The Federal Reserve as Last Resort

Abstract

The Federal Reserve, the central bank of the United States, is one of the most important and powerful institutions in the world. Surprisingly, legal scholarship hardly pays any attention to the Federal Reserve or to the law structuring and governing its legal authority. This is especially curious given the amount of legal scholarship focused on administrative agencies that do not have anywhere near as critical a domestic and international role as that of the Federal Reserve. At the core of what the Federal Reserve does and should do is to conduct monetary policy so as to safeguard pricing, including that of financial risk. The recent financial crisis brings the importance of this role into clear resolution, because mispriced financial risk was central to the crisis. To increase the Federal Reserve\u27s efficacy, recent financial reforms in Dodd-Frank created a new last-resort role for the central bank. Ironically, these same reforms threaten the efficacy of the Federal Reserve by increasing moral hazard, which could lead to additional mispricing of financial risk. This Article aims to contribute to legal scholarship focused on the Federal Reserve, an institution whose decisions significantly impact financial markets and much of the rest of the world. In particular, the Article\u27s first aim is to argue that the Federal Reserve has a new, permanent last-resort role: market-maker of last resort. This new responsibility flows from reforms contained in Dodd-Frank\u27s Title VIII, which transform and expand the Federal Reserve\u27s last-resort-lending legal authority. This Article\u27s second aim is to argue that Title VIII\u27s market stability-oriented reforms require additional accompanying reforms to counterbalance the moral hazard and related mispricing of financial risk that Title VIII\u27s reforms could promote. These proposed reforms aim to ensure that the Federal Reserve\u27s new last resort lending role does not inadvertently encourage the excessive risk taking and mispricing of financial risk that brought us the financial crisis and Dodd-Frank in the first place