Lehman Brothers Once Again…
Ah. The debate continues:
: Did The Fed Fail To Save Lehman Brothers Because It Legally Couldn’t?): “The Fed’s lawyers said, after the fact, 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…. Here’s Peter….
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 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.’…
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…. 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…
I have two points to make here…
My first point is one that is obvious to an economic historian. But I do not see picked up by the lawyers. It is that central banks are government-chartered corporations rather than government agencies precisely to give them additional freedom of action. Corporations can and do do things that are ultra vires. Governments then either sanction them, or decide not to.
During British financial crises of the nineteenth century, the Bank of England repeatedly violated the terms of its 1844 charter restricting its powers to print bank notes. The Chancellor the Exchequer would then not take any steps in response to sanction it. Such a policy–of writing a charter for the central bank with the expectation that in an emergency the Bank would do whatever was needed to stabilize the economy in spite of the limitations placed on it by its charter, was clearly envisioned by the author of the 1844 charter, then Prime Minister Robert Peel, who expected to see the Governor of the Bank of England take responsibility for doing what was needed:
My confidence is unshaken that we have taken all the Precautions which legislation can prudently take up against the Recurrence of a pecuniary Crisis. It my occur in spite of our Precautions, and if it does, and if it be necessary to assume a grave responsibility for the purpose of meeting it, I dare say men will be found willing to assume such a responsibility. I would rather trust to this than impair the efficiency and probable success of those measures by which one hopes to control evil tendencies in their beginning, and to diminish the risk that extraordinary measures may be necessary…
Peel saw a choice: either (i) give the Bank of England explicit powers (and so run the risk that financiers, expecting that those powers would be used, would exploit moral hazard and so produce irrational exuberance, extravagant overleverage, and repeated frequent financial crises), or (ii) forbid the Bank of England from acting and rely on financial statesmen in the future to take actions ultra vires under the principle that in the end salus populi suprema lex. Peel chose (ii). To him and his peers, the risks that granting explicit powers would enable moral hazard appeared greater than the risks that when a crisis should come the makers of monetary policy would not understand their proper role. And the Federal Reserve banks have inherited their non-agency but corporation legal structure from the Bank of England.
My second point is that Bernanke, Geithner, and their company at the head of the Federal Reserve in 2008 really, really, really want their decision not to have rescued Lehman in the fall of 2008 to have been a judgment call that went wrong.
They really do not want to have let a situation develop in which there is a systemically-important financial institution that they cannot support. Should any systemically-important financial institution ever approach a state in which the central bank could not support it in an emergency, the most elementary principles of central banking command that such an institution be resolved or shut down immediately.
To fail to do so is complete and total central banking malpractice.