Legal Authority in Unusual and Exigent Circumstances: The Federal Reserve and the Financial Crisis

Abstract

This Article considers the scope of the Federal Reserve’s emergency loan-making powers and analyzes their use during the recent financial crisis. It argues that many of the Fed’s responses to the crisis exceeded the bounds of its statutory authority.

In unusual and exigent circumstances, § 13(3) of the Federal Reserve Act empowers the Fed to provide an uncapped amount of liquidity to the financial system. It may, with the approval of the U.S. Treasury, establish programs of broad-based eligibility and lend freely against sufficient collateral. Before its amendment by the Dodd-Frank Wall Street Reform and Consumer Protection Act, § 13(3) also allowed the Fed, acting alone, to extend credit to particular individuals, partnerships, and corporations. From 2008 to 2009, the Fed invoked this authority repeatedly to purchase assets, lend money, and establish schemes that sought to restore market stability. However, this Article argues that § 13(3) was and remains a loan-making power of narrowly defined scope. On this view, the Fed’s asset purchases and certain of its lending activities raise great concerns. The impact of these concerns has yet to be addressed in the literature.

This Article first looks to the history of § 13(3) by tracing the development and use of the legislation. It then examines the transactional structures that the Fed created during the crisis and assesses these against the scope of its § 13(3) powers. Next, it evaluates the case for reform with which Congress was confronted, and its response in the Dodd-Frank Act. It concludes that the reforms to § 13(3) that the Act makes are to be welcomed overall, even though a key ambiguity remains in the statute. Finally, it traces the Fed’s new authority in the area of systemic risk regulation.

Keywords: Federal Reserve, section 13(3), financial crisis, systemic risk, financial regulation, Financial Stability Oversight Council, Federal Reserve Act, Dodd-Frank Act

JEL Classification: E44, E51, E52, E58, G21, G24, G28, G34, G38, K22, K23