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In his bestselling book with that title and in a more

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in his bestselling book with that title and in a more softened form in the Grayson-Paul amendment that was introduced in 2009, which would have subjected Fed decision making to audits and second-guessing by Congress. Somewhat fortunately, the Dodd- Frank Act of 2010, the biggest overhaul of financial regulation in the United States since the 1930s, mutes the Paul proposals. However, the Fed’s actions that pertain to Agency debt and securities have remained relatively unquestioned in the government debates. As explained, this is in fact what the government wants. In contrast, the Fed’s ability to provide emergency lending or support to
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85 individual financial firms – other than depository banks – is being restricted by the Dodd-Frank Act. Specifically, the Dodd-Frank Act legislates that emergency lending by the Federal Reserve can no longer be provided to any “individual, partnership, or corporation” but only to “participant[s] in any program or facility with broad-based eligibility.” Second, “any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company, and that the security for emergency loans is sufficient to protect taxpayers from losses and that any such program is terminated in a timely and orderly fashion.” The goal of these restrictions is presumably to reduce the moral hazard of too-big-to- fail non-banks and to prevent taxpayer assistance for their restructuring or liquidation (which under other parts of the Dodd-Frank Act is proposed to be driven through the new FDIC-led resolution mechanism). However, Dodd-Frank places no such explicit restrictions on the Fed with respect to lending to the GSEs and purchasing their debt and securities, even though they are technically non-banks. While there is some legal ambiguity on this matter, we conjecture that the GSEs will continue to have full access to the Fed under the new legislation. Explicitly imposing any restrictions with regard to Fed purchases of GSE debt and securities would in fact involve amending the Federal Reserve Act. It is worth reconsidering whether some restrictions might be desirable. There is little economic reason why the Fed’s lender-of-last-resort (LOLR) role should distinguish between a non-bank and a GSE if both pose an identical systemic threat and moral hazard problem. Indeed, while the systemic threat is certainly greater with the GSEs, there is in fact a much bigger moral hazard problem too due to their unfettered access to government guarantees. When the central bank of a country is, by legislation, required to support government- sponsored enterprises, but such support is clearly ruled out for others, what is created is a serious lack of a level-playing field in the financial sector. As we explained in Chapter 3, this situation can only lead to a race to the bottom in financial risk-taking. Eventually, the government institutions will be bailed out more generously and will crowd out the private firms, as we are seeing now in mortgage markets.
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