The Federal Reserve Board on Monday unanimously approved a rule to limit its ability to extend emergency loans to failing financial firms, a power widely criticized after the central bank bailed out AIG, Bear Sterns, Citigroup, Bank of America and others in the 2008 financial crisis, reports Reuters.
The new rule, approved by the Fed's Washington-based board in an open meeting, includes several provisions that were left out of a previous version of the rule proposed in late 2013. Critics said the previous rule, which was mandated by the 2010 Dodd-Frank Act, would still allow the Fed to bailout individual financial institutions in the future, according to The Washington Examiner. The new rule seeks to appease those concerns, and will take effect Jan. 1, 2016.
The Fed will be prohibited from extending financial assistance to a single bank or insurer, a measure that will help prevent conflicts of interest, according to The International Business Times. It can only conduct emergency lending when it would be considered "broad based," which is when at least five firms meet the criteria for participating in the program.
The rule also prohibits the Fed from giving out emergency loans to businesses that have failed to pay debts in the past three months, in order to ensure that the Fed doesn't rescue insolvent firms that should be allowed to fail. The Fed would also be prohibited from giving loans to solvent companies that would then be passed on to insolvent ones.
In the meeting Monday, Fed Chair Janet Yellen stressed the importance of the Fed's bailout authority: "Emergency 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 U.S. economy," she said.
As the financial crisis intensified in 2008, as a way to stabalize the crisis, the Fed used its emergency lending powers to provide $710 billion in loans and guarantees to banks and insurance companies.
While the loans have been repaid and the guarantees ended - netting the Fed a profit of $30 billion, according to the Congressional Research Service - the effort was criticized as an overreach that encourages risky behavior.
The 2010 Dodd-Frank Act introduced limitations on its lending abilities, mandating that all lending would be done at a penalty interest rate higher than market rates, and requiring the central bank to provide lawmakers with explicit justification for broad-based bailouts.
