NCPA - National Center for Policy Analysis

Dodd–Frank's Title XI Does Not End Federal Reserve Bailouts

October 6, 2015

Throughout its history, the Federal Reserve has acted as a lender of last resort (LLR) often rescuing insolvent institutions. The classic LLR prescription states that during a crisis, the central bank should provide short-term loans to all solvent institutions, on good collateral at a high rate of interest. However, this is still not a proper solution.

The main issue is a basic moral hazard problem. If central banks provide abundant credit to private banks on a regular basis, having easy access to these loans would likely encourage these companies to take on additional risk.

A main purpose of the Dodd-Frank Wall Street Reform and Consumer Protection Act was to protect taxpayers from saving insolvent financial firms in the future as they did during the 2008 financial crisis. However:

  • Dodd-Frank still allows many of the emergency lending programs that were conducted during the crisis.
  • It leaves intact the notion that the Fed should make emergency loans to firms during a financial crisis.
  • Congress should restrict the Fed to providing system-wide liquidity on an ongoing basis and restrict its emergency lending authority to conduct monetary policy.
  • The Fed's LLR policies have jeopardized its operational independence and put taxpayers at risk.

A better solution would be to ensure that the entire banking system has enough liquidity to prevent panic from spreading to the broader economy. Monetary policy should not require the Fed to make emergency loans to bail out firms.

Using public funds to bail out private firms should remain a part of the government's fiscal operations so that voters can hold those legislators accountable.

Source: Norbert J. Michel. "Dodd-Frank's Title XI Does Not End Federal Reserve Bailouts," Heritage Foundation, September 29, 2015.

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