Guest Post: Bernanke: The Man, The Legacy And The Law

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Submitted by Finance Addict

Bernanke: The Man, The Legacy And The Law

Fed chairman Ben Bernanke is covered in a long profile by Roger Lowenstein in the Atlantic. The sympathetic account takes the reader blow-by-blow through the criticism that he has received from virtually all quarters during his tenure as Fed chair. What Lowenstein hones in on are the reviews and criticisms of Bernanke’s performance in “resurrecting the economy” — the interest rate policy, his interpretation of the dual mandate, quantitative easing, Operation Twist, etc. But for a piece that clocks in at 8,287 words, Lowenstein pays scant attention to the emergency actions taken to save the financial system itself. Here’s one snippet:

Under the Federal Reserve Act, the Fed is authorized to make loans under “unusual and exigent circumstances” as long as the loans are “secured to the satisfaction of the Federal Reserve banks,” meaning, as long as the Fed does not expect to suffer any losses. A fair argument can be made that in the depths of the crisis, some of the Fed’s emergency loans violated this dictum. 

For some reason Lowenstein chooses not to actually discuss any of these arguments.

Did the Fed actually break the law?

Let me start by saying that this is a remarkable time to be a central banker. In fact, 2008 was the most extraordinary year of my 29 years at the Federal Reserve Bank of New York. If you had told me a year ago that we at the Fed would create a special purpose vehicle to hold assets acquired to facilitate the merger of JPMorgan Chase and Bear Stearns, rescue AIG at the eleventh hour, and eliminate tail risk in a $300 billion portfolio of Citigroup assets, I would have thought you were mad. But of course, all those things have happened in just the last ten months. 

-Thomas C. Baxter Jr., General Counsel of the Federal Reserve Bank of New York in a speech to the London School of Economics on January 19, 2009 (PDF)

The Fed did all of this and more. Was it actually allowed to?

Section 13(3) of the Federal Reserve Act says that then the right number of voting members are present and in agreement, then the Fed can to lend to any “individual, partnership or corporation” as long as certain conditions are met.

  1. The circumstances must be “unusual” and “exigent”.
  2. The loan must be secured with satisfactory collateral.
  3. The Fed must have evidence that the party in need “is unable to secure adequate credit accommodations from other banking institutions.”

Writing for the North Carolina Banking Institute, Thomas Porter (PDF) found that the Fed’s actions in the case of Bear Sterns were “legally defensible”. However, he also implies that it began to skate on thin ice when it used similar methods (making a collateralized loan to an SPV) to bail out AIG and its counterparties:

While the Fed’s initial response to rescue Bear were legal under § 13(3), subsequent actions raise questions about whether the Fed continued to meet the “unusual” standard required under § 13(3). It seems clear that § 13(3) was a loophole provision included in the Federal Reserve Act to help the Fed move swiftly and decisively in response to significant threats; however, it is unlikely that it was meant to form the basis of Fed action over a long horizon. At some point, continuing circumstances cease to be unusual. At what point? 

Meanwhile, Alexander Mehra identifies other concerns in a paper published in the University of Pennsylvania Business Law Journal. He hones in on the fact that the language in Section 13(3) only allows loans to troubled parties, not asset purchases. The Fed created an SPV and then lent it money to purchase Bear Sterns’ troubled assets, but Mehra argues that this was a loan in name only. Its real purpose was to remove the assets from Bear’s balance sheet and so facilitate the sale of Bear to JP Morgan Chase.

Mehra also argues that under § 13(3) the loans had to be given directly to the party in trouble, and not to an intermediary. Other Fed crisis programs like the Commercial Paper Funding Facility and the Money Market Investor Funding Facility suffered from similar flaws. The SPV structure used to assist AIG was a problem, too. In fact, of the alphabet soup of assistance programs created by the Fed, all of the ones highlighted below are viewed by Mehra as having one or more illegal elements:

  • Bear Sterns
  • CPFF – Commercial Paper Funding Facility
  • MMIF – Money Market Investor Funding Facility
  • AIG
  • TSLF – Term Securities Lending Facility
  • PDCF – Primary Dealer Credit Facility
  • AMLF – Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
  • TALF -  Term Asset-Backed Securities Loan Facility

OK…so maybe the Fed did break the law. Does it matter?

The thing about the Fed is that it’s very hard to haul in front of the courts. As Porter reminds us, “the courts have largely shied away from developing jurisprudence that interprets monetary policy.” Put simply — like Lowenstein, no judge really wants to go there.

And there seems to be a consensus among what Thomas Frank calls the “Too Smart to Fail”, i.e. mainstream pundits, that the ends justified the mean. Lowenstein:

Even rightward-leaning economists mostly give Bernanke a pass on his actions during the financial panic itself. The fog of war was pretty intense, and he avoided losing taxpayer money.

But those who can appreciate Bernanke’s good intentions might still question why the topic of legality has not been addressed in the media, at all. Even if one supports the outcomes achieved by the Fed, was there no way to accomplish this and still remain within the bounds of the law? As Thomas Porter writes,

Over time, the role of the Federal Reserve has been defined by the precedent of its own actions.

In other words, the fact that Bernanke’s Fed may have broken the law will give license to future Feds to do the same and then to argue that there was no alternative.

Again, why has there been such little analysis of this outside of the pages of the specialist journals? Is it really of unimportant whether the central bank of the world’s leading nation follows the rule of law?