Bernanke: Bipartisan Bill to Restrict Fed Emergency Powers Is a 'Mistake'

WASHINGTON — Former Federal Reserve Board Chairman Ben Bernanke is pushing back against a bipartisan proposal to rein in the agency's emergency lending powers.

Bernanke blasted a bill introduced earlier this week by Sens. Elizabeth Warren, D-Mass., and David Vitter, R-La., to impose new conditions on the Fed's authority, arguing the legislation would undermine regulators' ability to intervene in a financial emergency. The Warren-Vitter plan would require any Fed lending program to be "broad-based" — available to at least five financial institutions — and would mandate a "penalty rate" for borrowers of five percentage points above the rate for Treasury securities.

"If enacted, the bill would further restrict the Federal Reserve's emergency lending powers in a financial crisis," Bernanke, now a fellow in residence at the Brookings Institution, wrote in a blog post Friday. "That would be a mistake, one that would imprudently limit the Fed's ability to protect the economy in a financial panic."

The former Fed chair noted that the Dodd-Frank Act made several key changes to how the banking agencies can address troubled institutions in a crisis, establishing the "orderly liquidation authority" and thereby removing the Fed's ability to lend to individual institutions like Bear Stearns or AIG.

"As Fed chairman, I was delighted to see my institution taken out of the business of bailing out failing behemoths," Bernanke says.

But he adds that Dodd-Frank also "preserved what I saw as the Fed's most essential power, namely, the authority in an emergency (with permission from the Treasury secretary) to set up broad-based lending programs in a financial panic, and thereby serve as lender of last resort."

The Warren-Vitter proposal would undercut the Fed's ability to be the lender of last resort because it would establish "an insuperable stigma problem" for participating banks, Bernanke argues.

The Fed and other banking regulators would be required to determine that a financial institution is solvent and offer a written explanation of that decision before allowing it to participate, risking public identification of the firm. In addition, the Fed can only circumvent the broad-based and penalty rate requirements of the program if it wins approval from Congress within 30 days.

"No borrower would allow itself to be so identified, for fear of the inferences that might be drawn about its financial health," Bernanke writes, because it could spook the firm's counterparties in the markets.

Moreover, adding the 5-percentage-point penalty "would remove any doubt that those borrowing from the central bank had no access to other sources of funding, further worsening the stigma problem."

He warns that the impact of this stigma could render the program useless, worsening a potential crisis.

"If financial institutions and other market participants are unwilling to borrow from the central bank, then the central bank will be unable to put into the system the liquidity necessary to stop the panic," says Bernanke. "Instead of borrowing, financial firms will hoard cash, cut back credit, refuse to make markets, and dump assets for what they can get, forcing down asset prices and putting financial pressure on other firms. The whole economy will feel the effects, not just the financial sector."

The former Fed chair concludes that the lawmakers likely don't "mean to stop broad-based emergency lending in all circumstances, although their bill would have that effect," pointing instead to efforts under Dodd-Frank and the Basel III accord requiring banks to hold more cash as a better approach.

Bernanke likens the Warren-Vitter effort to "shutting down the fire department to encourage fire safety," arguing that instead it would be better to "toughen the fire code."

Supporters of the legislation, meanwhile, downplayed Bernanke's assertions, pointing to his leadership at the Fed during the financial crisis.

"The Fed's past abuse of emergency lending demands reforms. Is anyone surprised that the mastermind of the taxpayer funded bailouts for the megabanks wants to protect the ability to keep bailing them out?" Vitter said in a statement to American Banker.

In a statement from Warren, the senator responded: "Far from overturning a key legislative bargain in Dodd-Frank, this bipartisan proposal simply directs the Fed to honor that bargain and finally institute reasonable restrictions on its emergency lending authority - which the Chairman readily acknowledges led to the kinds of massive bailouts of failing banks that neither of us wants to see again."