Four Federal Reserve governors voted unanimously to approve a 28-day secured Fed loan facility to Bear Stearns Friday using a rarely used Depression-era provision of the Federal Reserve Act that normally requires five governors’ approval, Fed officials said.
The Fed normally has seven governors but two seats are currently vacant and one governor was traveling and unavailable to vote.
Officials said while the loan is being made via J.P. Morgan Chase, the risk is being borne by the Fed. That means if Bear Stearns fails and the collateral is insufficient to repay the loan, the Fed would incur a loss.
In that respect, the credit risk is similar to what the Fed assumes during its daily money-market lending operations with its 20 primary dealers, which include Bear. However, the exposure to Bear could be larger than what the Fed would normally have with any single firm during regular money market operations. Bear may also be at the moment a higher-risk counterparty than the banks to which it normally lends through its discount window, which must have regulators’ highest ranking for safety and soundness. (Less safe banks pay a higher penalty rate.)
The maximum size of the loan isn’t predetermined but is limited by how much collateral Bear can provide to satisfy the Fed’s requirements, officials said.
The Fed can normally only lend through its discount window to banks. Under Section 13-3 of the Federal Reserve Act, added in 1932, it can lend to “individuals, partnerships, or corporations” with the approval of not less than five governors, provided “such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions.”
However, under Section 11(r)(3)(ii)(I), approval can be granted with fewer than five governors in office if the “available members unanimously determine that … unusual and exigent circumstances exist and the borrower is unable to secure adequate credit accommodations from other sources” and “despite the use of all means available (including all available telephonic, telegraphic, and other electronic means), the other members of the Board have not been able to be contacted on the matter.”
Officials said the Fed used its authority to lend to nonbanks several times during the Depression. It was invoked at times during the 1960s but it wasn’t clear if money was ultimately lent in those latter instances. –Greg Ip