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Board Report: November 16, 2010
In response to the financial crisis, the Federal Reserve looked beyond its traditional monetary policy tools to restore economic stability, and initiated a number of lending facilities and special programs. Between March and November 2008, the Board, citing “unusual and exigent circumstances,” exercised its authority under section 13(3) of the Federal Reserve Act to authorize the creation of the following six lending facilities: the Term Securities Lending Facility (TSLF) (including the TSLF Options Program), the Primary Dealer Credit Facility (PDCF), the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the Commercial Paper Funding Facility (CPFF), the Money Market Investor Funding Facility (MMIFF), and the Term Asset-Backed Securities Loan Facility (TALF). The Federal Reserve Bank of New York (FRBNY) was authorized to implement and operate the TSLF, PDCF, CPFF, MMIFF, and TALF, while the Federal Reserve Bank of Boston (FRB Boston) was authorized to implement and operate the AMLF.
The objectives of our review were to (1) determine the overall function and status of each facility, including how it operated, the financial markets it was intended to support, the financial utilization of the facility, the total amount of loans extended, and the current outstanding balances; and (2) identify risks in each facility for the Board’s review in exercising its monetary policy function and in its general supervision and oversight of the Federal Reserve Banks.
Through these facilities, FRBNY and FRB Boston provided loans to depository institutions, bank holding companies, commercial paper issuers, and primarydealers. The lending facilities expanded the Federal Reserve’s traditional role as the “lender of last resort” beyond depository institutions, to corporations and other financial institutions. The Federal Reserve determined that such lending was necessary to avoid systemic financial failure within the U.S. economy. The six lending facilities shared the common objectives of reducing risks to financial stability and strengthening the effectiveness of monetary policy by targeting instability in the credit markets and increasing liquidity to corporations and financial institutions.
To respond to severely stressed market conditions and restore economic stability, the six lending facilities were created separately and quickly without the opportunity for extensive planning. In addition, the Federal Reserve designed the lending facilities to generally encourage broad participation by many borrowers. Thus, implementation of the lending facilities involved credit and operational risks, which varied by facility.
By providing for a broad scope of eligible borrowers and types of loan collateral, the lending facilities exposed the Federal Reserve to credit risks that included broad eligibility for borrowers, the non-recourse nature of some of the lending facilities’ loans, and the potential aggregate exposure to certain types of collateral and various types of borrowers. To mitigate these risks, the Federal Reserve implemented a number of credit risk management controls that varied by facility, with a focus on ensuring adequate collateral. The Federal Reserve incorporated, in most cases, a “haircut” on the collateral, imposed above-normal market interest rates and usage fees, and contracted with specialized vendors for critical functions.
The short lead time available for planning, coupled with the complex terms and conditions of the lending facilities, created operational risks associated with developing and maintaining policies and procedures; having sufficient, experienced staff to run the facilities; and managing vendor contracts and agent agreements. To mitigate these risks, dedicated teams were established to develop and maintain policies and procedures, operate the programs, and implement controls. To mitigate risks concerning staffing shortages, FRBNY borrowed staff from other sections, hired additional employees, and obtained operational assistance from other Federal Reserve Banks and contractors. To mitigate vendor and agent risks, FRBNY performed on-site reviews of vendors’ and agents’ compliance with contract and agreement provisions and established contractual conflict of interest provisions.
Overall, general indicators of market stress suggested that the lending facilities helped to stabilize financial markets, and as of the end of our fieldwork on June 30, 2010, the Board reported that none of the lending facilities had experienced any financial losses. On November 5, 2008, the combined usage of the lending facilities peaked at $600 billion. Each of the six lending facilities has expired, as market conditions have improved. As of June 30, 2010, only the TALF had outstanding loans, which totaled approximately $42.5 billion and were scheduled to mature no later than March 2015. Also as of June 30, 2010, the lending facilities had generated approximately $9.0 billion in interest earnings and fees.
Our report did not include any recommendations. In consolidated comments on a draft of our report, the Board’s Division of Reserve Bank Operations and Payment Systems, Division of Monetary Affairs, and Legal Division, indicated that our report provided a clear summary of the purpose, implementation, operation, expiration, and key risks associated with each of the six lending facilities.