Notice & Comment

Four Questions About the Fed & Treasury’s Response to the Coronavirus, by David Zaring

The Fed and Treasury are doing absolutely everything they can think up to respond to the coronavirus crisis, and because of the still very flexible Depression era statutory language constraining them doesn’t offer a whole lot of constraint, even after some amendment in Dodd-Frank, it is all just about legal. I want to raise four questions that show just how far the Fed and Treasury have pushed matters to support the heroic efforts to forestall economic collapse – and to be clear, many people think the Fed and Treasury have, so far, been doing the things you’re supposed to do in such a situation.

So the questions are not policy questions, but legal questions.

The questions matter because the get at the outer bounds of constraints on the administrative state. Eric Posner and Adrian Vermeule argue that in crisis governance political constraints on the executive branch are the only ones that matter. “In the modern administrative state, it is practically inevitable that legislators, judges, and the public will entrust the executive branch with sweeping power to manage serious crises,” they say. In the wake of the last financial crisis, Steven Solomon and I argued that the executive (and the Fed) were constrained by laws – they didn’t just do whatever they wanted – but they used deals (and admittedly aggressive interpretations of those laws) to get around the statutory limits of their powers. Philip Wallach agrees.

As with the last crisis, it is unlikely that any of these questions will find their way to a court, for standing, reviewability, and other reasons. Treasury and especially the Fed rarely get sued on administrative law grounds, which means they both practice relatively unique forms of administrative law.

In this crisis, my preliminary view is not that Fed and Treasury are orchestrating mergers to save the financial sector like they did last time, but rather are pumping almost every asset class, including ones never supported before, full of cash in an effort to do so. It is a different kind of “regulation by deal,” as Solomon and I put it last time. It also may not work. People like Marcus Stanley worry that institutions designed to support secondary financial markets are unlikely to be the best crisis managers – and that is surely a concern, given that the crisis here is foremost not a financial one, but a crisis of public health.

Can section 13(3) of the Federal Reserve Act justify all of the new facilities designed to support various financial markets?

The Fed has set up a number of facilities – special purpose vehicles – that essentially offer dollars for a variety of assets held by banks. In the last crisis is was asset backed securities, in this crisis, facilities have been created to provide dollars to nonbanks, most notably by buying up commercial paper, corporate bonds, and municipal commercial paper and bonds (Here’s the corporate bond term sheet). That takes the Fed pretty far out of its comfort zone of dealing with and regulating banks.

It’s the Fed’s discount window, outlined in section 13(3) of the Federal Reserve Act authority that appears in some of the term sheets (and not all), authorizing the new facilities. (The very brief term sheets will tell you how far we are from notice and comment rulemaking and cost benefit analysis.) That authority was amended a little in Dodd-Frank after criticism that the Fed had bailed out individual banks with the discount window, and inappropriately so. Under section 13(3), “in unusual and exigent circumstances,” the Fed can open the discount window to individuals, partnerships and corporations:

  1. With a vote of five board members
  2. With the approval of the Secretary of the Treasury
  3. Before “discounting any such note, draft, or bill of exchange, the Federal reserve bank shall obtain evidence that such participant in any program or facility with broad-based eligibility is unable to secure adequate credit accommodations from other banking institutions.” I haven’t seen this set forth in any formal way, or included with the announcement of the facility, so maybe that’s a modest problem.
  4. Upon an exchange of collateral “otherwise secured to the satisfaction of the Federal Reserve bank,” which I view as committed to agency discretion by law.
  5. The window must be opened to a class of firms etc. and “a program or facility that is structured to remove assets from the balance sheet of a single and specific company, or that is established for the purpose of assisting a single and specific company avoid bankruptcy” doesn’t count.
  6. There’s some after action required – the Fed is supposed to make sure it isn’t on the hook for losses, and must report to Congress, etc.

I think this basically supports these facilities, but certainly the facilities aren’t announced with a. reference to legal authority, and b. a finding of “evidence that such participant in any program or facility with broad-based eligibility is unable to secure adequate credit accommodations from other banking institutions.”

Why do a facility, rather than just enter the marketplace and buy commercial paper or corporate bonds? I asked around, and, in addition to tradition, it could help the Fed meet that collateral “requirement” by charging a few basis points to firms that want to sell assets into the facility. Some facilities are supported by an injection of funds from Treasury’s Exchange Stabilization Fund, and that, plus the retention of fees, etc., could provide the equity tranche that would kind of be used up before the Fed took losses, also reassuring if you’re insisting on good collateral.

Is the Exchange Stabilization Fund’s financing of some of these facilities kosher?

As I said, some of these facilities are supported by financing from Treasury’s Exchange Stabilization Fund, which was created to keep the dollar on the gold standard, but which also has some of that nice Depression-era flexibility:

Consistent with the obligations of the Government in the International Monetary Fund on orderly exchange arrangements and a stable system of exchange rates, the Secretary or an agency designated by the Secretary, with the approval of the President, may deal in gold, foreign exchange, and other instruments of credit and securities the Secretary considers necessary. However, a loan or credit to a foreign entity or government of a foreign country may be made for more than 6 months in any 12-month period only if the President gives Congress a written statement that unique or emergency circumstances require the loan or credit be for more than 6 months.

31 U.S.C. § 5302 (emphasis added). I’m not sure that using the ESF to bail out American corporates is consistent with the purpose of the ESF when created, but here too, Treasury has one instance of tradition on its side, and one indication that Congress wasn’t happy about the tradition. The ESF was used to bail out money market funds in the financial crisis. But Congress then passed a law providing that “The Secretary is prohibited from using the Exchange Stabilization Fund for the establishment of any future guaranty programs for the United States money market mutual fund industry.” 12 U.S.C. § 5236(b). Since that only applies to money market funds, the Secretary might argue that funding facilities supporting the primary and secondary corporate bond market, etc., are fair game.

Are the swap lines legal?

The Fed has provided an essentially unlimited supply of dollars to most of the central banks of wealthy countries, who can then give those dollars to financial institutions being asked for dollars admit the worldwide flight to safety and cash (and the safest cash is dollars, apparently). The swap lines got absolutely massive in the last financial crisis, but originated as a modest effort to make it easier for everyone to stay on the dollar standard before the Nixon dollar devaluation. The Fed’s general counsel in 1962 that there is “no provision of present law that specifically refers to foreign currency or foreign exchange operations by the Federal Reserve System: and, accordingly, it cannot be said that there is explicit and clear authority for such operations.” He worried that “there can be no assurance, in the absence of legislation, that it would not be criticized from some sources on legal grounds.”

Section 14(e) authorizes the Fed “to open and maintain accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may be deemed best for the purpose of purchasing, selling, and collecting bills of exchange.”

Peter Conti-Brown and I have posited that this isn’t a great basis to put billions in foreign exchange on the Fed’s balance sheet (it holds the euros and yen or whatever in exchange for the dollars it gives the foreign banks) – that seems different from opening an account for foreign exchange, though it may absolutely be the policy required. We also note that there’s a lot of foreign policy at play here, and it’s being practiced by an independent agency that may or may not be coordinating with the president. No Russia or China swap line, for example, and given the vast amounts of dollars held in China, that might be bad policy.

An alternative basis to justify swaps might – but also somewhat uncompellingly – be drawn from the Fed’s authority to do cable transfers (see page 106):

Any Federal reserve bank may, under rules and regulations prescribed by the Board of Governors of the Federal Reserve System, purchase and sell in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations, or individuals, cable transfers and bankers’ acceptances and bills of exchange of the kinds and maturities by this chapter made eligible for rediscount, with or without the indorsement of a member bank.

12 U.S.C. § 353. Doing hundreds of billions in swaps on the basis of the words “cable transfers” is, I would argue, pushing capacious Depression era statutory language pretty far – and anyway, the Fed’s doing the swaps with foreign central banks. Are they “foreign banks”?

See also Colleen Baker on swap lines.

Is regulatory forbearance consistent with prompt corrective action?

Briefly, one of the concerns in the wake of the S&L crisis of the 1980s was that regulators had looked the other way while bank capital levels declined. Congress mandated that regulators use “prompt corrective action” whenever they found impaired capital at a bank, the goal was pretty explicitly to force regulators not to do regulatory forbearance. Any port in a storm, but the Fed is easing capital requirements for a variety of different banks in a bunch of different ways, as are the other regulators. That isn’t too consistent with the spirit of laws like FDICIA.

David Zaring is a Professor of Legal Studies & Business Ethics at the Wharton School.

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