Content:
The “exigent and unusual circumstances” provision of 12 USC § 343, authorizes the U.S. central bank (the Federal Reserve) to provide discrete and immediate relief to an ailing entity (banks and non-banks alike[i]) via the issuance of emergency loans, should they fail to obtain credit accommodations elsewhere within the general banking system.[ii]
With the exception of a few general parameters, 12 USC § 343 was written quite vague by design. Virtually no formal restrictions were placed on the applicability of 12 USC § 343, leaving matters of proof and sufficiency (regarding need of alleviation and prior attempts to obtain aid elsewhere) to the satisfaction of the Board of Governors of the Federal Reserve System.[iii] Consequently, 12 USC § 343 (particularly the “exigent and unusual circumstances” provision) appears to be a rather flexible law, which is to say, that its applicability evolves and is, therefore, adaptable to a rapidly changing, complex global financial system[iv] — though the stringent restrictions on “credit-worthiness” and “importance” (to the greater economy) still apply, indicating an impermeable selectivity factor.[v]
History and Intent:
The Federal Reserve Act of 1913 (which contains 12 USC § 343) was signed into law by President Woodrow Wilson in an attempt to “provide the nation with a safer, more flexible, and more stable monetary and financial system.”[vi] The formation of the Federal Reserve system (that is, a system of multiple, regional, semi-sovereign branches of a central bank) came only after a devastating era when the country’s banks were plagued with fiscal irresponsibility, resulting in mass insolvency and bankruptcy (the “Panic of 1907); Without a properly suited government, the country came to depend on a private financier (J.P. Morgan), not the government nor its entities, to mitigate the further spread of panic and “bank runs;”[vii] The U.S. government had failed to prevent, stop, and mitigate the panic, and bring any alleviation of its own merits, for it lacked a corresponding body to do so. Even with the establishment of the Federal Reserve system, the “exigent and unusual circumstance” provision was not part of the 1913 legislation, continuing to severely hinder the federal government’s ability to provide any stimulus to an ailing economy.
Nearly two decades later, in the midst of national havoc, resulting primarily from widespread economic depression (deflation), President Herbert Hoover and his governing congress signed into law the Emergency Relief and Construction Act in 1932, amending and expanding the Federal Reserve Act vis-à-vis the addition of the “exigent and unusual circumstances” provision.[viii] Said provision provided the United States federal government with capability to oversee and manage the supply of money in circulation within the general economy via “discounts” (loans), and the selling and buying of treasuries.[ix] To that end, while not explicitly stipulated in the original provision, there was a general consensus that the United States government is not in the business of “bailing-out” institutions for the sake of an institution’s singular welfare; instead, such “bailouts” were to be made when and where the U.S. government believed that (for any given reason) the stability of the economy at large was, at the very least, marginally contingent on the success of the institution(s) in question.[x]
Furthermore, because the emergency loans that the Fed is authorized to issue under 12 USC § 343, (specifically the “exigent and unusual circumstances” provision) are taxpayer-funded, a government-sponsored “bailout” always presents the threat of colossal, internal financial loss to the United States (taxpayers), should the entity to which the loan is issued fail (despite having been “bailed-out”)[xi]. Given that 12 USC § 343 and its “exigent and unusual circumstances” were enacted during periods of national economic distress and despair, little opposition existed at the time of their enactment, as is suggested by an overview of relevant historical periodicals of the era of focus. Much of the heavy, heated debate and stark opposition (overwhelmingly from modern “fiscal conservatives”) to the government’s authority to provide such relief to, what very much appear to be, failing conglomerates are a product of the twenty-first century, primarily stemming from the 2008 recession.
After 2008:
In the wake of 2008’s global economic catastrophe, much scrutiny was placed on the ensuing bailouts that were carried-out under the “exigent and unusual circumstances’ provision of the Federal Reserve Act. The financial crisis originated in the United States, but it manifested itself with ripple-effects around the globe. The crisis was the result of a callous banking system plagued with lagging ethics and cynicism, and a self-interested market working in tandem — issuing faulty mortgages to the poor and financially illiterate[xii], and securitizing and reselling those mortgages to investors.[xiii] By the time the financial system realized that people were defaulting on their mortgages in masses, and that the mortgages owned by investors were worthless, it was too late! The demise of many conglomerates was foreseeable; that is, until the Federal Reserve with the full-backing of the United States government stepped-in.[xiv]
Enforcement protocol:
Ordinarily, when faced with the looming threat of illiquidity and insolvency, whether arising from fiscal irresponsibility or otherwise unfortunate events, private institutions have at their disposal the opportunity to file for bankruptcy.[xv] Yet, as mentioned before, sometimes the government deems the institutions in question to be far too crucial to functioning of the greater economy to be allowed to declare bankruptcy, for declaring bankruptcy is a tell-all sign of an institution’s failure and insecurity, hence, an emergency loan is issued to ensure that the institutions in distress continue to operate, giving rise to the coinage of “too big to fail.”[xvi]
Because the Federal Reserve is not “technically” a government institution, but rather a private central bank under legislative oversight, it is not required to obtain approval from any branch of government prior to acting on the “exigent and unusual circumstances” provision. How, when, and if relief will be issued is completely at the discretion of the Board of Governors of the Federal Reserve System. Following the 2008 financial crisis, however, the role of discretion was heavily scrutinized and amended to require a congressional hearing to, at the very least, explicate the rationale of any such bailout decision. Still, the hearing is merely a convention of officials after-the-fact. Congress has and always has had the power to change the law, but it does not otherwise have the power to prevent the Fed from taking actions within the limits of the law.
Critical court decisions and Pattern of enforcement:
Court decisions pertaining to bankruptcy filings of various financial conglomerates in the emergence of the Great Recession of 2008 had no effect, whatsoever, on 12 USC § 343; They tell us absolutely nothing about the evolvement of the law, going from one of absolute discretion to one with a great-deal of discretion yet limited effect, as a result of stringent constraints. That said, the value of the cases is not their impact on 12 USC § 343 itself; Instead, they serve to make an apparent pattern of enforcement salient.
As a general rule, the Federal Reserve does not make a routine of bailing-out ailing institutions, which is to say that those that are bailed-out are truly the exceptions. Too that point, under normal circumstances, the Fed is not supposed to bailout institutions, big or small.
Before the collapse of U.S. economy, before it was evident to the public that there was something wrong, the investment banks Lehman Brothers[xvii] and Bear Stearns[xviii] took to federal court in the Southern District of New York to declare bankruptcy. The Fed partially bailed-out Bear Sterns, helping it liquidate its remaining assets, and subsidizing the sale of the assets for purchasing by JP Morgan Chase & Co.[xix] In the case of Lehman Bros., however, the Fed refused to issue a bailout, and did nothing to mitigate the disastrous consequences that ensued the filing; To date, the Lehman bankruptcy remains the largest bankruptcy filing in U.S. history.[xx] And yet, in a bizarre twist, while the Fed did not move to alleviate Lehman Brothers, it acted, almost imperceptibly, to bailout AIG (American International Group) under the condition that AIG would not file for bankruptcy, though AIG was fifty percent larger than Lehman Brothers.[xxi] Additionally, the Fed acquired an eighty percent ownership stake, so as to directly benefit the American economy from potential success.[xxii]
The only way to make any sense of the aforementioned trend, is describe it as a “selective enforcement” of the Fed’s bailout authority. It is difficult to explain why some conglomerates of great economic import were saved while others were allowed to vanish and have an equally catastrophic effect on the economy. To attempt to describe a pattern would require a rather convoluted analysis on one’s behalf, all of which is owed to the vast discretion on the part of the Fed.
Critical Legislative Changes:
Since 2008, the U.S. government mandated and oversaw a systemic restructuring of the banking system, which represents a colossal portion of the global economy. In the ensuing decade, much controversy has focused on the paternalistic role that the U.S. government took in the wake of the financial crisis of 2008. Amidst widespread ambivalence amongst the legislature and its constituents, a new interpretation of 12 USC § 343 was introduced under the “Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010”, accompanied by a number of amendments.[xxiii] While it remains fairly vague, the new “Dodd-Frank” interpretation of 12 USC § 343 has significantly narrowed the Fed’s scope of action by adding a number of re-definitions, constraints, specifications regarding the eligibility to receive a bailout.[xxiv] It explicitly prohibits the Fed from lending to insolvent borrowers, and requires that the Fed take precautionary measures to protect “taxpayer[s]” by acquiring substantial ownership of the borrowers assets.[xxv]
Evaluation of Effectiveness & Ideas for reform:
The principal aim of 12 USC § 343 is to maintain system-wide solvency and liquidity. 12 USC § 343 has come a long way since its inception. By itself, it was effective for its time, being a tool for agricultural and industrial stability; yet, it was not sufficient for ensuring widespread economic stability in an era of rapid development and an emerging private financial sector, thus, necessitating an expansion of its applicability. In response, its “exigent and unusual circumstances” was added in 1932, witnessing an immediate influx of bailout requests from companies. Only twice in history has the Fed invoked the “exigent and unusual circumstances clause: The Great Depression and The Great Recession.[xxvi] While controversial, the Fed has effectively used its powers granted by 12 USC § 343, which is to say, that the 12 USC § 343 and its accompanying “exigent and unusual circumstances” provision have served their purpose. In both occasions, the U.S. economy has made a great recovery, emerging stronger than previously.[xxvii]
To say the least, the authority granted to the Fed under 12 USC § 343 and its “exigent and unusual circumstances” provision were intended to be utilized as tools of last resort; actions arising from said authorization were to serve as catalysts and deliver some sort of stimulus to the greater economy. The over-arching problem with 12 USC § 343 is that, as it stands, it limits the ability of the Fed to prescribe adequate relief during times of national economic distress. Certainly, it is a valid concern to call the formerly unrestrained power of the Fed into question, yet there’s an argument to be made that it was that same unhinged authority that provided a sense of economic security and reassurance to the national economy. Discretion should be the issue addressed and legislatively redefined, but the Fed’s vast power to bailout institutions ought to be reinstated, to once again — in anticipation of an economic emergency. While its formerly unrestrained power has been more clearly defined by “Dodd-Frank,” the legislation greatly hinders the bank’s ability to provide aid to those who most need it. Instead, 12 USC § 343 should be amended in such a way so as to allow for greater flexibility of its use by the fed, but require greater legislative involvement in the bailout process itself, as is the case with the Federal Reserve agenda goals (which can only be changed congress).
Notes:
[i] “Reserve Bank Makes Individual Loan.” Wall Street Journal (1923 – Current File), Aug 10, 1932.
[ii] Federal Reserve Act, 12 USC § 343 (2009)
[iii] Ibid
[iv] Ibid
[v] Ibid; “FIRST RELIEF LOAN BY RESERVE BANK.” New York Times (1923-Current File), Aug 09, 1932
[vi] The Federal Reserve. “What Is the Purpose of the Federal Reserve System?” The Federal Reserve, Board of Governors of the Federal Reserve System, 3 Nov. 2016, www.federalreserve.gov/faqs/about_12594.htm.
[vii] Moen, Jon R., and Ellis W. Tallman. “The Panic of 1907.” Federal Reserve History, Federal Reserve History, 4 Dec. 2015, www.federalreservehistory.org/essays/panic_of_1907.
[viii] “FIRST RELIEF LOAN BY RESERVE BANK.” New York Times (1923-Current File), Aug 09, 1932.
[ix] “BANKING SITUATION DECLARED STRONGER.” New York Times (1923-Current File), Sep 01, 1932.
[x] The revised, Dodd-Frank version of the “exigent and unusual circumstances” provision is adamant explicitly articulates that “such policies and procedures shall be designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company.”
[xi] Additionally, because the United States alone contributes roughly twenty-five percent of global GDP, large and turbulent disruptions on the global economy would likely ensue and reflect any negative economic happenings in the U.S. financial system.
[xii] Abramsky, Sasha. “Sasha Abramsky: Conservatives Are Blaming the Poor for the Financial Crisis.” The Guardian. October 10, 2008. Accessed November 06, 2018. https://www.theguardian.com/commentisfree/cifamerica/2008/oct/10/us-economy-credit-crunch-poverty.
[xiii] Bernanke, Ben. “The Subprime Spark.” The Courage to Act: A Memoir of a Crisis and Its Aftermath, 68-73. New York: W. W. Norton & Company, 2017.; Ashcraft, Adam, and Til Schuermann. “Understanding the Securitization of Subprime Mortgage Credit”. Newyorkfed.Org, 2008. https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr318.pdf.
[xiv] Ibid; “Timeline: Most Impactful Events of the U.S. Financial Crisis.” Reuters. March 31, 2011. Accessed November 02, 2018. https://www.reuters.com/article/us-usa-fed-lending-timeline/timeline-most-impactful-events-of-the-u-s-financial-crisis-idUSTRE72U4E720110331.
[xv] Skeel, David. “History Credits Lehman Brothers Collapse for the 2008 Financial Crisis. Here’s Why That Narrative Is Wrong.” Brookings.edu. September 20, 2018. Accessed November 5, 2018. https://www.brookings.edu/research/history-credits-lehman-brothers-collapse-for-the-2008-financial-crisis-heres-why-that-narrative-is-wrong/.
[xvi] Bernanke, Ben. “Bear Sterns: Before Asia Opens.” The Courage to Act: A Memoir of a Crisis and Its Aftermath, 167-169. New York: W. W. Norton & Company, 2017.
[xvii] Voluntary Petition: Chapter 11 Bankruptcy. (2008). [pdf] Available at: http://wsj.com/public/resources/documents/lehmanfiling916208.pdf [Accessed 3 Nov. 2018].
[xviii] Fraser.stlouisfed.org. (2007). Bankruptcy Filing: Bear Stearns High-Grade Structured Credit Strategies Master Fund, LTD and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund, LTD. | FRASER | St. Louis Fed. [online] Available at: https://fraser.stlouisfed.org/title/4972 [Accessed 3 Nov. 2018].
[xix] September 2008 was the focal point of the “Great Recession.” As it was during that time that much of the economic chaos came to light; most of the major bankruptcies, institutional acquisitions and mergers, and government sponsored bailouts took place in September 2008.
[xx] “Top 10 Bankruptcies.” Time. September 16, 2008. Accessed November 3, 2018. http://content.time.com/time/specials/packages/article/0,28804,1841334_1841431_1841342,00.html.
[xxi] Bernanke, Ben. “Prologue.” The Courage to Act: A Memoir of a Crisis and Its Aftermath, Xi. New York: W. W. Norton & Company, 2017.
[xxii] Bernanke, Ben. “Prologue.” The Courage to Act: A Memoir of a Crisis and Its Aftermath, 12. New York: W. W. Norton & Company, 2017
[xxiii] Federal Reserve Act, 12 USC § 343 (2010)
[xxiv] Ibid
[xxv] Federal Reserve Act, 12 USC § 343 (b) (2010)
[xxvi] WSJ. “Fed Invokes ‘Unusual and Exigent’ Clause – Again.” The Wall Street Journal. September 17, 2008. Accessed December 06, 2018. https://blogs.wsj.com/economics/2008/09/16/fed-invokes-unusual-and-exigent-clause-again/.
[xxvii] Litan, Robert E. “More than Ever, the American Project Demands a Strong Economy.” Brookings.edu. March 06, 2018. Accessed December 06, 2018. https://www.brookings.edu/research/more-than-ever-the-american-project-demands-a-strong-economy/.
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