WASHINGTON — The Federal Reserve Board's extensive use of emergency powers to prop up nonbanks and launch liquidity programs may have saved the nation from economic collapse, but some in Congress say the central bank has too much power.
House Republicans unveiled a plan last week that would ban the Fed from using its authority to act in "exigent and unusual circumstances" to help an individual company like American International Group Inc. and give Congress the chance to block any broader actions.
Though House Financial Services Committee Chairman Barney Frank did not specifically endorse that approach, he did signal a willingness to rein in the Fed's power in an interview last week.
Whether Congress will ultimately change anything remains unclear, but there is a debate under way: Has the Fed stretched its authority too far, and would restrictive changes hamstring it in a future crisis?
"I would hate to see the Fed not have the flexibility over a weekend to be able to do what central banks are formed to do," said Ernest Patrikis, a former general counsel for the Federal Reserve Bank of New York and now a partner in the New York office of White & Case LLP. "Through use of this authority, the Fed has prevented a depression, and I'd hate to have it become politicized in the future."
The question of whether and how to limit the Fed's power turns in part on what may replace it. Republicans want to limit the government's ability to bail out any institution, but Democrats are pushing for the creation of a regulatory council designed to oversee systemically important institutions.
Some said the creation of a systemic risk council and giving the government power to seize and resolve systemically important institutions would lessen the need for the Fed to have emergency powers.
"To just strip the authority or put so many constraints on it that it would be rendered ineffective" would be a mistake, said Ken Bentsen, a former Democratic congressman from Texas.
But giving a council the power to decide when such power is appropriate could make it more politically acceptable, he said.
"That way you don't hamstring the Fed's ability to act in a crisis, but you add the political component that needs to be there," said Bentsen, now the head of the Equipment and Leasing Finance Association.
But Rep. Scott Garrett, R-N.J., argues that the Fed has already gone too far, and that creating a risk council is not the right solution. "There is a growing concern both by the American public and clearly in Congress as far as the lack of transparency, accountability, fiscal and monetary responsibility of the Fed," said Garrett, the top Republican on the House Financial Services capital markets subcommittee. "There is significant potential to create bold reform in these areas, which I think would be good for the economy and taxpayers."
At issue is Section 13(3) of the Federal Reserve Act, which gives the central bank power to act in emergency situations to protect financial markets. Such power was used during the Great Depression but had remained untouched since then until the financial crisis.
During the past year and a half the Fed has invoked those powers to unwind Bear Stearns Cos., prop up AIG and set up a host of programs designed to promote liquidity in various markets.
Many in Congress say the Fed has gone too far and has put billions of tax dollars at risk — with no accountability to anyone. When House Republicans released a plan to address the Fed's powers, Senate GOP members said they also have concerns. "By requiring the secretary of the Treasury to officially sign off on all emergency actions, giving Congress approval authority and placing all emergency expenditures on Treasury's balance sheet, we can bring our system closer to the checks and balances of old," Sen. David Vitter, R-La., told American Banker.
An aide to Sen. Richard Shelby of Alabama said Friday that the Banking Committee's top Republican is interested in a thorough review of the Fed's powers.
"Sen. Shelby believes that 13(3) authority needs to be examined but should be examined in the broader context of regulatory reform," the aide said. "Part of that debate could include what the Fed has done with that authority, and whether that comports with what Congress intended them to have."
The concerns extend well beyond the GOP. In an interview Thursday, Frank said, "I do agree with some restraints of the 13(3) part."
A spokesman for the Massachusetts Democrat said Friday that any changes to the authority are likely to wait until after lawmakers have finished overhauling the financial regulatory system and the crisis has passed.
Still, there is clearly a need for "greater openness and further democratization of what goes on," the spokesman said. "All this should not be in the hands of one person, but it should be in the hands of others."
Some observers said that Fed officials have their own private doubts about how its emergency powers have been employed.
"Even the Fed and certainly several of the Federal Reserve Bank presidents have had deep misgivings about the programs that have been used under 13(3)," said Karen Shaw Petrou, managing director of Federal Financial Analytics Inc. Fed Chairman Ben Bernanke "is a strong proponent of aggressive central bank intervention, but much of what he's done has gone beyond the typical central bank role, and I know that many in the Fed think this needs a rethink."
Still, some of the proposals under consideration almost certainly go too far for the Fed. If, for example, it were blocked from helping an individual institution, it would have no way to assist a systemically important nonbank, even if doing so would prevent economic catastrophe.
Some kind of check on the Fed's power — such as requiring approval from the Treasury Department or other regulators — would likely be more palatable.
"Treasury approval and administration approval is an appropriate way to go," said George Kaufman, a finance professor at Loyola University in Chicago.
But observers warned against allowing Congress to block emergency action, saying that would make the situation too political and open the process to uncertainty. "Congress blocking it — that just doesn't work," Kaufman said.
Some warned that any constraint is a mistake, since the Fed must be free from political considerations.
"You really have to think long and hard before you start tinkering with the safety valve that is out there that enabled the Fed — at least in some people's minds — to provide sufficient liquidity to alleviate the crisis," said Gil Schwartz, a former Fed lawyer, now a partner at Schwartz & Ballen LLP.
Some former Fed officials argued that lawmakers may be missing the point. They say addressing Section 13(3) is appropriate, but only if legislators fix the underlying problem: having "too big to fail" institutions that pose a threat to the economy. "The root cause here of our problem is not 13(3)," said Cornelius Hurley, a former Fed lawyer and now a Boston University law professor. "The root cause is that we allowed institutions to become so ominous that we needed 13(3)."
