Enhanced Powers of the Federal Reserve and FDIC (§§ 1104 & 1105)

A final pillar of the new framework for US systemic risk regulation is the enhancement of the various crisis-management powers of the Federal Reserve and the FDIC. In many ways, these enhancements—often dubbed “foam on the runway” by Washington insiders—may be a necessary tool to safeguard US financial stability in the event of another crisis. In the autumn of 2008, the US government found itself largely without the legal authority to take steps necessary to prevent financial instability from spiraling out of control. When the moment came to “break the glass,” government officials found there was little behind that proverbial glass but arcane statutory authorities poorly designed for financial crises. Moreover, many of the provisions on which the US government was forced to rely permitted assistance only to particular entities, thereby sharpening the perception that its response was a “bailout” of individual companies. To address those limitations, the legislation amends the Federal Reserve’s lending authority under section 13(3) of the Federal Reserve Act and the FDIC’s authority to provide guarantees.

Since its enactment in 1932, section 13(3) has authorized the Federal Reserve to make tailored emergency loans to businesses as well as individuals in unusual or exigent circumstances. However, this authority sat unused from the Great Depression until the financial crisis, when the Federal Reserve relied on it to provide funding to individual firms and establish assistance programs. Although such measures have been controversial, Congress has decided to retain section 13(3), while eliminating the Federal Reserve’s ability to lend to individual companies outside a program or facility with “broad-based eligibility,” thus precluding the possibility of one-off bailouts. In order to establish a broad-based facility or program, the Federal Reserve must first obtain permission from the Treasury Secretary. In addition, Congress has explicitly forbidden the Federal Reserve to lend to insolvent borrowers under the revised section 13(3). Going forward, section 13(3) may be used only to provide liquidity and not as a back door for equity injections. Insolvent companies must face bankruptcy or—if their failure is adjudged to be a threat to US financial stability—the Liquidation Authority discussed above.

The legislation makes similar changes to the FDIC’s emergency authority. The legislation clarifies that the FDIC’s current systemic risk authority, which provides it greater flexibility in terms of resolution costs for banks and thrifts, may be used only when an institution is placed in receivership. In other words, the FDIC may not provide “open bank” assistance under its systemic risk authority; the depository must first be closed. Like the changes to section 13(3) above, Congress has eliminated the FDIC’s ability to bail out banks and thrifts on an individual basis. At the same time, the FDIC is empowered to establish, with congressional approval, a broad-based financial stabilization guarantee program available to solvent depositories or solvent holding companies of depositories. To establish such a program, the boards of both the FDIC and the Federal Reserve must conclude a “liquidity event” that threatens US financial stability has taken place.