Exigent and Unusual Circumstances: The Federal Reserve and the U.S. Financial Crisis

Abstract

The U.S. Federal Reserve has committed hundreds of billions of dollars in unprecedented lending activities and purchases of mortgage-backed securities based upon its authority under the Federal Reserve Act, and particularly upon its interpretation of Section 13(3), a formerly untested and unused clause in the Federal Reserve Act. Such efforts effectively doubled the size of the Federal Reserve’s balance sheet. This expansion of authority exercised by the Federal Reserve not only has significance in today's financial crisis but also sets a precedent for future Federal Reserve actions. The Federal Reserve has relied on Section 13(3) to authorize its controversial lending actions with respect to Bear Stearns, AIG, Citigroup and Bank of America. It also relied to Section 13(3) to create the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, Commercial Paper Funding Facility, Money Market Investor Funding Facility, Primary Dealer Credit Facility, the Term Asset-Backed Security Loan Facility. The Federal Reserve also greatly expanded its traditional lending to financial institutions and central banks through the creation of the Term Auction Facility and Central Bank Swap Facility. Finally, in an effort to stabilize the residential real estate market, the Federal Reserve has purchased over $1 trillion of mortgage-backed securities through the Federal Reserve’s MBS purchase program. Each of these actions represents a significant expansion from the traditional lending and purchase activities performed by the Federal Reserve. This paper analyzes these actions and discusses their current and future implications.

Keywords: Federal Reserve System, Federal Reserve Bank of New York, financial crisis, credit crunch, Federal Reserve Act, section 13(3), Bear Stearns, AIG, Citigroup, Bank of America, Central Bank Swap Facility, mortgage-backed securities, MBS, MBS Purchase Program

JEL Classification: E31, E32, E42, E44, E52, E58, E61, E62, G21, G38, H81