Of Last Resort: Evaluating the Treasury-Equity Model of Federal Reserve Emergency Lending
A new paper
New paper out, “Of Last Resort: Evaluating the Treasury-Equity Model of Federal Reserve Emergency Lending”, available here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5075729
Abstract
Despite the often-messy politics of Federal Reserve actions, particularly in crisis, the US Treasury Department has shown substantial unity with the Fed during modern crises. During the Global Financial Crisis of 2007-2009 (GFC), the COVID-19 pandemic in 2020, and the Banking Crisis of 2023, the Fed and Treasury cooperated to implement substantial and novel policy responses. This cooperative relationship has led to the increasing use of what this article calls the Treasury-Equity Model of Fed emergency lending. In the Treasury-Equity Model, fiscal resources available to Treasury are combined with money-creation powers of the Fed, with the intent of expanding what the Fed can accomplish with its emergency liquidity authorities provided by Section 13(3) of the Federal Reserve Act. This Model was conjured in the GFC, intended to alleviate the legal risk of a 13(3) program for the Fed—and later expanded to be a tool for enabling additional financial risk as well. Implemented for the final 13(3) program of the GFC, this Model became the standard during the pandemic response, covering seven of the nine Fed facilities rolled out in 2020. When the Fed invoked 13(3) in 2023, it implemented the Model once again. Before this Model becomes an institutional norm, to the detriment of other structures, it should be reevaluated in light of its history.
While theoretically a way to expand the Fed’s liquidity provision by supplementing it with loss-bearing fiscal resources, the history of the Treasury-Equity Model shows the politics of using fiscal resources lead to Section 13(3) programs with either the same or lower risk tolerance than the Fed could have accomplished without Treasury assistance. Even for programs that end up with the same risk tolerance, Treasury funding only slows program design and implementation. Moreover, the legal risk that functioned as the genesis of the Model appears to have been alleviated by post-GFC legislative reforms to the Federal Reserve Act. Thus, this article concludes, the Fed should be much more selective about accepting funding from the Treasury into its Section 13(3) emergency liquidity operations. Without an explicit understanding with Treasury that any fiscal support is meant to be spent—not lent—accepting Treasury funding support offers only drawbacks to a Section 13(3) program.
Full paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5075729
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