Did The Fed Fail To Save Lehman Brothers Because It Legally Couldn't?

My soon to be colleague Peter Conti-Brown and Brookings author (and future Glom guest) Philip Wallach are debating whether the Fed had the power to bail out Lehman Brothers in the wake of the crisis.  The Fed’s lawyers said, after the factor that no, they didn’t have the legal power to bail out Lehman.  Peter says yes they did, Philip says no, and I’m with Peter on this one – the discretion that the Fed had to open up its discount window to anyone was massive.  In fact, I’m not even sure that Dodd-Frank, which added some language to the section, really reduced Fed discretion much at all.  It’s a pretty interesting debate, though, and goes to how much you believe the law constrains financial regulators.

Here’s Peter:

as I discuss at much greater length in my forthcoming book, The Power and Independence of the Federal Reserve, the idea that 13(3) presented any kind of a statutory barrier is pure spin. There’s no obvious hook for judicial review (and no independent mechanism for enforcement), and the authority given is completely broad. Wallach calls this authority “vague” and “ambiguous,” but I don’t see it: broad discretion is not vague for being broad. In relevant part, the statute as of 2008 provided that “in unusual and exigent circumstances,” five members of the Fed’s Board of Governors could lend money through the relevant Federal Reserve Bank to any “individual, partnership, or corporation” so long as the loan is “secured to the satisfaction of the Federal reserve bank.” Before making the loan, though, the relevant Reserve Bank has to “obtain evidence” that the individual, partnership, or corporation in question “is unable to secure adequate credit accommodations from other banking institutions.”

In other words, so long as the Reserve Bank was “satisfied” by the security offered and there is “evidence”—some, any, of undefined quality—the loan could occur. 

Here’s Philip:

I (and most observers) read the “satisfaction” requirement as meaning that the Fed can only lend against what it genuinely believes to be sound collateral—i.e., it must act as a (central) bank, and not as a stand-in fiscal authority. The Fed’s assessment of Lehman Brothers as deeply insolvent at the time of the crisis meant that it did not have the legal power to lend. Years later, we have some indication that this assessment may have been flawed, but I don’t take the evidence uncovered as anything like dispositive. As I note in the book, the Fed’s defenders make a strong substantive case that the Fed was right to see Lehman as beyond helping as AIG (rescued days later) was not.

And the debate will be going on over at the Yale J on Reg for the rest of the week.  Do give it a look.