Why Does the Fed Really Use SPVs?

Often maligned as a legal gimmick, there are several strategic considerations to using SPVs when fighting a crisis. (And the legal underpinnings are solid.)

The Federal Reserve “borrowed a tool from financial engineers whose handiwork had led to the Great Panic. It created a ‘special purpose vehicle’ . . ." – David Wessel, In FED We Trust (2009)

It was March 2008, and the Fed was helping rescue Bear Stearns by facilitating its sale to JPMorgan (JPM). To get it done, JPM hived off $30 billion of Bear Stearns’s assets in a bankruptcy-remote special purpose vehicle (SPV)—$29 billion of which would be financed by the Fed, the remainder by junior funding from JPM. This would become known as Maiden Lane (named for the street next to New York Fed). It would be the first of three Maiden Lanes (with the second and third established as part of the AIG rescue); it was the first of five SPVs set up by the Fed during the Global Financial Crisis (GFC)—of the 7 SPV programs and 11 actual SPVs authorized. Since the start of the GFC through today, the Fed has provided emergency liquidity from 10 different SPVs.

Reputable discussion of the Fed’s use of SPVs—from journalistic coverage to legal articles to governmental reports—often take as received wisdom that the Fed sets up these vehicles to evade its legal limitations. However, the Fed itself has never said this anywhere. Indeed, the Fed’s communications surrounding its SPV interventions have mentioned the creation of SPVs without offering a justification.

A comprehensive look at the Fed’s history with SPVs reveals the oft-postulated story of legal evasion does not hold up. For one, the Fed’s history with SPV use and non-use is not consistent with that story. Additionally, formerly confidential internal documents from the time of the GFC lay out the Fed’s thinking and make clear it analyzed the use of SPVs within the bounds of its authorities. Moreover, several interviews conducted by the Yale Program on Financial Stability (YPFS) with past crisis fighters reveal more strategic reasons for using SPVs. This article lays out the legal underpinnings as well as the benefits and costs of using SPVs when fighting crises in the US…. Continue reading at the Systemic Risk Blog here.