Too Big to Fail vs. Too Handcuffed to Act

Mistrust of the Federal Reserve makes strange bedfellows. Representative Scott Garrett (R-N.J.) received a 100 percent score from the American Conservative Union last year, while Senator Elizabeth Warren (D-Mass.) earned 4 percent. Yet the two have found common cause on one issue: restricting the Fed’s freedom to lend to troubled banks in the next financial crisis. “If the board’s emergency lending authority is left unchecked, it can once again be used to provide massive bailouts to large financial institutions without any congressional action,” says an Aug. 18 letter to Fed Chair Janet Yellen signed by Garrett and Warren, along with five other congressional Republicans and eight Democrats.

Sounds sensible: Who wants the Federal Reserve picking and choosing which zombie banks to rescue? But there’s another side to the story. If the Fed faces tight limits on lending in the next crisis, it might not be able to stop a panic that could drag down fundamentally solvent financial institutions with short-term financing problems. The unnecessary failure of those banks would damage the economy and raise the cost of a government rescue. That’s the counterargument made in a report scheduled for release on Sept. 4 by the Bipartisan Policy Center, a Washington advocacy group. The report’s authors include Peter Fisher, a former senior official at the Department of Treasury who until early last year was head of fixed income at BlackRock, the world’s largest asset manager. “We’re eager to do something about too big to fail, but tying the Fed’s hands is not the right way to go,” Fisher says.