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Federal Reserve Lending to Troubled Banks During the Financial Crisis, 2007-2010

Numerous commentaries have questioned both the legality and appropriateness of Federal Reserve lend- ing to banks during the recent financial crisis. This article addresses two questions motivated by such commentary: Did the Federal Reserve violate either the letter or spirit of the law by lending to under- capitalized banks? Did Federal Reserve credit constitute a large fraction of the deposit liabilities of failed banks during their last year before failure? The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) imposed limits on the number of days that the Federal Reserve may lend to under- capitalized or critically undercapitalized depository institutions. The authors find no evidence that the Federal Reserve ever exceeded statutory limits during the recent financial crisis, recession, and recovery. In most cases, the number of days that Federal Reserve credit was extended to an undercapitalized or critically undercapitalized depository institution was appreciably less than the number of days permitted under law. Furthermore, compared with patterns of Fed lending during 1985-90, the authors find that few banks that failed during 2008-10 borrowed from the Fed during their last year prior to failure, and even fewer had outstanding Fed loans when they failed. Moreover, Federal Reserve loans averaged less than 1 percent of total deposit liabilities among nearly all banks that did borrow from the Fed during their last year. It is impossible to know whether the enactment of FDICIA explains differences in Federal Reserve lending practices during 2007-10 and the previous period of financial distress in the 1980s. However, it does seem clear that Federal Reserve lending to depository institutions during the recent episode was consistent with the congressional intent of this legislation.

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