Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Political Origins of Section 13(3) of the Federal Reserve Act

Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Political Origins of Section 13(3) of the Federal Reserve Act

Article excerpt

* When the Federal Reserve made emergency loans to nonbank financial institutions in 2008 in an effort to stem the financial crisis, it did so under the auspices of Section 13(3) of the Federal Reserve Act.

* Section 13(3), added at the height of the Great Depression in 1932, expanded the Fed's emergency-lending authority beyond the financial sector to include a broader set of institutions.

* However, the scale and nature of the 2008 lending activity raise the question of what Congress intended in 1932.

* This detailed analysis of the legislative events and political environment in the years prior to the addition of Section 13(3) leads the author to conclude that the section's original framers meant to endow the Fed with the ability to lend directly to the real economy in an emergency.

1. INTRODUCTION

The Federal Reserve resorted to statutory authorities that had lain dormant for more than seven decades when, in 2008, it took steps to bolster a financial system on the brink of collapse. The Fed had been granted these powers in 1932 through passage of the Emergency Relief and Construction Act, which added Section 13(3) to the Federal Reserve Act. Section 13(3) as amended gave Federal Reserve Banks the authority to "discount" for any "individual, partnership, or corporation" notes "indorsed or otherwise secured to the satisfaction of the Federal Reserve Bank[s]," (1) subject to a finding by the Federal Reserve Board (now the Board of Governors of the Federal Reserve System) of "unusual and exigent circumstances" (2)

In 2008, at the height of the financial crisis, the Federal Reserve System used its 13(3) authority to provide loans in support of a variety of markets and market participants, including broker-dealers, commercial paper issuers, and money market mutual funds. (3) The Board of Governors created six emergency facilities, and authorized direct loans to three special purpose vehicles, four broker-dealers, and an insurance company (see Table 1). (4) Federal Reserve lending under the section peaked at more than $700 billion in late 2008, as shown in Chart 1.

The unprecedented variety, scale, and nature of the 13(3) loans and loan facilities raise the question of what Congress intended in 1932. This article explores that question, examining the legislative history of the section and the economic and political environment that influenced congressional views.

The original Federal Reserve Act of December 23, 1913, incorporated strict limits on the scope of discretionary central bank credit policy, and these restrictions were, for the most part, left unchanged in the early years of the Federal Reserve System. Before the 1930s, federal initiatives aimed at mitigating credit market dysfunctions usually involved the creation of government-sponsored enterprises endowed with funds from the U.S. Treasury and given targeted lending authorities (such as the Federal Land Banks). However, in the throes of the Great Contraction (1929-33), Congress turned to the Federal Reserve System, relaxing its statutory strictures and authorizing expansive lending.

Given the nature of other Depression-era credit initiatives, it is not unreasonable to conjecture that Congress added 13(3) to allow for discount window lending to distressed financial intermediaries such as nonmember banks and other financial institutions outside the Federal Reserve System. However, the legislative history and political context of the section suggest a much broader mandate. This article concludes that the framers of the section intended to authorize credit extensions to individuals and nonfinancial businesses unable to get private-sector loans. In other words, Section 13(3) sanctioned direct Federal Reserve lending to the real economy, rather than simply to a weakened financial sector, in emergency circumstances.

The article is organized as follows. Section 2 explores the early history of the Federal Reserve Act, focusing on how the conceptual underpinnings of the act influenced legislative approaches to dysfunction in the credit markets prior to the Great Contraction. …

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