I am using this excellent J.P. Koning post (at Nick Rowe’s hangout) for an upcoming paper, but I wanted to draw everyone’s attention to this interesting fact:
There is also a not-so-well known legal route by which the Fed has purchased assets in the past. The restrictions set by Section 14 [of the Federal Reserve Act] clearly prohibited the massive Fed purchases of all sorts of private assets during the 2008 crisis, including private label RMBS (much of it subprime), CDOs, CMOs, ABS, swaps, whole commercial mortgage loans, and asset-backed and unsecured commercial paper. Furthermore, in many cases these purchases were often not made in the open market, but directly from distressed banks. (Bear Stearns and AIG)
In announcing its purchasing programs in 2008, the legal route taken by the Fed invariably drew on section 13.3 of the Federal Reserve Act. But oddly, Section 13 sets out the rules and regulations regarding Fed loans, not purchases. Section 13.3 is an incredibly open ended passage, allowing the Fed to lend to any individual, partnership, or corporation upon any collateral the Fed deems satisfactory.
Over the course of the crisis, the Fed mobilized 13.3’s lending powers so as to justify purchases by creating five separate Delaware limited liability companies: Maiden Lane LLCs I, II, and III, Commercial Paper Funding Facility LLC (CPFF), and Term Auction Lending Facility LLC (TALF). It lent to these corporations under the authority of Section 13.3. These LLCs proceeded to use these funds to purchase assets not specifically authorized by the Federal Reserve Act.
In short, the Federal Reserve attempted to get around the limitations concerning asset purchases found in Section 14 by lending under the much broader Section 13.3 to the five recently created LLCs it controlled, and ordering these LLCs to purchase whatever assets it deemed necessary. Presumably as long as the LLCs were doing the purchasing, and not the Federal Reserve itself, Fed lawyers felt that Section 14 was not being violated.
Dubious? It would take a court of law to determine how legal the entire range of transaction conducted though these LLCs was. Certainly it seems to have violated the spirit of the law, though perhaps not the letter. [Bold added.]