Why The Bailout Prevention Act May Be Unwise

On May 13, 2015, Sens. Elizabeth Warren, D-Mass., and David Vitter, R-La., introduced a bill in the United States Senate aimed at limiting the authority of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to provide emergency lending to financial institutions seeking credit during a liquidity crisis. This proposed legislation, known as the Bailout Prevention Act, has already proven to be a controversial measure, with supporters and critics speaking out from both sides of the aisle and across the public and private sectors.

While the issues raised by the bill merit vigorous debate, they must also be assessed in a realistic context and not merely as the application of abstract policy views. In particular, it may be a grave mistake to assume that private sector alternatives to Federal Reserve emergency lending will be as available as they have been in the past.

Private institutions are now less willing to serve as alternative sources of support for companies facing significant and immediate financial emergencies. This reluctance to assist in future crises principally is due to staggering liabilities that financial institutions have faced as a result of agreeing to acquire troubled institutions (or their assets) during the financial crisis — liabilities primarily arising from government enforcement actions attacking acquirers for conduct of the acquired institution before the transaction was consummated.

Congress should think twice before further limiting the availability of government-based solutions for struggling institutions in the absence of concomitant measures to address the simple fact that most sources of private capital, for good reason, will be unwilling to participate in resolving a future idiosyncratic failure of a major financial institution or in ameliorating a potential future systemic crisis.

Originally published in Law360. Reprinted with permission.