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In a recent Wall Street Journal op-ed, former Federal Reserve Bank of Philadelphia President Patrick Harker recounts an interaction with a protester who did not understand the Fed’s limits:
Early in my tenure at the Fed, I sat down with a group of protesters to hear their concerns. One man in particular stood out. Passionate, persistent and frustrated, he made clear that he held a Ph.D. in economics from a major university. He insisted that the Fed provide loans directly to struggling nonprofits and community organizations. I interjected to explain that doing so would be illegal. Congress hasn’t authorized the Fed to lend to those groups, only to banks and financial institutions under certain conditions. He seemed genuinely surprised.
Harker says the moment stayed with him over the years, “not because of the confrontation, but because it illustrated something more troubling: Misplaced expectations erode the Fed’s independence.”
Harker is certainly right about the inevitable disappointment that follows when “the public expects things from the central bank it isn’t designed, or authorized, to do.” He is also right in recognizing that “disappointment, when widespread and sustained, corrodes trust.” But there is a glaring omission in Harker’s account: under current Chair Jerome Powell, the Fed has been complicit in setting unreasonable expectations.
Consider the Fed’s emergency lending authority. As Harker notes, Section 13(3) of the Federal Reserve Act permits the Fed to lend in “unusual and exigent circumstances” to banks and non-bank financial institutions “for the purpose of providing liquidity to the financial system, and not to aid a failing financial company.” In times of crisis, previous Fed Chairs have pointed to these limits in order to circumscribe their sphere of action — and limit the risk of becoming politicized. Three examples serve to illustrate.
In 2008, Congress called on the Fed to bail out failing automakers. As then-Chair Ben Bernanke writes in his memoir The Courage to Act:
Members of Congress called on the Fed to lend to the auto companies. We were extremely reluctant. We believed that, consistent with the Fed’s original purpose, we should focus our efforts on the financial panic. We were hardly the right agency to oversee the restructuring of a sprawling manufacturing industry, an area in which we had little or no expertise.
Bernanke recognized that lending to automakers was inconsistent with the Fed’s authority. Such loans would not be “for the purpose of providing liquidity to the financial system.” Rather, it would be “to aid a failing […] company” — and not even a financial company, at that.
Then, in 2011, Bernanke was asked if the Fed could bail out defaulting municipal governments. Once again, he said no.
“We have no expectation or intention to get involved in state and local finance,” Bernanke told the Senate Budget Committee. Such lending exceeded the Fed’s authority to provide liquidity to the financial system in unusual and exigent circumstances. “This is really a political, fiscal issue,” he said.
A similar exchange unfolded in 2015, when then-Chair Janet Yellen was asked if the Fed could bail out Puerto Rico. She, too, said no.
“It is something the Federal Reserve can’t and shouldn’t be involved in,” Yellen told the House Financial Services Committee. “I think it’s appropriate for Congress to consider what’s best to do in this case.”
Time and again, Congress has asked the Fed to venture beyond its narrow emergency lending authority. And, time and again, the Fed chair said no. That allowed the Fed to focus on its core competencies and prevented it from getting sucked into political disputes.
Chair Powell, in contrast, has shown much less restraint. Under his leadership, the Fed opened a host of facilities following the onset of the pandemic in 2020. It is difficult to justify the Primary Market Corporate Credit Facility, Secondary Market Corporate Credit Facility, Paycheck Protection Program Liquidity Facility, Main Street Lending Program, and Municipal Liquidity Facility under Section 13(3).
These facilities were not intended to provide general liquidity. Rather, as Powell told the Senate Committee on Banking, Housing, and Urban Affairs in May 2020, they were intended “to facilitate more directly the flow of credit to households, businesses, and state and local governments” in order to prevent those entities from failing during the pandemic.
An especially telling exchange occurred during that May 2020 hearing, when Powell was asked whether the Fed would consider a larger and longer-term facility for municipal lending. Whereas Bernanke and Yellen had unequivocally ruled out such lending, Powell left the option open.
“Yes, we will take a look at that,” he said. “I will say, though, that generally with 13(3), what we are trying to do is address liquidity needs, and those are really longer-term funding needs. But notwithstanding that, we are taking a look.”
In other words, Powell acknowledged that (i) the Fed’s 13(3) lending authority is limited to providing general liquidity and (ii) municipalities were suffering from longer-term funding needs, not from a lack of general liquidity. And, yet, he did not rule out the additional lending to municipalities.
Bernanke and Yellen said no. Powell said we’ll see what we can do.
Fed officials — and recently retired officials, like Harker — are right to worry about the Fed’s independence. But they should not be surprised. Under Powell’s leadership, the Fed has drifted into the political arena. Now, Fed officials are expected to play politics.