Fed Has Giant, and Opaque, Role in Financial Crisis Aid

By Neil Irwin
Washington Post Staff Writer
Monday, November 24, 2008

Wall Street analysts, congressional overseers and the media have parsed every detail of the Treasury Department's financial rescue program -- $250 billion and counting.

Largely outside public view, however, the Federal Reserve is lending far more than that amount -- $893 billion, roughly the equivalent of the annual economic output of Mexico -- to help a wide range of institutions weather the economic storm.

As of last week, the Fed's loans included $507 billion to banks, $50 billion to investment firms, $70 billion for money market mutual funds, and $266 billion to companies that use a form of short-term debt called commercial paper. It is considering a new program that would make billions more available to prop up consumer lending: auto loans, credit cards and the like.

In lending these vast sums, the Fed is essentially substituting its own unlimited ability to supply cash for that of private markets, which are not functioning normally. The central bank is even fulfilling some of the original goals of the Treasury Department's $700 billion rescue program by allowing financial institutions to use securities that are difficult to sell as collateral for loans.

"The existing system of lending is broken," said David Shulman, a senior economist at the UCLA Anderson Forecast, which analyzes economic trends. "The Fed is coming in to do that lending. That's why they call it the lender of last resort."

But unlike the Treasury's rescue package, which has elaborate disclosure requirements and oversight mechanisms, the Fed lending is occurring quietly and at the discretion of its five governors, as well as top officials of the 12 regional Fed banks. Timothy F. Geithner, president of the Federal Reserve Bank of New York and the Obama administration's expected nominee for Treasury secretary, has been a leading architect of the new lending programs.

Following a long-standing practice designed to protect investor and depositor confidence in the institutions it deals with, the Fed refuses to name the banks and other companies accessing the cash. It has also declined to specify which assets institutions have pledged as collateral in exchange for loans, a decision that has drawn skeptical questioning from Capitol Hill and at least one lawsuit under the Freedom of Information Act. Fed officials argue that any disclosure along those lines would create a stigma for banks and others that need to borrow from the Fed, making the programs less effective at jump-starting lending.

"There's a concern that if the name is put in the newspaper that such and such bank came to the Fed to borrow overnight for a good reason, that people might begin to worry: Is this bank credit-worthy?" Fed Chairman Ben S. Bernanke told Congress last week. "And that might create a stigma, a problem, and might cause banks to be unwilling to borrow."

Bernanke also said there is little chance taxpayers will lose money on most of that lending, because the central bank lends money only to institutions it views as sound and requires that the collateral borrowers put up be worth more than the amount of the loan.

Outside experts generally agree that Bernanke has been prudent in his decision-making, but they note that Fed lending to support the purchase of Bear Stearns and the government takeover of American International Group entails greater risk than the central bank usually takes on.

The expansion in Fed lending has come in the form of numerous new programs to inject cash into the financial system, attempts to combat a crisis in which banks and other firms are hoarding it. To enact those steps, the Fed has increased the size of its balance sheet and replaced the ultra-safe U.S. government bonds it normally keeps on its books with loans to banks and others.

A year ago, the central bank had assets of $868 billion, of which about 90 percent was in Treasuries. Last week, it had assets of $2.2 trillion on its books, of which 22 percent was in Treasuries. Much of the remainder represents the new lending to banks and other financial institutions. Even the weekly report that summarizes the Fed's financial position has grown -- to eight pages from four pages a year ago.

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