DURING a financial panic, said Walter Bagehot, a former editor of The Economist, a central bank should help the deserving and let the reckless go under. Bagehot reckoned that the monetary guardians should follow four rules: lend freely, but only to solvent firms, against good collateral and at high rates. Many American politicians complain that the Federal Reserve is all too happy to lend, but that it ignores Bagehot’s other dictums. On May 13th two senators of very different hues—Elizabeth Warren, a darling of the left, and David Vitter, a southern conservative—joined forces to introduce a bill that would restrict the Fed’s ability to lend during the next financial panic. Does that make sense?
Emergency lending under Section 13(3) of the Federal Reserve Act was one of the most controversial policy responses to the financial crisis. In a letter to Janet Yellen, the chair of the Fed, Ms Warren and Mr Vitter say that from 2007 to 2009 the Fed provided over $13 trillion to support financial institutions. The loans were cheap. A study from 2013 by the Levy Institute, a nonpartisan think-tank, found that many of them were “below or at the market rates” (sometimes less than 1%). Many of the banks that benefited were insolvent at the time. And much of the $13 trillion went to just three banks (Citigroup, Merrill Lynch and Morgan Stanley),...Continue reading
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