By Alexander Saeedy
Alexander Saeedy is a senior at Yale University studying history.
With six years of historical distance between the beginning of the Great Recession and the present, it is clear that the United States and Europe have had fundamentally different, though not opposite, experiences with the global crisis. One possible reason for this difference was the Federal Reserve’s invocation of emergency powers in 2008. The invocation was an obviously legal action—emergency powers are included within the Federal Reserve’s charter—but it is fair to ask: how constitutional and democratic was it?
We may find some answers by turning back to 2008. When Bear Stearns, the former investment bank that became defunct in that same year, was found to have mortgage securities that were toxic, the Federal Reserve created a limited liability corporation called Maiden Lane LLC and floated $30 billion to the corporation, a loan designed to absorb Bear Sterns’ toxic assets. The remainder of Bear Stearns was sold to JPMorgan Chase. [1] The process was repeated in September of 2008 as Maiden Lane II LLC and Maiden Lane III LLC took on $43.8 billion of AIG’s toxic assets. [2]
Alexander Saeedy is a senior at Yale University studying history.
With six years of historical distance between the beginning of the Great Recession and the present, it is clear that the United States and Europe have had fundamentally different, though not opposite, experiences with the global crisis. One possible reason for this difference was the Federal Reserve’s invocation of emergency powers in 2008. The invocation was an obviously legal action—emergency powers are included within the Federal Reserve’s charter—but it is fair to ask: how constitutional and democratic was it?
We may find some answers by turning back to 2008. When Bear Stearns, the former investment bank that became defunct in that same year, was found to have mortgage securities that were toxic, the Federal Reserve created a limited liability corporation called Maiden Lane LLC and floated $30 billion to the corporation, a loan designed to absorb Bear Sterns’ toxic assets. The remainder of Bear Stearns was sold to JPMorgan Chase. [1] The process was repeated in September of 2008 as Maiden Lane II LLC and Maiden Lane III LLC took on $43.8 billion of AIG’s toxic assets. [2]
This rightly raised concerns in the eyes of legislators. Section 2A of the Federal Reserve’s charter outlines the system’s monetary policy objectives. It states that the Federal Reserve “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” [3] But just how far can we take the Federal Reserve’s powers to “maintain long run growth” or promote “long-term interest rates”?
In total, the Federal Reserve lent out over $13 trillion to banks. [4] The efficacy of the choice is hard to argue with, but the legality is not. Where did the Federal Reserve locate its right not only to create a corporation, but also to bail out those banks deemed worthy of salvation?
The Dodd-Frank Act of 2010 provides a check to the Federal Reserve’s power. With the Maiden Lane controversy, the rule of authority prevailed, not the rule of law. Section 1101 of the Dodd-Frank Act amends section 13(3) of the Federal Reserve Act, which now delineates that the Fed’s Board of Governors “may authorize any Federal reserve bank… to discount for any participant in any program or facility with broad-based eligibility, notes, drafts, and bills of exchange.” [5] Previously, the “participant” –that is, a bank or corporation—did not have to belong to any kind of “program or facility.”
Moreover, “such emergency facilities can [now] only be created with prior approval of the Treasury Secretary and must be for the purposes of providing liquidity to the financial system and not to aid a failing financial company.” [6] The Executive Branch enters the picture. Therefore, yes: on paper, the power of the Federal Reserve has been limited. It cannot arbitrarily choose who may or may not receive a bailout.
Yet we should be skeptical at the last statement. How can the Federal Reserve truly determine if a “failing financial company” is pivotal to the “financial system” here referenced? Again, arbitration. This further retains the logic of “too big to fail,” which the Dodd-Frank act literally claims to end. [7]
The constitutionality of the Federal Reserve’s choices is hard to measure. All American government officials pledge to uphold the Constitution. This implies that the rule of law—the rule of the Constitution—stands above the agency of any human agent. But when law inevitably opens itself to interpretation by agents, where then is the source of authority? The actors, or the law itself?
In a debate in 1791, when Alexander Hamilton argued in favor of the creation of the First Bank of the United States, he insisted, “The degree in which a measure is necessary can never be a test of the legal right to adopt it.” [8] If necessity determined legal right, then government and law would be no more than an extension of unregulated power.
The questions of the eighteenth century are still our own questions. Skeptics may roll their eyes and argue that my example is far removed from the realities of twenty-first century capitalism. But we should remember the context. Hamilton’s arguments concerned the legality of a government-created corporation. His rival, Thomas Jefferson, feared the power of an independent corporation, which held informal political power. Was the same not the concern of the Dodd-Frank Act, and did it not act in fear of the powers implied by the three Maiden Lane corporations?
The Federal Reserve has long acted in the shadows, at once an arm of the federal government and a privately held bank. It is fair to wonder just how long this body—which may have saved the United States from true catastrophe—will continue to straddle this border.
[1] "Bear Stearns, JPMorgan Chase, and Maiden Lane LLC." Board of Governors of the Federal Reserve System. August 2, 2013. Accessed October 14, 2014.
[2] "Maiden Lane Transactions." Federal Reserve Bank of New York. Accessed October 14, 2014.
[3] "Federal Reserve Act Section 2A: Monetary Policy Objectives." Board of Governors of the Federal Reserve System. Accessed October 14, 2014.
[4] "Lawmakers Slam Fed's Crisis Lending Proposal." Reuters. August 18, 2014. Accessed October 14, 2014.
[5] "Federal Reserve Act Section 13: Powers of Federal Reserve Banks." Board of Governors of the Federal Reserve System. Accessed October 14, 2014.
[6] "The Discount Window." Federal Reserve Bank of New York. March 1, 2011. Accessed October 14, 2014.
[7] DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT, US Government Printing Office, Web.
[8] “Hamilton's Opinion as to the Constitutionality of the Bank of the United States: 1791,” The Avalon Project, Yale Law School, Web.
Photo credit: Flickr user Lance McCord
In total, the Federal Reserve lent out over $13 trillion to banks. [4] The efficacy of the choice is hard to argue with, but the legality is not. Where did the Federal Reserve locate its right not only to create a corporation, but also to bail out those banks deemed worthy of salvation?
The Dodd-Frank Act of 2010 provides a check to the Federal Reserve’s power. With the Maiden Lane controversy, the rule of authority prevailed, not the rule of law. Section 1101 of the Dodd-Frank Act amends section 13(3) of the Federal Reserve Act, which now delineates that the Fed’s Board of Governors “may authorize any Federal reserve bank… to discount for any participant in any program or facility with broad-based eligibility, notes, drafts, and bills of exchange.” [5] Previously, the “participant” –that is, a bank or corporation—did not have to belong to any kind of “program or facility.”
Moreover, “such emergency facilities can [now] only be created with prior approval of the Treasury Secretary and must be for the purposes of providing liquidity to the financial system and not to aid a failing financial company.” [6] The Executive Branch enters the picture. Therefore, yes: on paper, the power of the Federal Reserve has been limited. It cannot arbitrarily choose who may or may not receive a bailout.
Yet we should be skeptical at the last statement. How can the Federal Reserve truly determine if a “failing financial company” is pivotal to the “financial system” here referenced? Again, arbitration. This further retains the logic of “too big to fail,” which the Dodd-Frank act literally claims to end. [7]
The constitutionality of the Federal Reserve’s choices is hard to measure. All American government officials pledge to uphold the Constitution. This implies that the rule of law—the rule of the Constitution—stands above the agency of any human agent. But when law inevitably opens itself to interpretation by agents, where then is the source of authority? The actors, or the law itself?
In a debate in 1791, when Alexander Hamilton argued in favor of the creation of the First Bank of the United States, he insisted, “The degree in which a measure is necessary can never be a test of the legal right to adopt it.” [8] If necessity determined legal right, then government and law would be no more than an extension of unregulated power.
The questions of the eighteenth century are still our own questions. Skeptics may roll their eyes and argue that my example is far removed from the realities of twenty-first century capitalism. But we should remember the context. Hamilton’s arguments concerned the legality of a government-created corporation. His rival, Thomas Jefferson, feared the power of an independent corporation, which held informal political power. Was the same not the concern of the Dodd-Frank Act, and did it not act in fear of the powers implied by the three Maiden Lane corporations?
The Federal Reserve has long acted in the shadows, at once an arm of the federal government and a privately held bank. It is fair to wonder just how long this body—which may have saved the United States from true catastrophe—will continue to straddle this border.
[1] "Bear Stearns, JPMorgan Chase, and Maiden Lane LLC." Board of Governors of the Federal Reserve System. August 2, 2013. Accessed October 14, 2014.
[2] "Maiden Lane Transactions." Federal Reserve Bank of New York. Accessed October 14, 2014.
[3] "Federal Reserve Act Section 2A: Monetary Policy Objectives." Board of Governors of the Federal Reserve System. Accessed October 14, 2014.
[4] "Lawmakers Slam Fed's Crisis Lending Proposal." Reuters. August 18, 2014. Accessed October 14, 2014.
[5] "Federal Reserve Act Section 13: Powers of Federal Reserve Banks." Board of Governors of the Federal Reserve System. Accessed October 14, 2014.
[6] "The Discount Window." Federal Reserve Bank of New York. March 1, 2011. Accessed October 14, 2014.
[7] DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT, US Government Printing Office, Web.
[8] “Hamilton's Opinion as to the Constitutionality of the Bank of the United States: 1791,” The Avalon Project, Yale Law School, Web.
Photo credit: Flickr user Lance McCord
