In September and November of 2008, the Federal Reserve extended credit to the affiliates of these Wall Street firms under terms very similar to those it was making under the Primary Dealer Credit Facility. But because these affiliates were not actually primary dealers, loans under that facility were not officially available.

But the Fed made the loans anyway, citing its powers under Section 13(3) of the Federal Reserve Act to extend loans in “exigent circumstances.” But it never explained exactly why it decided these loans qualified under this provision.

Prior to 2008, the Federal Reserve had rarely invoked Section 13(3).

But beginning with the rescue of Bear Stearns, it began to use this provison more frequently. The provision allows the Federal Reserve to lend to “any individual, partnership or corporation” in “unusual and exigent circumstances” when the borrower “is unable to secure adequate credit accommodations from other banking institutions.” (You can read a history of 13(3) put together by the Minneapolis Fed here.)

“In explaining the basis for these exceptional credit extensions, Federal Reserve Board officials cited the continuing strains in financial markets and concerns about the possible failures of these dealers at the time. However, the Federal Reserve Board could not provide documentation explaining why these extensions were provided specifically to affiliates of these four primary dealers,” the GAO writes.

The GAO goes on the explain that when it asked for documentation about the finding of exigent circumstances, it was told that the Fed had never documented its views. Fed officials responded to auditors' requests by just reiterating the blanket claim that “unusual and exigent circumstances” existed.

The GAO is not satisfied with this. In its view, the law doesn’t just give the Fed complete discretion to declare exigent circumstances and transfer funds. The Fed should have to explain and document its findings.

“However, without more complete documentation, how assistance to these broker-dealer subsidiaries satisfied the statutory requirements for using this authority remains unclear. Moreover, without more complete public disclosure of the basis for these actions, these decisions may not be subject to an appropriate level of transparency and accountability,” the GAO reports.

In other words, this is more than just a case of a bureaucracy forgetting to cross its Ts or dot its Is. It goes to the basic question of whether the Fed’s powers under the law have any real limitations. If just declaring “exigent circumstances” exist is enough, then there are no real limits. If the declaration must be backed up in a way that can be publicly examined and debated, then the prospect of having to articulate a public justification at least creates a potential limit.

The Fed’s position is apparently that its powers are not limited and do not require the articulation of a public justification. Even the Supreme Court explains its rulings, so this is quite a claim by the Fed.

Fortunately, it won’t be one the Fed can make going forward. The Dodd-Frank Act includes new requirements for the Fed to report to Congress on any loan authorized under Section 13(3). Those reports must include not just the amounts, terms and borrowers but the justification for the assistance.

Next time just declaring “exigent circumstances” won’t be good enough.

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