Yes, the Fed can be constrained by a law granting it discretion

Peter Conti-Brown argues that the Fed could have bailed out Lehman Bros. but chose not to and is using the law as “ex post rationalization” for political action. Philip Wallach argues that the fact that the Fed wasn’t satisfied with Lehman’s collateral means that it could not bail out Lehman.

The underlying question is this: What does the criterion in section 13(3) of the Federal Reserve Act, “secured to the satisfaction of the Federal Reserve Bank” mean? In my view the text itself makes clear that the interpretation of the meaning of the term “secured” has been delegated by Congress to the Federal Reserve Bank in question, subject in theory (although arguably not in practice) to a “reasonableness” standard.

For this reason, I am having difficulty following Conti-Brown’s argument. He writes in a follow up post:

The point is that “satisfaction,” in the midst of a financial crisis, is an entirely discretionary concept. . . . Instead, my argument—and critique—is that Bernanke, Paulson, Geithner, and others made a decision. They exercised the discretion they were entitled to make. They made these decisions knowing that there would have been enormous political fallout if they had bailed out another Wall Street “bank.” And they made it knowing that the legal authority to go in another direction was broad, robust, and entirely left to the discretion of two bodies of decision-makers within the Federal Reserve System. The Fed wasn’t legally obliged to do anything. But nor was it legally prevented from doing something.

I think there is confusion here. The Fed was granted discretion to interpret the meaning of the term “secured” within reasonable bounds.  It was not, however, granted discretion to do whatever it thought was necessary in a financial crisis.

Thus, I don’t think it makes sense to call the Fed’s claim that the law prevented it from lending to Lehman an “ex post rationalization.” Conti-Brown appears to be arguing that he knows that the Fed first decided not to bail out Lehman and then later determined that it did not have adequate collateral to “secure” a loan. But it seems much more likely to me that these two determinations were so closely intertwined that they were more or less determined at the same time: that is, it is at least equally likely that the Fed was unwilling to bail out Lehman, because in its discretion it found Lehman’s collateral to be inadequate. Given that the Fed is by law the entity that interprets the meaning of the term “secured” in section 13(3) of the FRA, such a finding by the Fed is close to a final determination on the issue. Thus, far from being an “ex post rationalization,” the Fed’s explanation that a bailout of Lehman was not permitted seems to me simply a description of its decision-making process.

In my view, the fact that the Fed could potentially have exercised its discretion differently is irrelevant. What makes this complicated is, of course, the fact that the Fed turned around found that collateral that was deemed inadequate on September 15 had become adequate a few days later. In short, Conti-Brown appears to be arguing that, if the Fed had authority to bail out AIG et al., then it must have had authority to bail out Lehman.

In my view, this gets the reality of the situation precisely backwards. I think that since the Fed didn’t have the authority to bail out Lehman, it probably didn’t have the authority to bail out AIG. Indeed, the AIG trial has made it clear that regulators believed that an AIG bailout was necessary and that they pushed legal interpretations of Fed authority to their absolute limits. In fact, I suspect you could even get some of the attorneys involved to admit the latter — though they would almost certainly also assure us that no lines were actually crossed. (For an example of this, see the Sept. 21 email from Fed General Counsel Scott Alvarez indicating that a term sheet produced five days after the AIG loan-for-stock bailout was announced had to be changed because the Fed couldn’t own AIG stock.) Whenever you are that close to a boundary, however, it seems very likely that there are lawyers and regulators close to the action and possibly even at a decision making level who believe that lines were in fact crossed — but that they were crossed in order to do what was necessary and in that sense in good faith. On the other hand, I would not expect any such privately held views to come to light until the passage of time has rendered them statements of only historical interest. (And even then only the non-lawyers are likely to speak out.)

In short, it seems to me that a position equally valid to that taken by Conti-Brown is that the Fed didn’t have the authority to bail out Lehman and didn’t have the authority to bail out AIG et al. But the more important point is that the law as drafted deliberately renders this whole discussion moot. The Fed was granted the authority by Congress to make two decisions within a week of each other that would appear to be contradictory. This, in fact, is the essence of what “to the satisfaction of the Fed” means.


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