Posted by: Dirk | December 15, 2014

The Fed and its use of emergency powers in the last financial crisis

I have lately asked whether the private sector – firms and households – can borrow from the central bank, and the answer was no. I should have made it clear, perhaps, that the “no” is not a “never” but a “no, but”. Since there is not one central bank but many, rules differ. Also, the definition of a financial crisis should be “things are so bad that rules are broken, procedure ignored”. Let’s look at one of the instances of financial crisis: the Federal Reserve Bank in the last financial crisis. The following discussion is based on the paper “When the Fed Conducts Monetary Credit Policy” by David Price, which was published in 2012 at the Richmond Fed (kudos to Erik Jochem for pointing out that paper). The Fed has “emergency powers”, which have been granted by Congress in 1932 and expanded in 1991, according to the paper. The Fed’s timeline mentions banking acts of 1932, and a quick search gave me the Emergency Banking Act from 1933, which contains this clause:

Subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe, any Federal reserve bank may make advances to any individual, partnership, or corporation on the promissory notes of such individual, partnership, or corporation secured by direct obligations of the United States or by any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by any agency of the United States. Such advances shall be made for periods not exceeding 90 days and shall bear interest at rates fixed from time to time by the Federal reserve bank, subject to the review and determination of the Board of Governors of the Federal Reserve System.

Then, there is the 1991 Federal Deposit Insurance Corporation Improvement ActThere are also rumors that the Fed has a book – the doomsday book – which contains information about what it can do when push comes to shove, and what it did in the past. In the last financial crisis, the Fed created some new facilities, like the Term Asset-Backed Securities Loan Facility (TALF). The Fed writes in its FAQ:

What types of investment funds are eligible borrowers?
Investment funds that are organized in the United States and managed by an investment manager that has its principal place of business located in the United States are eligible borrowers for purposes of the TALF. However, any investment fund which is not a U.S. company in accordance with the last sentence of the first FAQ in the “Borrower Eligibility” section is not an eligible borrower for purposes of the TALF.

So, there was some lending to investment funds. The Rolling Stone’s Matt Taibi in 2011 wrote an article in which it was suggested that this resulted in some doubtful loans. The Fed also extended credit to rescue Bear Stearns and American Insurance Group (AIG), which was also highly controversial when it happened. The Fed was forced to reveal some information about the balance sheet operations, with a summary being published on its website. There were also swap programs with five central banks. The Fed writes:

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. These arrangements were established to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in currencies of the counterparty central banks (that is, in Canadian dollars, sterling, yen, euros, and Swiss francs). The Federal Reserve lines constitute a part of a network of bilateral swap lines among the six central banks, which allow for the provision of liquidity in each jurisdiction in any of the six currencies should central banks judge that market conditions warrant. In October 2013, the Federal Reserve and these central banks announced that their liquidity swap arrangements would be converted to standing arrangements that will remain in place until further notice. Since their initial establishment in 2009, the Federal Reserve has not drawn on any of the foreign-currency liquidity swap lines.

 

The article by Price mentions a statement issued in 2009, delineating the responsibilities of Treasury and Federal Reserve Bank. The statement ends like this:

In the longer term and as its authorities permit, the Treasury will seek to remove from the Federal Reserve’s balance sheet, or to liquidate, the so-called Maiden Lane facilities made by the Federal Reserve as part of efforts to stabilize systemically critical financial institutions.

 

By now, all the Maiden Lane facilities have been resolved.


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