Federal Reserve: Emergency Lending.

The deepening of the financial crisis in 2008 led the Federal Reserve (Fed) to revive an obscure provision found in Section 13(3) of the Federal Reserve Act (12 U.S.C. 344) to extend credit to nonbank financial firms for the first time since the 1930s. Section 13(3) provides the Fed with greater flexibility than its normal lending authority. Using this authority, the Fed created six broadly based facilities (of which only five were used) to provide liquidity to "primary dealers" (i.e., certain large investment firms) and to revive demand for commercial paper and asset-backed securities. More controversially, the Fed provided special, tailored assistance exclusively to four firms that the Fed considered "too big to fail"-AIG, Bear Stearns, Citigroup, and Bank of America. Credit outstanding (extended in the form of cash or securities) authorized by Section 13(3) peaked at $710 billion in November 2008. At present, all credit extended under Section 13(3) has been repaid with interest and all Section 13(3) facilities have expired. Contrary to popular belief, the Fed earned income of more than $30 billion and did not suffer any losses on transactions authorized by Section 13(3). These transactions exposed the taxpayer to greater risks than traditional lending to banks through the discount window, however, because in some cases the terms of the programs had fewer safeguards. The Fed's use of Section 13(3) in the crisis raised fundamental policy issues: Should the Fed be lender of last resort to banks only, or to all parts of the financial system? Should the Fed lend to firms that it does not supervise? How much discretion does the Fed need to be able respond to unpredictable financial crises? How can Congress ensure that taxpayers are not exposed to losses? Do the benefits of emergency lending outweigh the costs, including moral hazard? How can Congress ensure that Section 13(3) is not used to "bail out" failing firms? Should the Fed tell Congress and the public to whom it has lent? The restrictions in Section 13(3) placed few limits on the Fed's actions in 2008. However, in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) added more restrictions to Section 13(3), attempting to ban future assistance to failing firms while maintaining the Fed's ability to create broadly based facilities. The Dodd-Frank Act also required records for actions taken under Section 13(3) to be publicly released with a lag and required the Government Accountability Office (GAO) to audit those programs for operational integrity, accounting, financial reporting, internal controls, effectiveness of collateral policies, favoritism, and use of third-party contractors. Although Section 13(3) must be used "for the purpose of providing liquidity to the financial system," some Members of Congress have expressed interest in-while others have expressed opposition to-the Fed using Section 13(3) to assist financially struggling entities, including states, municipalities, and territories of the United States. Chairman Jeb Hensarling contends that "Dodd-Frank tried but failed to rein in the Fed's emergency lending authority." In the 114th Congress, legislation-including H.R. 2625, H.R. 3189, and S. 1320-has been introduced that would limit the Fed's discretion under Section 13(3). On November 19, 2015, H.R. 3189 was passed by the House. It would require the approval of three-quarters of the Fed regional presidents to activate Section 13(3), tighten the definition of solvency, limit borrowers to financial firms, and provide a formula for setting the interest rate above market rates. Chair Janet Yellen contends that this bill would "essentially repeal the Federal Reserve's remaining ability to act in a crisis." A Fed governor has opposed further reducing the Fed's discretion under Section 13(3) on the grounds that the Fed needs "to be able to respond flexibly and nimbly" to threats to financial stability. [ABSTRACT FROM AUTHOR]