On December 27, 2020, the President signed into law the Consolidated Appropriations Act, 2021.1 Title X of Division N of that law ("Title X") contains several provisions that change the authority of the Board of Governors of the Federal Reserve System (the "Federal Reserve") to extend credit or purchase assets under Section 13(3) of the Federal Reserve Act (the "FRA").2 This provision was inserted into the bill by Senator Patrick Toomey of Pennsylvania, who believed that the Federal Reserve's programs initiated under Section 13(3) and funded under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act")3 should be permanently discontinued and made unable to be restarted.4
However, the interplay between Section 13(3), the CARES Act provisions and Title X is complex and open to significant interpretation. Below, we review and analyze the changes made by Title X. In sum, we do not believe the provisions provide much (or effectively any) restriction on the Federal Reserve's future actions.
What is Section 13(3)?
Section 13(3) is a singular power of the Federal Reserve to permit Federal reserve banks to provide liquidity directly to non-bank, commercial entities.5 This power is only available in times of crisis, when the Federal Reserve, by a vote of five governors, finds that "exigent and unusual circumstances" exist. In recent practice, this authority has been invoked in times of market disruption, such as during the financial crisis of 2008-10, as befits the title assigned to this authority by the Federal Reserve: "Emergency credit for others."6
Once invoked, the Federal Reserve has broad authority to create a facility or program of broad-based eligibility to discount for "any participant" pledging certain eligible collateral. Section 13(3) and its implementing regulation, Regulation A,7 do place certain limits on such facilities or programs, including:
- The Federal reserve bank must obtain evidence that any participant is unable to obtain adequate credit accommodations from other banking institutions.8
- The Secretary of the Treasury (the "Secretary") must approve of the facility and its terms.
- The Federal Reserve, with the Secretary, must design such facility to ensure that security for emergency loans is sufficient to protect taxpayers from losses.
- As part of this structure, a Federal reserve bank must assign a lendable value to all collateral supporting emergency loans to determine if it is sufficient to protect taxpayers from loss.9
- The Federal Reserve may not provide credit to an insolvent borrower.10
- Such facilities must be terminated in a timely and orderly fashion, which, if not further authorized, means a facility may not last more than one year.11
- Unlike other provisions by which the Federal Reserve provides liquidity, Section 13(3) leaves the design and implementation of the facility entirely up to the Federal Reserve (with the approval of the Secretary).12
How has Section 13(3) been employed during the COVID-19 crisis?
The Federal Reserve has, with the approval of the Secretary, invoked Section 13(3) to create numerous facilities to combat the economic dislocation caused by the coronavirus pandemic. These facilities include:
- The Commercial Paper Funding Facility ("CPFF")
- Primary Dealer Credit Facility ("PDCF")
- Money Market Mutual Fund Liquidity Facility ("MMMFLF")
- Primary Market Corporate Credit Facility ("PMCCF")
- Secondary Market Corporate Credit Facility ("SMCCF")
- Term Asset-Backed Securities Loan Facility ("TALF")
- Paycheck Protection Program Liquidity Facility ("PPPLF")
- Municipal Liquidity Facility ("MLF")
- Main Street Lending Program ("MSLP")
The CPFF, PDCF, MMLF, PMCCF, SMCCF, TALF, PPPLF, MLF and MSLP were each authorized pursuant to Section 13(3), and the announcement of certain of these programs predated the passage of the CARES Act:
- The CPFF and the PDCF were announced on March 17, 2020.13
- The MMLF was announced on March 18, 2020.14
- The PMCCF, SMCCF and TALF were announced on March 23, 2020; on the same day, the Federal Reserve also announced its intention to establish a Main Street Business Lending Program, an apparent predecessor to what became the MSLP. 15
The CARES Act became law on March 27, 2020.
- The PPPLF was announced on April 6, 2020.16
- The MLF and the full, revised MSLP were announced on April 9, 2020.17
Several of these programs—the CPFF, the PDCF, the MMLF, and TALF—were revised iterations of programs that had previously been employed by the Federal Reserve in the aftermath of the 2008 financial crisis. Others were newly created to combat specific market deficiencies from the COVID-19 crisis, including the MLF,18 PMCCF,19 SMCCF20 and MSLP.21 Still others were adopted pursuant to programs authorized or contemplated by the CARES Act, including the PPPLF.22
Given the above chronology, the Federal Reserve, with the approval of the Secretary, had announced certain facilities prior to the adoption of the CARES Act (even if those facilities had not yet been employed).23 This timing is relevant as it demonstrates the authority of the Federal Reserve to establish such facilities without the separate authority or funds granted by the CARES Act.
The Federal Reserve has also taken action and provided liquidity pursuant to its other authorities, including short-term loans to financial institutions pursuant to the discount window and dollar swap lines to other Central Banks.24
Most of the above facilities began in March, April or May and had termination dates of either September or December (once extended). The Secretary eventually announced the termination of new funding for the facilities being funded by the CARES Act but left open other of the facilities.25
What changes to Section 13(3) does the new bill make?
Title X contains several provisions that make changes to the authority of the Federal Reserve to use Section 13(3) to provide liquidity to non-banks. It is important to note that the Federal Reserve retains its full authority under the other provisions of the FRA to provide liquidity to financial institutions and non-banks under the terms provided therein (as listed above). It is also important to note that the final text of the bill does not appear to provide a significant limitation even on the use of Section 13(3), except in very specific situations.
Section 1003 of Title X directs the unobligated balance of funds provided for the use of the Secretary (US$429,000,000,000) in the CARES Act to be permanently rescinded immediately, and for certain other funds to be rescinded on other dates.
Section 1005 of the bill amends the CARES Act, and provides the following new provision:
"(c) Federal Reserve Programs or Facilities. –
(1) In General. – After December 31, 2020, the [Federal Reserve] and the Reserve banks shall not make any loan, purchase any obligation, asset, security, or other interest, or make any extension of credit through any program or facility established under [Section 13(3)] in which the Secretary made a loan, loan guarantee, or other investment pursuant to section 4003(b)(4) [of the CARES Act], other than a loan on or before December 14, 2020, to the Main Street Lending Program [under certain terms].
(2) No Modification. – After December 31, 2020, the [Federal Reserve] and the Federal Reserve banks –
a. Shall not modify the terms and conditions of any program or facility of the [FRA] in which the Secretary made a loan, loan guarantee, or other investment pursuant to section 4003(b)(4) [of the CARES Act], including by authorizing transfer of such funds to a new program or facility established under section 13(3) of the [FRA]; [except for certain situations listed]
(3) Use of Funds. –
a. In General. – Except as provided by in subparagraph (b), the Secretary is permitted to use the [ESF] for any purpose permitted under that section.
b. Exception. – The [ESF] shall not be available for any program or facility established under section 13(3) of the [FRA] that is the same as any program or facility in which the Secretary made an investment pursuant to section 4003(b)(4) [of the CARES Act], except the [TALF]." (emphasis added)
Section 1006 states: Rule of Construction
"Except as expressly set forth in paragraph (1) and (2) of subsection (c) of section 4029 of the CARES Act, as added by this [bill], nothing in this [bill] shall be construed to modify or limit the authority of the [Federal Reserve] under Section 13(3) of the [FRA] as of the day before the enactment of the [CARES Act]."
What do these changes to the Federal Reserve's authority under Section 13(3) do?
Senator Toomey clearly intended that these changes permanently end any program or facility that the Federal Reserve initiated pursuant to Section 13(3) that was funded by CARES Act funds allocated by the Secretary. Others, concerned about unintended consequences to the ability of the Federal Reserve to use Section 13(3) to combat future crises, wanted to ensure that any such limitations applied only to the CARES Act related programs. Our analysis shows below that these two Congressional themes conflict in certain material ways. Here are the key points:
1. The Title X provisions are directed at programs funded by the ESF.
Section 1003, the first operative section of Title X, speaks directly to the intended recission of funds granted by the CARES Act and used (or allocated and unused) to fund open programs by the Federal Reserve pursuant to Section 13(3). The Section speaks directly to this point in Section 1003(a)(2)(B)(ii)(II), directing its instruction at funds that are not needed to meet the commitments, as of January 9, 2021, established under Section 13(3) of the [FRA] in which the Secretary of the Treasury has made or committed to make a loan, loan guarantee, or other investment using funds appropriated under [the CARES Act].26
2. The termination and restriction provisions are directed at programs created "pursuant" to the CARES Act.
Section 1005 amends the CARES Act, and not any other provision of law, when it terminates programs existing pursuant to Section 13(3) of the FRA. It creates a new subsection (c) which states, in relevant part, that:
"(1) In General. – After December 31, 2020, the [Federal Reserve] and the Federal Reserve banks shall not make any loan, purchase any obligations, asset, security, or other interest, or make any extension of credit through any program or facility established under [Section 13(3)] in which the Secretary made a loan, loan guarantee, or other investment pursuant to [the CARES Act funds allocated to the ESF] …"
Section 1005 also places similar restrictions on the Federal Reserve in modifying these same loans.
3. Sections 1005 and 1006 contain "savings" provisions providing the Federal Reserve and the Secretary of the Treasury may otherwise continue normal operations in the future.
The new subsection (c) has a paragraph "(3) Use of Funds" that states
(A) In General. – Except as provided in subparagraph (B), the Secretary is permitted to use the fund established under section 5302 of title 31, United States Code, for any purpose permitted under that section.
(B) Exception. – The fund established under section 5302 of title 31, United States Code, shall not be available for any program or facility established under [Section 13(3)] that is the same as any such program in which the Secretary has made an investment pursuant to [the CARES Act], except the [TALF]." (emphasis added)
Section 1006, entitled "Rule of Construction" provides:
"Except as expressly set forth in paragraphs (1) and (2) of subsection (c) of the Cares Act, as added by this Act, nothing in this Act shall be construed to modify or limit the authority of the [Federal Reserve] under [Section 13(3)] as of the day before the date of enactment of the [CARES Act]."
Given these changes, how should we apply them to the authority of the Federal Reserve pursuant to Section 13(3) going forward?
A few things are certain:
1. These changes by their terms do not affect any other authority of the Federal Reserve besides Section 13(3).
As described above, the Federal Reserve has other grants of authority that may permit it to accomplish its underlying goals in a manner similar to the programs affected by these changes. For example, Section 14(2)(b) of the FRA permits the Federal Reserve to provide liquidity to states and subdivisions on certain specified terms.27 This authority could be used to provide liquidity to entities that were previously eligible for assistance under the MLF, even if the authority under Section 14(2)(b) is less expansive in certain respects than the actions contemplated under the MLF.28 Further, the underlying goals of the MSLP—i.e., providing credit to small- and medium-sized businesses—could be replicated in shorter-term facilities by use of the discount window.29 Under the MSLP, the Federal Reserve indirectly provided credit to borrowers by purchasing participations in loans made by financial institutions to certain eligible corporate and non-profit borrowers. So long as funds are provided to borrowers through financial institutions, the Federal Reserve has abundant authority to essentially replicate the terms of those loans, with the possible exception of their duration.30
2. These changes only affect funds provided by the Secretary of the Treasury from the ESF.
The ESF was the fund into which the CARES Act placed funds for these purposes. There is nothing stopping the Secretary from allocating funds from other sources for programs established under Section 13(3). Further, the limitation on use of the ESF funds appears to apply only to those programs that are exactly the same as those in which the Secretary made an investment pursuant to the CARES Act (except for the TALF). In sum, the Federal Reserve, with the approval of the Secretary, could establish highly similar programs to those previously created and fund such programs with ESF funds separate from those allocated by the CARES Act. We note the PDCF and the PPPLF did not require such funding and have been extended for an additional 90 days from their scheduled termination date of December 31, 2020 (and may be extended by the Federal Reserve again with the approval of the Secretary).
Also worth considering is the language in section 1005 adding "(c)(3)(B)," which specifically states that the use of funds limitation only applies to programs "in which the Secretary made an investment" with CARES Act funds. It is unclear whether all of the programs to which the Secretary allocated funds actually received those allocated funds, especially in instances where the programs in question reportedly extended little, if any, credit. To the extent a program was merely allocated funds by the Secretary with no actual funds being transferred, such a program would arguably not be covered by these restrictions.31
3. These changes leave several programs under Section 13(3) untouched or able to be restructured and restarted.
The Secretary has acknowledged that certain programs will continue, claiming they were not subject to CARES Act funding termination requirements. As noted, this includes the PDCF and the PPPLF. As the new statutory limitations are directed at use of the CARES Act funds from the ESF for the same programs, it appears that the Federal Reserve could recreate the same programs so long as it restructures them to not use such funds. As noted, the Secretary could allocate non-ESF funds. Or, perhaps more likely, the Federal Reserve, with the approval of the Secretary, could create the same programs but restructure them in a way to operate without the need for "first-loss" investment by the Secretary.
There are several ways in which this goal may be accomplished, while keeping in mind the requirements under Section 13(3) and Regulation A that any loan be secured to the satisfaction of the appropriate Federal reserve bank and ensures protection to the taxpayer. The Federal Reserve has not interpreted this provision to bar it from accepting any credit risk; however, this language does appear to require greater collateral or security than do other forms of Federal Reserve advances.
Past practice provides a few examples of how the Federal Reserve could satisfy the collateralization requirement while continuing to use existing Section 13(3) programs without the benefit of a first-loss investment by the Secretary:
- It could use a version of the "Bear Stearns" facility. In this structure, the Federal Reserve created a structure in which it shared the risk of certain hard-to-value assets with the pledging institution, JP Morgan. Certain amounts of first loss were allocated to JP Morgan prior to the Federal Reserve being exposed.32
- It could use a version of the "AIG" facility. In this structure, the Federal Reserve extended credit to AIG while the Treasury Department accepted warrants for equity in the pledging institution, allowing the government to share in potential upside for the entity pledging. The viability of this structure was confirmed following litigation against the Federal Reserve by AIG shareholders.33
- It could create a new chart for discounting collateral pledged pursuant to Section 13(3). The Federal Reserve has issued a chart showing its required discounts for certain groups of assets pledged by financial institutions to the discount window.34 It could extend the chart to pledges under Section 13(3) and apply greater discounts to account for the greater exposure and requirements of such loans.
The new changes to Section 13(3) will require the termination or amendment of programs established or funded pursuant to the CARES Act. However, they do not appear to place any significant restriction on the Federal Reserve's use of similar programs moving forward.
1 H.R. 133 (2020).
212 U.S.C. § 343(3) (2020).
3 P.L. 116-136 (2020).
4 The Federal Reserve did not believe ending these programs was the appropriate action to take at this time, but it did agree to return the uncommitted and unused amounts of money provided by the CARES Act and invested by the Secretary to the Exchange Stabilization Fund (the "ESF"). While the Secretary's demand and the Federal Reserve's acquiescence effectively ended current use of this pool of funds, there had been speculation that a new Secretary under the Biden Administration could restart the same programs by reapproving them and reinvesting the CARES Act funds now held in the ESF. This concern led to the language proposed by Senator Toomey and a negotiated set of provisions being placed in the bill.
5 We note that the Federal Reserve has numerous other powers by which it may provide liquidity to financial institutions. Apart from Section 13(3), the Federal Reserve cites Sections 10A, 10B, 11(i), 11(j), 13, 13A, 14(d), and 19 of the Federal Reserve Act (12 U.S.C. 248(i)-(j), 343 et seq., 347a, 347b, 347c, 348 et seq., 357, 374, 374a, and 461) as authority to provide such liquidity under specified terms and conditions. The Federal Reserve also has the authority to lend directly to States and sub-divisions thereof under certain terms pursuant to Section 14(2)(b)(1) of the FRA (12 U.S.C. § 355).
6 Regulation A, 12 C.F.R. § 201.4(d).
7 12 C.F.R. Part 201.
8 Regulation A states "(8) Evidence regarding unavailability of adequate credit accommodation. (i) Each lending Federal Reserve Bank must obtain evidence that, under the prevailing circumstances, participants in a program or facility established under this paragraph (d) are unable to secure adequate credit accommodations from other banking institutions. (ii) Evidence required under this paragraph (d)(8) may be based on economic conditions in the market or markets intended to be addressed by the program or facility, a written certification from the person or from the chief executive officer or other authorized officer of the entity at the time the person or entity initially borrows under the program or facility, or other evidence from participants or other sources." 12 C.F.R. § 201.4(d)(8).
9 Regulation A states: "(6) Indorsement or other security. (i) All credit extended under a program or facility established under this paragraph (d) must be indorsed or otherwise secured, in each case, to the satisfaction of the lending Federal Reserve Bank. (ii) In determining whether an extension of credit under any program or facility established under this paragraph (d) is secured to its satisfaction, a Federal Reserve Bank must, prior to or at the time the credit is initially extended, assign a lendable value to all collateral for the program or facility, consistent with sound risk management practices and to ensure protection for the taxpayer." 12 C.F.R.§ 201.4(d)(6).
10 Regulation A, 12 C.F.R. § 201.4(d)(5).
11Id. at § 201.4(d)(9).
12 Regulation A states "(iv) A Federal Reserve Bank may extend credit through a program or facility with broad-based eligibility established under this paragraph (d) through such mechanism or vehicle as the Board determines would facilitate the extension of such credit." 12 C.F.R. § 201.4(d)(4)(iv).
13 https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317a.htm and https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317b.htm.
14 https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm. A final interim rule for the MMLF was issued on March 19, 2020. https://www.federalreserve.gov/newsevents/pressreleases/monetary20200319a.htm.
22 CARES Act, Section 1102.
23 E.g., March 16, 2020. https://www.federalreserve.gov/newsevents/pressreleases/monetary20200316a.htm.
24 Beginning March 15, 2020. https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315c.htm; https://www.federalreserve.gov/newsevents/pressreleases/monetary20200319b.htm; and https://www.federalreserve.gov/newsevents/pressreleases/monetary20200320a.htm.
26 Title X, Section 1003.
27 12 U.S.C. § 355.
28 In particular, Section 14(2)(b) of the FRA only allows the Federal Reserve to purchase municipal debt with maturities of less than six months.
29 See Section 10B of the FRA and the Federal Reserve's Regulation A, at 12 C.F.R. Part 201.
30 The Federal Reserve could technically commit to make several consecutive short-term loans on the same terms at the same time to replicate the duration of the MSLP purchases. Programs under Section 13(3) terminate after one year unless extended by the Federal Reserve; however, this restriction seems to be directed the program rather than the duration of an advance. 12 C.F.R. § 201.4(d)(9).
31 For example, as of December 10 the Secretary had not invested any funds into the CPFF. https://www.federalreserve.gov/files/pdcf-mmlf-cpff-pmccf-smccf-talf-mlf-ppplf-msnlf-mself-msplf-nonlf-noelf-12-11-20.pdf
32 See https://www.federalreserve.gov/regreform/reform-bearstearns.htm.
33 See https://www.federalreserve.gov/regreform/reform-aig.htm.
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