LENDER OF LAST RESORT IN THE MODERN FINANCIAL SYSTEM

DEVELOPMENT OF THE FEDERAL RESERVE’S POLICY

Nov 30 2012

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Public uproar followed the Federal Reserve’s actions during the 2008 financial panic. Bear Stearns, Lehman Brothers, and American International Group (AIG) were seared into America’s conscience. Two very different movements—the Tea Party and Occupy—arose, in part, because of the Fed’s actions.

Many are appalled that the Federal government may have had a “policy of enablement” during the crisis, perceiving that the Treasury and the Fed enabled the excesses of politically-connected financial institutions via “bailouts,” especially for firms that posed systemic risks, or were “too big to fail.” Thus, the normal central banking function of “lender of last resort” (LOLR)—known since Walter Bagehot, editor of The Economist, articulated the principles of a LOLR in his groundbreaking 1873 work, Lombard Street—has been confused with “bailouts,” in which the federal government will use any means, including the Federal Reserve, to “keep things going.” However, bailouts and LOLR functions are distinctly different in their purpose, economic effects, and appropriateness in a free market economy.

 

Read the entire JEC Republican staff commentary attached below in pdf format:

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