New Laws And Court Battles Finally Extract Details Of The Federal Reserve's Mammoth Secret Loan Program

December 2011

In a November 29, 2011 article entitled “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress”, Bloomberg provided details of detailed original analysis of the Federal Reserve’s loan program that began in 2008 and continued at a high level throughout 2009. This Federal Reserve loan program has not received anywhere near the attention that it deserves.

The $13 billion giveaway is Bloomberg’s estimate of what returns the borrowers could have earned by investing the low-interest-rate funds, even if every penny of the loans is repaid. The $13 billion estimate was calculated as each borrower’s net interest margin, times the amounts borrowed from the Fed, times the periods that the loans were outstanding. While some might claim that the borrowings from the Fed were not used for a typical loan, it is undeniable that (i) the Fed loans were at favorable interest rates when compared to other borrowing alternatives, and (ii) the loans were outstanding for a sufficiently long period that income-generating activities were certainly possible.

The Federal Reserve actively fought disclosure

Putting aside the give-away using public funds, the loans lacked transparency and oversight. Bloomberg described the previously-available information as follows:

“The Fed initially released lending data in aggregate form only. Information on which banks borrowed, when, how much and at what interest rate was kept from public view. The secrecy extended even to members of President George W. Bush’s administration who managed TARP. Top aides to Paulson weren’t privy to Fed lending details during the creation of the program that provided crisis funding to more than 700 banks, say two former senior Treasury officials who requested anonymity because they weren’t authorized to speak. ”

The loans had no Congressional or other meaningful oversight or restrictions outside of the Fed itself. Bloomberg described the enormity of the secret loan program as follows:

“It dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year.”

In order to get all of the data, Bloomberg required extensive court battles. Bloomberg described these as follows:

“The size of the bailout came to light after Bloomberg LP, the parent of Bloomberg News, won a court case against the Fed and a group of the biggest U.S. banks called Clearing House Association LLC to force lending details into the open.

The Fed, headed by Chairman Ben S. Bernanke, argued that revealing borrower details would create a stigma -- investors and counterparties would shun firms that used the central bank as lender of last resort -- and that needy institutions would be reluctant to borrow in the next crisis. Clearing House Association fought Bloomberg’s lawsuit up to the U.S. Supreme Court, which declined to hear the banks’ appeal in March 2011.”

Bloomberg’s Methodology

Bloomberg should be congratulated and thanked for the effort put into this work. Bloomberg took measures to ensure that the amounts they reported were not overstated, and included only amounts that were previously not disclosed.

Bloomberg described the data and methodology for their work as follows:

”The data were extracted from 29,000 pages of documents and 18 Fed-prepared Microsoft Excel spreadsheets listing more than 21,000 transactions. The records were made public in batches on Dec. 1, 2010, and March 31 and July 6 of this year. The Fed released some of them under the 2010 Dodd-Frank Act and the rest in responses to Freedom of Information Act requests by media outlets including Bloomberg News and related federal court orders. The data covered money borrowed from the central bank from August 2007 through April 2010.

More than a dozen lending programs were deployed by the Fed in response to the crisis. From those, Bloomberg News selected the seven available to a broad set of banks, brokerage firms and other companies. They included the Fed’s discount window, the last-resort lender for troubled banks, and six temporary measures: the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility; the Commercial Paper Funding Facility; the Primary Dealer Credit Facility; the Term Auction Facility; the Term Securities Lending Facility; and so-called single-tranche open market operations.

Many firms borrowed from two or more programs through multiple subsidiaries, all disclosed separately in the Fed data. The central bank didn’t detail how much each borrower had outstanding from all programs on any given day, a measure of vulnerability during the crisis. …

Emergency measures that targeted specific companies -- Bear Stearns Cos., American International Group Inc. (AIG), Citigroup Inc. (C)and Bank of America Corp. (BAC) -- were disclosed at the time and so were excluded. Loans to these companies from the other seven programs were included.”

Non-US companies dominate the loan list

Bloomberg reported the loans to each company separately, which made it more difficult to understand how the various loans compared between companies. We compiled the following table based on the Bloomberg statistics. The companies are listed in the order of the product of the average balance and the time the loans were outstanding. Using this approach, the largest loan at any point in time (Morgan Stanley, at $107 billion) appears later in the list because the Morgan Stanley loan was paid off more rapidly and had a smaller average balance than others’ loans.

This author found the identity of the loans shocking. More than half of the largest borrowers are banks and investment companies that are not U.S. based. The Federal Reserve has not publicly justified these foreign bank loans. For example, this author cannot justify why the American public should make a $21.4 billion average balance loan to the Royal Bank of Scotland for almost two years. And, although the Arab Banking Corp is towards the bottom of the table, a bank from Bahrain should not be receiving American public assistance for more than two years (the longest period of any company), regardless of whether the U.S. is in a recession or not.

In a December 6, 2011 letter to four lawmakers, Federal Reserve Chairman attempted to rebut the Bloomberg claims (although not mentioning Bloomberg by name). Bloomberg subsequently indicated that it stands by all of its reporting, and did a paragraph by paragraph rebuttal of the Federal Reserve’s letter. Having read the Bloomberg reporting, it was easy to see that it was the Federal Reserve’s claims that were inaccurate, and a gross misstatement of what Bloomberg reported. The Federal Reserve attempted to say that Congress knew about the loans, but a parade of Senators and Congressman are stating plainly that they had no idea the magnitude of the lending, or to whom the loans were being made.

Despite the claims of public knowledge, the Federal Reserve’s letter actually acknowledges that important details of the loans were not released until relatively recently. Even then, the details that were released lacked perspective and appropriate summarization. The Fed’s letter includes:

“It is true that, generally, the names of the counterparties and borrowers from the emergency facilities were not immediately disclosed. … [Disclosure] was addressed as part of the Dodd-Frank Act. Under provisions of the Sanders Amendment, the names of all counterparties and borrowers from the emergency lending facilities and the Term Auction facility (TAF) were disclosed on December 1, 2010. … Additional disclosures of discount window borrowers and transactions information were made on March 31, 2011.”

Congress should change the laws to prevent this type of activity from occurring without additional oversight, control, and disclosure.

Fulcrum Inquiry performs forensic accounting services.