For decades, the Federal Reserve Bank frowned on financial institutions that sought to borrow funds through the Fed’s discount window. That policy was essentially eviscerated in recent years, especially during the recent financial crisis.
During the past five years, financial institutions have substantially benefited from as much as $29 trillion in liquidity
from the federal government and the Fed. This largess was in the form of asset purchases, loans and guarantees. Hundreds of banks received multiple loans from the Fed’s discount window during the financial crunch.
Finally, the Fed is reverting to its past prudent policy of limiting private access to taxpayer funds. In recent times, this privilege seems to have served the upper echelons of wealth to the detriment of the lower and middle classes.
This explicit response was proffered due to differing interpretations of the analysis provided by the Fed and the Federal Deposit Insurance Corporation (FDIC) regarding the recently submitted bank contingency plans.
Both regulatory agencies believed these plans were wholly inadequate and cited areas that needed substantial improvement.
Included in their recommendations were the following:
- expect foreign regulators to seize assets, branches and subsidiaries of U.S. parent companies to prevent capital outflows that undermine foreign creditors;
- permit early termination of derivative contracts by counterparties if leverage ratios are too high and insufficient collateral has been pledged to offset potential losses;
- provide accurate and transparent internal reporting systems to verify the ownership and availability of adequate collateral;
- forced divestitures may occur if complex legal entities are not simplified and liquidity and reserves are not increased.
The banks assumed that they could conduct business as usual and rely on subsidies from the federal government and the Fed, especially from the Fed's discount window. The Fed and FDIC disagreed with this interpretation, since the premise of these plans was to increase bank independence, where future losses would be realized by shareholders, bondholders and management, not taxpayers.
The FDIC has taken a more stringent view than the Fed. While the Fed recommends that the banks strengthen their contingency plans, or living wills, the FDIC is leaning toward punitive punishments.
This regulatory intervention is positive news for the financial industry and the general economy.
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