WASHINGTON — The Senate Banking Committee, trying to restrict the "too-big-to-fail" protection for troubled banks, Thursday endorsed unprecedented restrictions on the Federal Reserve Board's ability to provide financial aid to ailing institutions.
The new policy could force taxpayers to bear the burden of failures of large banks. But advocates say it would ultimately save money by forcing a faster shutdown of troubled banks before they pile up billions of dollars in additional losses.
The action came as the committee began considering more than 300 amendments to a bank reform bill that could provide the biggest change in banking laws since the Great Depression.
The willingness of the Fed to keep troubled banks open had allowed large depositors to withdraw their funds before a failure. The policy, known as the too-big-too-fail doctrine, meant that regulators would not close down large institutions because of fear of starting a panic in the banking system.
The policy, however, caused greater costs to the Federal Deposit Insurance Corp.'s insurance fund once a bank is shut down. That fund is now considered close to insolvency.
The Fed has provided aid to 500 troubled banks, 90% of which later failed anyway. Under the law now, the Fed has a claim on the assets of the failed institutions, giving it protection against loss if the banks fail.
The proposed Senate bill says the Fed would no longer be a secured creditor in the event of bank failure. This means "the taxpayer will bear at least a portion of the cost," Fed Chairman Alan Greenspan said in a letter read to the committee.
"Do we want to reverse the entire history of central banking in America . . . so the American taxpayer is the first loser in event of failure?" asked Sen. Phil Gramm (R-Tex.), who offered an amendment to alter the committee bill and keep current policy unchanged.
But committee Chairman Donald Riegle (D-Mich.) said the Fed policy of providing money for troubled financial institutions allows them to stay open while foreign depositors withdraw their funds. "That's the ultimate outrage," he said.
Gramm's amendment was defeated by the Democrats on a 12-9 party-line vote.
The committee is to consider a slew of other amendments to the wide-ranging bank reform bill, which would give banks the right to move unrestricted across state lines and would provide $70 billion to bolster the ailing deposit insurance fund, which protects savings up to $100,000.
One amendment adopted Thursday provides a federal loan guarantee for $180 million to rescue the funds of 100,000 depositors in Rhode Island credit unions whose money was frozen when the state's private insurance system collapsed in January.