used emergency lending power to stave off the failure of AIG and Bear Stearns, and help other "too big to fail" companies including Citigroup and Bank of America.

The Fed also enacted a series of more general emergency programs, in all providing $710 billion in loans and guarantees. Those programs were separate from the much larger Fed asset and bond purchases known as quantitative easing.

The loans have been repaid and the guarantees ended, ultimately earning the Fed a net profit of $30 billion, according to a September Congressional Research Service review.

However, the effort was criticized as overreach, arguably important in limiting the crisis but also not clearly in line with the intended use of the Fed's emergency authority. The Fed routinely lends money to banks on a short-term basis to smooth the operations of the financial system. That is part of why it exists.

But since the 1930s it has had the power to lend more broadly in a crisis.

The Fed's support of major banks and non-financial firms highlighted the risks of having companies that are considered too big to fail, and of the implicit promise that they would be rescued.