The federal government's $3.5 billion, five-year cash loan to the troubled Continental Bank of Illinois was arranged last May so that it would not show up anywhere as a budget expenditure, according to a new report by the Congressional Budget Office.
The money was put up in cash by the Federal Reserve Bank, and the loan was then assumed by the Federal Deposit Insurance Corp. as part of the overall government bailout of the Chicago bank.
The CBO report, which in general says that the Fed should be more accountable for its spending, reveals that instead of the normal procedure by which the FDIC would have directly acquired the cash by the sale of its own securities, the Fed's discount window "served as the source of financing."
Under the regular procedure, a $3.5 billion FDIC loan would have shown up as a budget expenditure item. The way it was done, there is no record of the loan in the budget.
Normally, says the CBO report, loans and equity assistance from the FDIC's fund are listed in the budget as expenditures; repayments of assistance are listed as offsetting collections. An FDIC sale of securities would show up as a decrease in FDIC's unobligated balances.
In the Continental case, because the cash was provided by the Fed, eliminating the need for the FDIC to disburse cash or to draw down its equity, the Office of Management and Budget decided that the transaction didn't have to show up as a budget outlay, the CBO study says.
The FDIC then assumed Continental's debt of cash to the Fed, acquiring in exchange some of Continental's troubled loans. "Over the next five years, the FDIC will pay the interest and principal payments due on these loans to the Federal Reserve," financing any shortfall from its own reserve fund, according to the CBO. Any FDIC losses will show up as expenditures in future budgets, a congressional source said.
Former Wisconsin congressman Henry S. Reuss said "it is unheard of" for the Fed to use its discount window for a five-year loan. He suggested a bad precedent had been created, whereby the Fed had printed money to help bail out a bank. However, a House Banking Committee staff member said the Fed window was used on a smaller scale in the Franklin National Bank case.
"The Continental Illinois loan is not recorded in the FDIC's budget because the FDIC did not provide any 'budgetary resources,' even though the FDIC did assume the risk of loss in the transaction," according to the CBO report. "The loan is not recorded in the budget under the Federal Reserve's account because the discount operations of the Federal Reserve are excluded from the budget."
The "moral of the tale," said economist James K. Galbraith, former staff director for the Joint Economic Committee, "is that the normal rules for spending and lending money don't apply to the Fed, because discount operations are excluded from the budget."
Legislation to implement some of the CBO's recommendations to make the Fed more accountable will be introduced by Rep. Lee H. Hamilton (D-Ind.), chairman of a Joint Economic subcommitee that released the CBO report. Hamilton's bill would require that all receipts and expenditures of the Federal Reserve System be presented in the budget.