The Federal Reserve’s Ability to Lend to the Economy under Section 13(3) of the Federal Reserve Act Amid its Response to the Coronavirus Pandemic
By Michael Murphy, RBFL Student Editor
The Coronavirus pandemic has thrust the world into the worst financial crisis since the Great Depression. To stymie the devastating effects of business shutdowns, mass layoffs, and supply chain disruptions that shocked the United States economy instantaneously in March 2020, the Federal Reserve activated its lending powers under Section 13(3) of the Federal Reserve Act for the first time since the 2008 Financial Crisis.
Section 13(3) authorizes the Fed to lend to non-bank institutions under “unusual and exigent circumstances.” It was under section 13(3) that the Fed engineered its rescue of the financial system in 2008 by backstopping liquidity markets and, somewhat infamously, providing bailouts to “too big to fail” financial firms. The Fed’s use of 13(3) was politically unpopular and resulted in amendments to 13(3) as part of the sweeping Dodd-Frank Wall Street Reform and Consumer Protection Act. The amendments ostensibly limit the Fed’s ability to lend as freely as it did in 2008. Congress’ intended to preserve the Fed’s ability to provide broad-based lending to the economy while simultaneously preventing future bailouts of individual firms.
Many commentators feared that the Fed’s circumscribed 13(3) power under Dodd Frank spelled doom for the economy in future financial crises. Particularly concerning to some were the requirements for broad-based eligibility, heightened collateral standards, and Treasury approval prior to establishing a new lending facility under 13(3). These detractors of Dodd-Frank maintained that the Fed needed unfettered power to provide credit to the economy to stave off economic devastation in financial crises.
Until the Coronavirus induced mass turmoil in the American economy, there had not been a chance to evaluate the practical effects of the Dodd-Frank amendments on the Fed’s ability to lend under 13(3). The Fed reacted swiftly and dramatically to abate the effects of the Coronavirus and so far has deployed its 13(3) lending powers to an unprecedented scope. Specifically, it has resurrected lending facilities first established in 2008 designed to provide liquidity to the financial system. It has also created a range of new lending facilities that are designed to provide lending to the real economy — nonfinancial businesses, states, and municipalities. The latter category of lending facilities might not be valid exercises of the Fed’s newly limited 13(3) power. At the very least, they appear to strain the new Dodd-Frank restrictions on 13(3) even if the statutory requirements are technically satisfied.
For example, the Fed would struggle to meet the Dodd-Frank collateral requirements for its loans in this environment where the risk of default is high, and there has been no effort to determine that it has. Congress resolved this issue with the passage of the CARES Act, affording up to $454 billion to backstop Fed loans against losses.
Moreover, under the amended 13(3), the Fed may not lend to insolvent firms. But it still may do so indirectly by purchasing loans from eligible banks that themselves are solvent. The recipient of the bank loan may be a firm in, or on the verge of insolvency.
Finally, Dodd-Frank amended 13(3) to impose the requirement that lending be for the purpose of providing liquidity to the financial system. The Fed’s response so far has involved significant lending to the non-financial economy. But this has been authorized, once again, by the CARES Act which instructs the Fed to provide lending to sectors of the real economy.
Whether the Dodd-Frank amendments are being interpreted loosely, or outright ignored, it seems impossible to conclude that the Fed’s ability to lend under 13(3) is significantly impaired. Perhaps this is an unsurprising conclusion in the current environment as the impetus behind the Dodd-Frank Amendments was to prevent future bailouts of individual firms rather than broad-based lending, which is exactly what the Coronavirus response demanded. In that sense, it should be caveated that the full impact of the Dodd-Frank amendments will not be clear until the economy is threatened by the impending failure of a “too big to fail” firm and the Fed finds itself unable to provide a tailored bailout to that firm.
Sources:
Marc Labonte, Cong. Research Serv., R44185, Federal Reserve: Emergency Lending (2020).
Peter Conti-Brown, Explaining the New Fed-Treasury Emergency Fund, Brookings Inst., (Apr. 3, 2020), https://www.brookings.edu/research/explaining-the-new-fed-treasury-emergency-fund/ [https://perma.cc/R9FQ-29LS].
March Labonte, Cong. Research Serv., R46411, The Federal Reserve’s Response to COVID-19: Policy Issues 22 (2020).
Lev Menand, Fed to the Rescue: Unprecedented Scope, Stretched Authority, Colum. Law Sch.: The CLS Blue Sky Blog (Apr. 27, 2020), https://clsbluesky.law.columbia.edu/2020/04/27/fed-to-the-rescue-unprecedented-scope-stretched-authority/#_edn2 [https://perma.cc/TLV5-L2UQ].
Christian A. Johnson, From Fire Hose to Garden Hose: Section 13(3) of the Federal Reserve Act, 50 Loy. U. Chi. L. J. 715 (2019).
John L. Walker, Emergency Tools to Contain a Financial Crisis, 35 Bos. U. Rev. Banking & Fin. L. 672 (2016)
Hal Scott, Dodd-Frank Worsens Covid’s Risk, Wall St. J (March 11, 2020, 7:01 PM), https://www.wsj.com/articles/dodd-frank-worsens-covids-risk-11583961933.
Jefferey Cheng et al., What’s the Fed Doing in Response to the COVID-19 Crisis? What More More Could it do?, Brookings Inst. (Jul. 17, 2020), https://www.brookings.edu/research/fed-response-to-covid19/ [https://perma.cc/5MAZ-589M].
Rosalind Wiggins, CARES Act $454 Billion Emergency Fund Could Add up to Much More for Businesses, States, and Municipalities, Yale School of Management: Program on Financial Stability (April 1, 2020), https://som.yale.edu/blog/cares-act-454-billion-emergency-fund-could-add-up-to-much-more-for-businesses-states-and-municipalities [https://perma.cc/Y9LD-LNDA]
Marc Jarsulic & Greg Gelzinis, Making the Fed Rescue Serve Everyone in the Aftermath of the Coronavirus Pandemic, Ctr. for Am. Progress (May 14, 2020), https://www.americanprogress.org/issues/economy/news/2020/05/14/484951/making-fed-rescue-serve-everyone-aftermath-coronavirus-pandemic/ [https://perma.cc/7L9F-RFLQ]