29 Jul 2013

Why Maiden Lane?

Federal Reserve 6 Comments

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.]

6 Responses to “Why Maiden Lane?”

  1. Transformer says:

    What a heart-warming story of central bankers prepared to live outside the law and risk their very freedom to ensure that the economy didn’t suffer from too tight a monetary policy !

    I think JP should turn this into a screenplay.

  2. skylien says:

    Who would have thought that the reigns they put on themselves don’t really bind them… Anything else would have been a surprise. See the Maastricht Treaty. Those rules are not worth the paper they are written on.

    It’s not that their effect is zero. I just mean that when it really becomes serious and they would be needed most, that is the time they become entirely useless, then it is always an exceptional situation…

  3. Tel says:

    The key question is what happens in the case of a default? If they followed the spirit of the law and held RMBS as collateral only, without making a purchase, then in case of default they could chase up that debt by other means… possibly including taking ownership of the collateral but not limited to that.

    If the LLCs purchase the RMBS then should that stuff become worthless there is no one else to chase for the debt. In effect this is a legal manouver to cover the tracks of the bad debt, presumably in preparation for a write off.

  4. Major_Freedom says:

    If a private entity created shell companies to launder money like this, they’d be charged.

  5. Joe Esty says:

    Like it really matters. Okay, so the “spirit” of a law that wasn’t a law but legislation was violated. Just like the Constitution — where everything under the sun is both constitutional and unconstitutional — matters. I’m sure there’s some section 14.1, paragraph three, sentence 10 somewhere, that makes it all legal and all okay. Or at least there is some judge somewhere who will interpret some legislative scribbling somewhere to make it all okay.

Leave a Reply