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CONGRESS OF THE UNITED STATES
CONGRESSIONAL BUDGET OFFICE

A

CBO
STUDY
MAY 2010

The Budgetary Impact
and Subsidy Costs of
the Federal Reserve’s
Actions During the
Financial Crisis

Pub. No. 4011

A

CBO
S T U D Y

The Budgetary Impact and
Subsidy Costs of the
Federal Reserve’s Actions
During the Financial Crisis
May 2010

The Congress of the United States O Congressional Budget Office

Notes
Unless otherwise indicated, all years referred to are calendar years.
On the cover: The Marriner S. Eccles Federal Reserve Board Building, Washington, D.C.,
photo by Britt Leckman.

CBO

Preface

O

ver the past several years, the nation has experienced its most severe financial crisis
since the Great Depression of the 1930s. In response, policymakers undertook a series of
extraordinary actions to stabilize financial markets and institutions. The Federal Reserve Sys
tem used its traditional policy tools to reduce short term interest rates and increase the avail
ability of funds to banks, and it created a variety of nontraditional credit programs to help
restore liquidity and confidence to the financial sector. In doing so, it more than doubled the
size of its asset portfolio to over $2 trillion and assumed more risk of losses than it normally
takes on.

This Congressional Budget Office (CBO) study—prepared at the request of the Ranking
Member of the Senate Budget Committee—describes the various actions by the Federal
Reserve to stabilize the financial markets and how those actions are likely to affect the federal
budget in coming years. The report also presents estimates of the risk adjusted (or fair value)
subsidies that the Federal Reserve provided to financial institutions through its emergency
programs. Unlike the cash treatment of the Federal Reserve in the budget, fair value subsidies
include the cost of the risk that the central bank has assumed. Thus, those subsidies are a more
comprehensive measure of the cost of the central bank’s actions.
The report was written by Kim Kowalewski and Wendy Kiska of CBO’s Macroeconomic
Analysis Division, under the direction of Robert Dennis, and by Deborah Lucas of CBO’s
Financial Analysis Division. The report is based on an earlier draft written by Barbara
Edwards of CBO’s Tax Analysis Division and Thomas Woodward, formerly of CBO. Barbara
Edwards, Wendy Kiska, and Steven Weinberg prepared the baseline budget estimates with the
assistance of Francesca Castelli, and Wendy Kiska and Deborah Lucas prepared the estimates
of the fair value subsidies. Holly Battelle and Priscila Hammett provided valuable research
assistance. Jennifer Gravelle, Jeffrey Holland, Damien Moore, and Steven Weinberg offered
comments on earlier versions of the study.
Leah Mazade edited the manuscript, and Christine Bogusz proofread it. Jeanine Rees prepared
the report for publication, and Maureen Costantino produced the cover. Lenny Skutnik
printed the initial copies, Linda Schimmel coordinated the print distribution, and Simone
Thomas prepared the electronic version for CBO’s Web site (www.cbo.gov).

Douglas W. Elmendorf
Director
May 2010
CBO

Contents
Summary and Introduction

1

Actions by the Federal Reserve to Address the Financial Crisis

9

Expanded Lending to Depository Institutions

9

New Liquidity Programs for Nondepository Financial Institutions and
Other Market Participants

9

Open Market Purchases of Securities

10

Support for Systemically Important Financial Institutions

10

The Projected Impact of the Federal Reserve’s Actions on the Federal Budget

11

Effects of the Federal Reserve’s Liquidity Programs and Purchases of Securities

12

Effects of Support for Systemically Important Institutions

13

Estimates of Fair-Value Subsidies from the Federal Reserve’s Actions

14

Methodological Considerations

15

Subsidy Estimates

16

Appendix A: Programs Created by the Federal Reserve During the Financial Crisis

21

Appendix B: CBO’s Fair-Value Models

33

CBO

VI

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Tables
1. Fair Value Subsidies Arising from the Federal Reserve’s Actions
During the Financial Crisis
A 1. Overview of the Federal Reserve’s Lending Programs
During the Financial Crisis

8
22

Figures
1. Assets of the Federal Reserve Banks, January 2007 to December 2009

4

2. Liabilities of the Federal Reserve Banks, January 2007 to December 2009

5

3. Funding Provided Through Selected Federal Reserve Programs

17

Boxes
1. Background on the Federal Reserve System
2. Monetary Policy

CBO

2
6

The Budgetary Impact and Subsidy Costs of the
Federal Reserve’s Actions During the Financial Crisis

Summary and Introduction

The financial system plays a vital role in the U.S. econ
omy. It channels funds from savers to businesses, house
holds, and governments that need money to finance
investments and other expenditures, and it provides
services that are essential for commercial and financial
transactions. When the financial system is functioning
smoothly, investors trade securities in liquid markets that
provide reliable signals about the values of assets, and
loans are readily available to creditworthy borrowers.1 As
the nation’s central bank, the Federal Reserve System
plays an important role in maintaining the stability and
liquidity of the financial system through its conduct of
monetary policy and its authority as a supervisor and reg
ulator of banking institutions. (See Box 1 for more infor
mation about the Federal Reserve System.)

lending became more severe as the turmoil spread beyond
the subprime mortgage market, several large financial
institutions failed, and the economy weakened. Net lend
ing by the private financial sector fell from more than
$3.0 trillion in 2007 to annual rates of about $1.4 trillion
in the fourth quarter of 2008 and $1.8 trillion in the
first quarter of 2009.2
In response to that contraction, the Federal Reserve
undertook a series of extraordinary actions to stabilize
financial markets and institutions. It continued to use its
traditional monetary policy tools, but in addition, it cre
ated a variety of targeted credit programs to help restore
liquidity and confidence to the financial sector. Its actions
included:

1. When the market for a financial asset is liquid, the asset can be
readily and inexpensively converted to cash at a price that will not
be very different from the price of the previous transaction.
(Financial assets are claims that entitle the owner to receive a pay
ment or a series of payments from an entity to which the owner
has provided funds. They include bank accounts, retirement
accounts, stocks and bonds, and various kinds of securities.)
When markets become illiquid, large quantities of the asset can
not be sold (or bought) without at least temporarily depressing (or
raising) the asset’s price. The Federal Reserve can increase liquidity
in a market—essentially make it easier to convert assets to cash—
by standing ready to buy securities or to lend against them as
collateral.

Expanding lending to depository institutions—that is,
to financial institutions, such as commercial banks
and savings and loan associations, whose liabilities
largely consist of checking and savings accounts and
other deposits;

B

Creating new lending programs, or “facilities,” for
nondepository financial institutions and other partici
pants in the financial markets;

B

Over the past several years, the nation has experienced its
most severe financial crisis since the Great Depression of
the 1930s. Unexpected losses on subprime mortgages
(loans made to borrowers with poorer than average
credit) as well as heightened uncertainty about how
exposed some financial institutions might be to addi
tional losses led to a sharp decline in the liquidity of some
markets and the availability of credit. The contraction in

B

Purchasing mortgage related securities and medium
and long term securities of the U.S. Treasury in the
open market to put downward pressure on medium
and long term interest rates in the mortgage and debt
markets; and

B

Extending support to financial institutions whose fail
ures policymakers believed could lead to a systemic
collapse of financial markets and institutions.

2. Net lending is negative when the amount of repayments and losses
on all types of lending exceeds the amount of new lending.

CBO

2

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Box 1.

Background on the Federal Reserve System
The Federal Reserve System is the nation’s central
bank.1 It was created by the Congress in 1913 to pro
vide a safer, more flexible, and more stable monetary
and financial system. Its duties have expanded to
include:
B

Conducting monetary policy by influencing the
monetary and credit conditions in the economy in
pursuit of maximum employment, stable prices,
and moderate long term interest rates;

B

Supervising and regulating certain banking insti
tutions both to ensure the safety and soundness of
the U.S. banking and financial system and to pro
tect the rights of consumers;

B

Maintaining the stability of the financial system
and containing the risk of a financial crisis; and

B

Providing financial services to depository institu
tions (such as commercial banks, credit unions,
and savings and loan associations), the U.S. gov
ernment, and foreign official institutions. Those
services include a major role in operating the
nation’s payments system—the paper based and
electronic mechanisms for moving funds, pay
ments, and money among financial institutions
throughout the country.

ton, Chicago, Cleveland, Dallas, Kansas City,
Minneapolis, New York, Philadelphia, Richmond,
San Francisco, and St. Louis. (The geographic area
that each Reserve Bank serves is known as a Federal
Reserve District.) The Board of Governors of the
Federal Reserve System is an agency of the federal
government whose members are appointed by the
President with the advice and consent of the Senate.
The board supervises the Reserve Banks, which are
the operating arms of the central bank.
The Reserve Banks were established by law as private
institutions with certain privileges; however, that leg
islation restricts them to conducting business only as
specified in the Federal Reserve Act.2 Nominally, they
are owned by their “stockholder,” or member, banks.
Like those private institutions, the Reserve Banks
establish their own compensation and hiring policies
(subject to the oversight of the Board of Governors)
and pay local property taxes.

The Federal Reserve System comprises a board of
governors and 12 Reserve Banks—in Atlanta, Bos

Each Reserve Bank has its own board of nine direc
tors who are chosen from outside the bank as pro
vided by law. The Board of Governors appoints three
directors to represent the public (they reflect a cross
section of business, labor, and consumer interests
within the Federal Reserve District); one director is
appointed the chairman and another the deputy
chairman. The member banks of the Federal Reserve
District elect six directors—three to represent them
and three to represent the public.

1. This box draws on material from Board of Governors of the
Federal Reserve System, The Federal Reserve System: Purposes
and Functions, 9th ed. (2005).

2. Information about the act is available at www.
federalreserve.gov/aboutthefed/fract.htm.

Continued

In effect, the Federal Reserve assumed some of the credit
providing functions that participants in the financial
markets were unable or unwilling to perform. In doing
so, it also assumed significantly more risk of incurring
losses than it normally takes on in its operations.
The Federal Reserve’s activities during the crisis have had
a striking impact on the amount and types of assets that it
CBO

holds (see Figure 1). In July 2007, before the financial
crisis began, the Federal Reserve held about $900 billion
in assets; U.S. Treasury securities accounted for about
$790 billion of that amount. The central bank had
acquired those securities during its normal operations in
conducting monetary policy—the process of influencing
the level of short term interest rates and consequently the
pace of U.S. economic activity. (Box 2 on page 6 outlines

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Box 1.

3

Continued

Background on the Federal Reserve System
Member banks must hold stock in their regional Federal Reserve Bank in an amount equal to 6 percent of
their capital and surplus. Half that amount must be
paid in to their Reserve Bank; the other half can be
called in by the Board of Governors.3 The holding of
such stock, however, does not carry with it the control and financial interest conveyed to holders of the
common stock of for-profit organizations. Rather, it
is a legal obligation of Federal Reserve membership,
and the stock may not be sold or pledged as collateral
for loans, nor may it be purchased by individuals or
entities other than member banks. Member banks
receive a 6 percent dividend annually on their paid-in
stock, as specified by law.
The Federal Reserve System is considered to be an
independent central bank because its decisions do not
have to be ratified by the President or anyone else in
the executive branch of government. Many experts
consider that independence important for effective
3. The Board of Governors requires each Reserve Bank to
maintain a surplus equal to the paid-in capital of its member
banks.

the basic mechanics of monetary policy.) By the end of
2008, the value of the Federal Reserve’s assets had grown
to about $2,275 billion; of that amount, loans and other
support extended to financial institutions made up
$1,686 billion. At the end of 2009, when the turmoil in
the financial markets had subsided, the total value of the
central bank’s assets remained essentially where it was at
the end of 2008. The amount of direct loans and other
support to financial institutions, though still quite high
by historical standards, had fallen markedly by the end of
2009, to about $280 billion, but holdings of mortgagerelated securities had risen, to just over $1,000 billion.
The Federal Reserve’s activities during the crisis have also
led to a marked shift in the composition of the central
bank’s liabilities (see Figure 2). Before the crisis, the
major liability on the Federal Reserve’s balance sheet was

policymaking by central banks.4 However, the system
is subject to Congressional oversight. The Board of
Governors must report annually to the Congress on
the Federal Reserve’s operations and semiannually on
its conduct of monetary policy. Other actions and
policies are also subject to Congressional scrutiny,
and the Chairman and other members of the Board
of Governors testify before the Congress frequently.5
The Federal Reserve finances its own operations and
thus does not rely on Congressional appropriations
for funding. It remits its net income from those operations to the Treasury.

4. See, for example, Christopher Crowe and Ellen E. Meade,
“The Evolution of Central Bank Governance Around the
World,” Journal of Economic Perspectives, vol. 21, no. 4 (Fall
2007), pp. 69–90.
5. Moreover, the Board of Governors, the Federal Reserve
Banks, and the Federal Reserve System as a whole are subject
to several layers of audit and review. For example, the financial statements of the Board of Governors and the Reserve
banks are audited annually by outside auditors.

the amount of currency (Federal Reserve notes) in circulation—about $814 billion as of July 2007. At the end of
2009, the amount of reserves that banks held with the
Federal Reserve was the central bank’s largest liability.
Such reserves have grown from about $6 billion at the
end of July 2007 to more than $1,022 billion at the end
of 2009; those reserves greatly exceed the amount that
banks are required to hold.5 In effect, the Federal Reserve
financed its activities during the crisis primarily by
5. A depository institution’s reserve requirement is based on the type
and amount of its deposits. Historically, most banks have held
small amounts of excess reserves because reserves did not earn
interest. However, the Emergency Economic Stabilization Act of
2008 (Division A of Public Law 110-343) authorized the Federal
Reserve, as of October 1, 2008, to begin paying interest on
reserves.

CBO

4

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Figure 1.

Assets of the Federal Reserve Banks, January 2007 to December 2009
(Billions of dollars)
2,500

AIG and Bear Stearnsa
2,000

Nonbanksb
1,500

Depository Institutionsc
Agency Debt and MBSsd

1,000

500

U.S. Treasury Securities
Othere

0
Jan.
2007

Apr.
2007

Jul.
2007

Oct.
2007

Jan.
2008

Apr.
2008

Jul.
2008

Oct.
2008

Jan.
2009

Apr.
2009

Jul.
2009

Oct.
2009

Source: Congressional Budget Office based on data from the Federal Reserve.
Notes: Data are as of the last Wednesday of each month. The last data point is December 30, 2009.
Appendix A contains further information on the programs noted below.
a. For the American International Group (AIG), the total consists of the outstanding balance on the line of credit, the assets of Maiden
Lane II and Maiden Lane III, and the Federal Reserve’s equity holdings in AIA Aurora Limited Liability Company (LLC) and ALICO Holdings LLC. For Bear Stearns, the total covers the assets of the initial Maiden Lane company.
b. Consists of loans made by the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility.
c. Comprises loans through the discount window, the assets of the Term Auction Facility, central bank liquidity swaps, and repurchase agreements.
d. Agency debt consists of securities of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Agency mortgage-backed securities
(MBSs) are securities guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae.
e. Comprises gold stock, special drawing rights, Treasury currency outstanding, “float,” and other assets.

creating bank reserves rather than by issuing more cur
rency or increasing its other liabilities.4
The amount and composition of the central bank’s assets
and liabilities are major determinants of the Federal
4. When the Federal Reserve makes a loan to a bank, for example, it
credits the reserve balances of the bank by the amount of the loan,
thereby increasing both its assets (its lending to banks) and its lia
bilities (reserve balances held at the Federal Reserve) by the same
amount. For more information on the relationship between the
Federal Reserve’s activities during the financial crisis and bank
reserves, see Todd Keister and James J. McAndrews, “Why Are
Banks Holding So Many Excess Reserves?” Current Issues in Eco
nomics and Finance, Federal Reserve Bank of New York, vol. 15,
no. 8 (December 2009), available at www.newyorkfed.org/
research/current_issues/ci15 8.pdf.

CBO

Reserve’s impact on the federal budget. That impact is
measured by the central bank’s cash remittances to the
Treasury, which are recorded as revenues in the budget.
(The amount that is remitted is based on the Federal
Reserve System’s income from all of its various activities
minus the costs of generating that income, dividend pay
ments to banks that are members of the Federal Reserve
System, and changes in the amount of the surplus that it
holds on its books.) For fiscal years 2000 through 2008,
annual remittances by the Federal Reserve ranged
between $19 billion and $34 billion.
The Congressional Budget Office (CBO) projects that
the Federal Reserve’s actions to stabilize the financial sys
tem will boost its remittances to the Treasury during the
next several years. That increase reflects the Federal

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

5

Figure 2.

Liabilities of the Federal Reserve Banks, January 2007 to December 2009
(Billions of dollars)
2,500

Othera
Treasury Deposits

2,000

1,500

Bank Reserves
Agency Debt and MBSs

1,000

500

Currency

0
Jan.
2007

Apr.
2007

Jul.
2007

Oct.
2007

Jan.
2008

Apr.
2008

Jul.
2008

Oct.
2008

Jan.
2009

Apr.
2009

Jul.
2009

Oct.
2009

Source: Congressional Budget Office based on data from the Federal Reserve.
Note: Data are as of the last Wednesday of each month. The last data point is December 30, 2009.
a. Comprises reverse repurchase agreements (see Box 2), Treasury cash holdings, deposits other than those of the U.S. Treasury, and other
Federal Reserve liabilities and capital.

Reserve’s larger portfolio of assets, most of which are
likely to earn a great deal more than the amount the sys
tem must pay in interest on reserves and its other liabili
ties. CBO projects that remittances will grow from about
$34 billion in fiscal year 2009 to more than $70 billion
in fiscal years 2010 and 2011.5
Projections of the Federal Reserve’s remittances to the
Treasury over the next few years, however, are more
uncertain than projections made in the past. The system’s
asset holdings are now riskier, exposing the central bank
to a considerably greater possibility of losses than its usual
holdings of Treasury securities do. Moreover, the risk of
losses from default associated with the amounts of the
remittances is asymmetric. The chances are great that the
Federal Reserve will remit slightly more than the amounts
CBO expects. But there is also a small chance that it will
remit much less—or even nothing—if serious problems
reemerge in the financial markets or the economy greatly
weakens again.
5. Congressional Budget Office, An Analysis of the President’s Budget
ary Proposals for Fiscal Year 2011 (March 2010).

Measuring the impact of the Federal Reserve System’s
actions by the magnitude of its cash remittances to the
Treasury fails to account for the cost of the risks to tax
payers from those actions. When the Federal Reserve
invests in a risky security, it increases its expected net
earnings because the return it anticipates on that security
exceeds the interest rate it pays on the debt used to fund
the purchase. If the Federal Reserve purchases the security
at a fair market price, equivalent to what private investors
would have paid, then the purchase creates no economic
gain or loss for taxpayers; the price compensates the cen
tral bank for the risk it has assumed. By contrast, if the
Federal Reserve purchases a risky security for more than
the amount that private investors would have paid, it
gives a subsidy to the seller of the security, creating an
economic loss, or cost, for taxpayers.
The economic cost of the Federal Reserve System’s
actions to stabilize the financial markets—which incor
porates the risks to taxpayers—can be estimated using
“fair value” subsidies. Fair value in many instances corre
sponds to market value; it is defined as the price that
would be received by selling an asset in an orderly trans
action between market participants on a designated

CBO

6

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Box 2.

Monetary Policy
A primary function of the Federal Reserve System is
the conduct of monetary policy. The central bank is
charged by the Congress to use monetary policy “to
promote effectively the goals of maximum employ
ment, stable prices, and moderate long term interest
rates,” as required by the Federal Reserve Act.1 Since
the mid 1980s, the central bank has carried out that
directive on a day to day basis primarily by targeting
the federal funds rate—the interest rate that banks
charge each other for overnight loans of their spare
reserves.
The Federal Reserve influences the federal funds rate
by changing the amount of available funds in the fed
eral funds market. Before the financial crisis, the cen
tral bank altered the amount of funds primarily by
buying and selling U.S. Treasury securities and by
participating in repurchase and reverse repurchase
agreements.2 Those activities have direct effects on
the federal funds rate and indirect effects on other
interest rates in the financial markets. For example,
when the Federal Reserve wants to lower the federal
funds rate, it buys Treasury securities from dealers in
the open market. (To raise the federal funds rate, it
1. Information about the Federal Reserve Act of 1913 is avail
able at www.federalreserve.gov/aboutthefed/fract.htm. Fur
ther discussion of the Federal Reserve’s monetary policy role
is at www.federalreserve.gov/generalinfo/faq/faqmpo.htm.
2. Repurchase agreements are similar to collateralized loans. In a
repurchase agreement, a primary dealer (a bank or another
financial institution that meets the central bank’s capital and
other requirements) sells high quality securities, such as Trea
sury securities, to the Federal Reserve and agrees to buy them
back on a set date and for a set price. In a reverse repurchase
agreement, a dealer buys high quality securities from the Fed
eral Reserve and pledges to sell them back to the central bank
on an agreed upon date and at an agreed upon price.

CBO

sells securities.) Those transactions add to the supply
of bank reserves that banks can lend in the overnight
market—because the dealers deposit the proceeds of
such sales in their banks—thereby lowering the fed
eral funds rate and adding to the Federal Reserve’s
holdings of Treasury securities. The central bank can
also increase (or decrease) the amount of reserves by
carrying out a repurchase (or a reverse repurchase)
agreement.
The central bank has traditionally used two other
methods as well for adjusting the amount of reserves
in the banking system, although those methods are
less useful for day to day adjustments of the federal
funds rate. First, the Federal Reserve can increase the
amount of reserves by making loans through its so
called discount window, a facility that makes collater
alized loans (typically overnight) to banks and other
depository institutions. However, the Federal Reserve
has discouraged banks from using the discount win
dow in situations that do not constitute an emer
gency. Consequently, the amount of discount
window lending is typically very small.
A second method that the central bank can use to
adjust reserves is to change its reserve requirements—
which specify the amount of reserves that depository
institutions must hold at the Federal Reserve Banks.
However, frequent alterations in the requirements are
impractical.
Recently, the Federal Reserve was granted the author
ity to pay interest on bank reserves, giving it a new
tool with which to influence the level of reserves in
the system as well as interest rates in the broader
financial market.

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

measurement date.6 Subsidies estimated on a fair value
basis provide a more comprehensive measure of cost than
do estimates made on a cash basis: They take into
account the discounted value of all future cash flows asso
ciated with a credit obligation, and they include the cost
of bearing risk.7 CBO and the Administration’s Office of
Management and Budget (OMB) use a conceptually sim
ilar subsidy measure, as specified by the Emergency Eco
nomic Stabilization Act of 2008, to estimate the budget
ary cost of the Troubled Asset Relief Program, or TARP.8
(CBO calls such subsidies “fair value” in part to distin
guish them from subsidies calculated through the method
specified by the Federal Credit Reform Act of 1990 and
used by CBO and OMB to estimate the budgetary cost of
federal credit programs.)9
In CBO’s estimation, the fair value subsidies conferred by
the Federal Reserve System’s actions to stabilize the finan
cial markets totaled about $21 billion (see Table 1 for
details). The subsidies are estimated as of the date of
inception of the main programs that the central bank put
in place—when the major economic commitments
occurred—and they incorporate CBO’s projections of all
future cash flows over the life of those facilities, the
uncertainty surrounding the flows, and the expected rate
of return that investors would have required for taking on
the same obligations. The gains or losses that will ulti
mately be realized from the Federal Reserve’s activities
6. As such, a fair value reflects the presence of a risk premium, which
is the additional rate of return that investors require to bear mar
ket risk—the risk that losses will be greatest during times of eco
nomic stress. See Financial Accounting Standards Board,
Statement of Financial Accounting Standards No. 157, Fair Value
Measurements (September 2006), p. 2.
7. The discounted value of a future stream of promised cash flows is
the amount they are worth today—their present value. The dis
counted value is calculated by applying a “discount rate” to future
cash flows that accounts for the time value of money and for the
risk of the cash flows.

7

will almost certainly deviate from CBO’s estimates of the
fair value subsidies those actions provided. Such forward
looking estimates are based on averages over many possi
ble future outcomes, whereas realized gains or losses
reflect a particular outcome.
In total, the fair value subsidies that CBO has estimated
are modest when compared, for instance, with CBO’s
estimate of the $189 billion subsidy provided by the
TARP at its inception—even though most of the central
bank’s facilities were introduced near the height of the
crisis, when the price of risk was substantial and the prob
ability of default was elevated.10 The subsidies’ relatively
small magnitude reflects the fact that the Federal
Reserve’s potential for losses was limited in most instances
by requirements for borrowers to provide collateral, by
guarantees from the Treasury under the TARP and from
the Federal Deposit Insurance Corporation (FDIC), or
by various restrictions on the programs. Furthermore,
some of the assistance that the Federal Reserve provided
involved no subsidies because the transactions were con
ducted on a fair value basis or at prices determined in
competitive auctions—meaning that the central bank was
fully compensated for the risks it assumed.
CBO’s estimates of the economic subsidies that the Fed
eral Reserve has provided are highly uncertain. The esti
mates necessarily rely on judgments about the probability
that the crisis would have deepened or abated, about the
sums that might be borrowed and their associated interest
rates at such times, and about the severity of losses.
Uncertainty also surrounds the discount rates used in
CBO’s calculations, but that effect is mitigated by the
short time over which most of the facilities were sched
uled to operate. Indeed, most programs have already been
ended.

8. The measure is described in Congressional Budget Office, The
Troubled Asset Relief Program: Report on Transactions Through
December 31, 2008 (January 2009).

It bears emphasizing that CBO’s fair value estimates
address the costs but not the benefits of the Federal
Reserve’s actions. In CBO’s judgment, if the Federal
Reserve had not strategically provided credit and
enhanced liquidity, the financial crisis probably would

9. For the Federal Credit Reform Act of 1990, see title XIII,
section 13201, of the Omnibus Budget Reconciliation Act of
1990; 2 U.S.C. 661, 104 Stat. 1388 610. The law specifies that in
calculating those subsidy costs, interest rates on Treasury securities
with similar maturities be used as discount rates (to determine the
present value of the expected cash flows associated with a loan or
loan guarantee). Because Treasury securities are considered to have
little chance of default, their interest rates do not include a charge
for the cost of default risk.

10. CBO’s estimates of the fair value subsidies provided by the TARP
at or near the inception date of that program are described in
Congressional Budget Office, The Troubled Asset Relief Program:
Report on Transactions Through December 31, 2008. By design,
some activities pursued under the TARP involved a much greater
assumption of risk by the government and the purchase of some
assets at prices that were significantly above their fair values. CBO
now estimates that the TARP will cost $109 billion.

CBO

8

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Table 1.

Fair-Value Subsidies Arising from the Federal Reserve’s Actions During the
Financial Crisis
Program/Activity

Lending to Depository Institutions
Term Auction Facility
Repurchase agreements
Reciprocal currency arrangements
Lending to Nondepository Financial Institutions and
Other Market Participants
Primary Dealer Credit Facility
Term Securities Lending Facility
Asset-Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility
Money Market Investor Funding Facility
Commercial Paper Funding Facility
Term Asset-Backed Securities Loan Facility
Direct Purchases of Securities
Support for Systemically Important Financial Institutionsb
Maiden Lane LLC
Maiden Lane II LLC
Maiden Lane III LLC
AIG revolving credit facility
Citigroup
Bank of America

Inception Date

Subsidy at Inception
(Billions of dollars)

December 12, 2007
Ongoing
December 12, 2007

a

0
0
n.a.

March 17, 2008
March 27, 2008

0
0

September 22, 2008
October 21, 2008
October 27, 2008
March 3, 2009

2
0
2
13

Ongoing

0

March 14, 2008
October 31, 2008
October 31, 2008
September 16, 2008
November 23, 2008
January 16, 2009

Total

0
0
0
2
2
1
____
21

Source: Congressional Budget Office.
Notes: Subsidies estimated on a fair-value basis, unlike estimates made on a cash basis, take into account the discounted value of all future
cash flows associated with a credit obligation and include noncash costs, such as that for bearing risk.
For further information on the programs and activities listed above, see Appendix A.
n.a. = not applicable; LLC = limited liability company; AIG = American International Group.
a. Numbers in the column do not add to the total because of rounding.
b. The Maiden Lane LLC was established in conjunction with the sale of the investment bank Bear Stearns to JPMorgan Chase & Company.
Maiden Lanes II and III were established to provide support to AIG.

CBO

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

have been deeper and more protracted and the damages
to the rest of the economy more severe. Measuring the
benefits of the Federal Reserve’s interventions in avoiding
those worse outcomes is much more difficult than esti
mating the subsidy costs of the interventions, and CBO
has not attempted to do so. It is likely, though, that the
benefits of the Federal Reserve’s actions to stabilize the
financial system exceeded the relatively small costs
reported here for fair value subsidies.

Actions by the Federal Reserve to
Address the Financial Crisis

In reacting to the recent turmoil in the financial markets,
the Federal Reserve used its traditional tools for imple
menting monetary policy as well as new facilities to help
restore liquidity and confidence within the financial mar
kets and among institutions. Using its traditional tools,
the Federal Reserve expanded lending to depository insti
tutions and lowered its target for the overnight federal
funds rate to almost zero to put downward pressure on
market interest rates. The Federal Reserve also created
new facilities to provide liquidity to nondepository finan
cial institutions and other market participants and pur
chased mortgage related securities and medium and
long term U.S. Treasury securities in the open market. It
also extended direct loans and other support to certain
“systemically important” financial institutions (institu
tions whose financial problems during the crisis were
believed to seriously threaten the stability of the financial
system as a whole).

on those and other actions by the Federal Reserve to meet
the crisis in the banking system.) Taken together, the out
standing amount of lending through those programs rose
from about $19 billion at the end of July 2007 to a peak
of $1,201 billion in December 2008. By the end of 2009,
however, lending to depository institutions had fallen to
about $106 billion (see Figure 1 on page 4).

New Liquidity Programs for Nondepository
Financial Institutions and Other Market
Participants
As the crisis deepened, the Federal Reserve created new
programs to provide liquidity directly to other financial
institutions and participants in the financial markets—in
particular, primary dealers, money market mutual funds,
and participants in the markets for commercial paper and
asset backed securities.12 Those institutions and partici
pants directly or indirectly provide a significant amount
of credit to consumers and businesses. In normal times,
the Federal Reserve could have provided liquidity to
many such institutions indirectly by providing additional
reserves to banks, which could then have lent the funds to
the institutions. However, the curtailment of banks’ lend
ing activities during the crisis blocked the normal chan
nels through which the Federal Reserve could affect the
financial markets and the economy more broadly. Conse
quently, the central bank created:
B

The Primary Dealer Credit Facility and the Term
Securities Lending Facility (TSLF), to provide primary
dealers with access to short term liquidity;

B

The Asset Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility (AMLF) and the

Expanded Lending to Depository Institutions
In its earliest actions to address the financial crisis, the
Federal Reserve focused on providing liquidity to deposi
tory institutions, generally by using existing programs. It
expanded opportunities for borrowing from its discount
window, which serves as a backup source of liquidity for
individual depository institutions, by reducing the cost of
loans and extending their maximum maturity from over
night to 90 days. And it increased its use of repurchase
agreements (short term collateralized loans) to add
liquidity to the banking system. Other actions included
expanding its currency swap lines with foreign central
banks to make additional dollar denominated funding
available to foreign commercial banks and creating the
Term Auction Facility (TAF) to provide longer term
loans to depository institutions at market determined
rates of interest.11 (Appendix A provides additional details

9

11. A currency swap line is an arrangement between the Federal
Reserve and a foreign central bank to temporarily trade an
amount of U.S. dollars for an equivalent amount of a foreign
currency.
12. Primary dealers—commercial banks as well as brokers and dealers
who buy and sell U.S. government and other securities in the pri
vate financial markets—trade with the Federal Reserve. Such firms
must meet requirements set by the central bank for liquidity and
capital as well as for other aspects of their operations. The market
for commercial paper (unsecured short term promissory notes
issued primarily by corporations) is an important source of fund
ing for financial institutions and some commercial firms. Asset
backed securities derive their income from the assets—for exam
ple, a pool of credit card loans—that back the securities.

CBO

10

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Money Market Investor Funding Facility (MMIFF),
to ease the liquidity problems of money market
funds;13
B

The Commercial Paper Funding Facility (CPFF), to
support the issuance of commercial paper by buying
highly rated offerings; and

B

The Term Asset Backed Securities Loan Facility
(TALF), to encourage the issuance of asset backed
securities and hence increase the availability of credit
to businesses and households.

Support for Systemically Important Financial
Institutions
In conjunction with the Treasury and the Federal Deposit
Insurance Corporation, the Federal Reserve provided
substantial additional support to four institutions whose
financial problems during the crisis were believed to seri
ously threaten the financial system’s stability.
B

The Federal Reserve created the Maiden Lane
facility in conjunction with the sale of the troubled
investment firm Bear Stearns to the bank JPMorgan
Chase & Company. The facility, which is structured as
a limited liability company, received financing from
the Federal Reserve to purchase about $30 billion of
Bear Stearns’ assets, which were residential and com
mercial mortgage loans and other mortgage related
assets.15 (In essence, the Federal Reserve owns those
underlying assets.)

B

The Federal Reserve also provided assistance to Amer
ican International Group (AIG), a large financial insti
tution with businesses in insurance and other financial
products. The assistance mainly included a line of
credit and the creation of the Maiden Lane II and
Maiden Lane III facilities, which own a portion of
AIG’s asset backed securities financed by the central
bank. (Here again, the Federal Reserve effectively

Total lending by those facilities (excluding the TSLF,
which lent securities rather than cash) peaked at over
$400 billion in late November 2008 and then declined
to approximately $62 billion at the end of 2009 (see Fig
ure 1 on page 4). In October 2008, the TSLF had loans
totaling close to $200 billion; by August 2009, it had no
outstanding loans.

Open-Market Purchases of Securities
The Federal Reserve began purchasing medium and
long term securities (those with maturities of 2 to
10 years and more than 10 years, respectively) in the
open market in late 2008 in an effort to lower medium
and long term interest rates, including mortgage rates,
and thereby support the housing market and the broader
economy. The Federal Reserve stated that it would pur
chase as much as $200 billion (later reduced to $175 bil
lion) in debt securities—known as agency debt—from
Fannie Mae, Freddie Mac, and the Federal Home Loan
Banks, as well as up to $1,250 billion in mortgage backed
securities guaranteed by Fannie Mae, Freddie Mac, and
Ginnie Mae—known as agency MBSs.14 (A mortgage
backed security is a claim on the cash flows of a pool of
mortgages.) By the end of 2009, the Federal Reserve
owned $160 billion of agency debt and $908 billion of
agency MBSs. Over the course of that year, the central
bank had also purchased $300 billion of medium and
long term Treasury securities.
13. Money market mutual funds are a significant source of short term
funding for financial institutions as well as for some corporations
and government entities. For investors, the funds are an alterna
tive to bank deposits: They pay a slightly higher rate of interest,
but they expose investors to greater risk because they are not
insured.

CBO

14. Fannie Mae and Freddie Mac (formally, the Federal National
Mortgage Association and the Federal Home Loan Mortgage
Corporation) are two federally chartered institutions that provide
credit guarantees for almost half of the outstanding residential
mortgages in the United States. After the two firms experienced
sizable losses on their mortgage related investments and guaran
tees, the Treasury placed them in conservatorship—essentially the
government took control of them—in September 2008. Ginnie
Mae is a government owned corporation that guarantees securities
backed by federally insured loans—mainly loans insured by the
Federal Housing Administration and the Department of Veterans
Affairs. The Federal Home Loan Banks are government sponsored
enterprises that lending institutions use to obtain low cost financ
ing through “advances,” which are loans backed by high quality
collateral.
15. In a limited liability company, the profits and losses of the busi
ness pass through to its owners, although, as the name implies,
this particular legal structure offers protection from personal lia
bility for business debts, just as a corporation does.

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

owns the underlying assets.)16 Maiden Lane II holds
residential MBSs, whereas Maiden Lane III holds col
lateralized debt obligations—that is, securities backed
by a pool of various assets.
B

The Federal Reserve, together with the Treasury’s
Troubled Asset Relief Program and the FDIC, pro
vided guarantees on certain assets owned by the com
mercial banks Citigroup and Bank of America. Under
the agreements, the Federal Reserve would provide so
called contingent loans to the banks in the event that
losses on the assets exceeded the amounts covered by
the TARP and the FDIC.17 By December 2009, those
agreements had been terminated.

The Projected Impact of the
Federal Reserve’s Actions on the
Federal Budget

In the course of its regular activities, the Federal Reserve
generates a stream of income in excess of its expenses and
other payments that flows to the Treasury and reduces
the budget deficit. Ordinarily, most of that income arises
from the interest paid on Treasury securities that the Fed
eral Reserve acquires in carrying out monetary policy.
The central bank’s other major sources of income are the
interest on its investments in foreign currency and on
loans to depository institutions, and the fees it receives
for services it provides to such institutions—such as
check clearing, transfers of funds, and automated
clearinghouse operations. The central bank’s income
minus its expenses, the dividends paid to member banks,
and additions to its surplus account is remitted to the
Treasury and appears in the federal budget as revenues—
specifically, the remittances are labeled “deposits of earn
ings of the Federal Reserve System” under the category
“miscellaneous receipts.”18 Annual remittances by the
16. The Federal Reserve also created the Securities Borrowing Facility
to help AIG avoid selling a portfolio of residential mortgage
backed securities in a weak market, but the facility was terminated
about two months later upon the creation of Maiden Lane II. See
Board of Governors of the Federal Reserve System, Report Pursu
ant to Section 129 of the Emergency Economic Stabilization Act of
2008: Securities Borrowing Facility for American International
Group, Inc., available at www.federalreserve.gov/monetarypolicy/
files/129aigsecborrowfacility.pdf.
17. The contingent loan to the Bank of America was in the form of a
line of credit, which was never opened.

11

Federal Reserve during fiscal years 2000 to 2008 ranged
between $19 billion and $34 billion.
The Federal Reserve’s actions to stabilize the financial
markets are likely to significantly increase the amount of
its remittances over the next few years. CBO incorporates
estimates of the Federal Reserve’s annual remittances in
its 10 year baseline projections of the federal budget. In
CBO’s estimation, remittances will more than double
from about $34 billion in fiscal year 2009 to over $70 bil
lion in fiscal years 2010 and 2011 but then taper off to
$41 billion in 2013.19 The near term increase in remit
tances reflects CBO’s expectations that the size of the
Federal Reserve’s asset portfolio will remain unusually
large for the next few years and that the return on those
assets will exceed the interest rate that the Federal Reserve
pays on reserves. The projected decline in remittances
between 2011 and 2013 reflects CBO’s assumptions that
short term interest rates will be higher and the Federal
Reserve will be reducing its asset holdings, primarily its
holdings of agency MBSs. After 2013, CBO projects,
annual remittances will rise gradually to $55 billion in
2020, in line with growth in the overall economy, and
derive increasingly from interest receipts on the central
bank’s holdings of Treasury securities.
The expansion of the central bank’s activities has also
significantly increased the uncertainty associated with its
remittances over the next several years. That is because
some of the Federal Reserve’s new credit activities entail
considerably more risk of losses—from increased interest
rates, defaults, or prepayment of the mortgages backing
its MBSs—than its normal asset holdings entail. More
over, the Maiden Lane facilities are a source of greater
expected volatility in the central bank’s remittances
because changes in the fair values of the facilities’ assets
flow through to the Federal Reserve’s reported earnings.20
In addition, the risk of default associated with the Federal
Reserve’s remittances is asymmetric, with a large proba
18. The Federal Reserve’s expenses include those for its operations
(mostly salaries and employee benefits) and various interest pay
ments, such as interest on reserves (see Box 1 on page 2).
19. Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2010 to 2020 (January 2010), pp. 91–92.
20. The accounting treatment of the assets held by the Maiden Lane
facilities differs from the treatment of the Federal Reserve’s other
assets, most of which are valued at their historical cost. As a result,
earnings on those assets are based on realized gains and losses
rather than on changes in the assets’ estimated fair values.

CBO

12

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

bility of slightly more in remittances than the amount
CBO expects but a small probability of much less in the
event that serious problems reemerge in the financial
markets or the economy goes into another downturn.21

Effects of the Federal Reserve’s Liquidity
Programs and Purchases of Securities
CBO’s projections of the Federal Reserve’s annual remit
tances to the Treasury depend on projections of the size
and composition of the central bank’s portfolio of assets
and the returns expected from it. Those estimated returns
depend in turn on projections of economic activity, the
stance of monetary policy, and developments in the
financial markets. CBO expects that the Federal Reserve’s
increased income over the next several years will largely
derive from its substantial holdings of agency debt and
agency MBSs. (CBO’s projections reflect only a small
amount of income from the emergency liquidity facilities
that the central bank established because most of those
facilities were winding down and ceasing operation dur
ing the first half of fiscal year 2010.) Indeed, CBO
expects the Federal Reserve to earn more than $45 billion
annually in interest income from its holdings of agency
debt and agency MBSs in fiscal years 2010 and 2011,
accounting for about two thirds of its income. Offsetting
some of that income, however, will be interest that the
Federal Reserve pays on bank reserves. The interest rate
on reserves is a short term rate; CBO expects short term
interest rates to rise as the economy continues to recover
but to remain lower than the interest rates on the Federal
Reserve’s longer term assets.
Size of the Federal Reserve’s Asset Portfolio. In its latest
set of baseline economic projections issued in January
2010, CBO concluded that the economy would grow at a
subdued pace over the next few years.22 That pace in part
reflects CBO’s assessment that financial systems both in
the United States and abroad will take some time to heal.
CBO believes that in those circumstances, the Federal
Reserve will implement monetary policy by slowly reduc
ing the amount of liquidity in the financial markets over
21. If such losses occurred and caused the Federal Reserve’s net earn
ings to become negative, the central bank would have no income
to remit to the Treasury. In that case, the Treasury would not be
obligated to make payments to the Federal Reserve to cover the
losses.
22. See Chapter 2 in Congressional Budget Office, The Budget and
Economic Outlook: Fiscal Years 2010 to 2020.

CBO

the next two years, while the economy is recovering from
the recession. CBO has thus assumed that the central
bank will carefully reduce the size of its asset portfolio,
raise the interest rate that it pays on reserves (which will
lead to higher short term interest rates in the financial
markets), and otherwise adjust the amount of its other
liabilities to manage the reduction in liquidity. The total
amount of the Federal Reserve’s assets in CBO’s projec
tion begins to fall later this year, but it remains above
$2 trillion through the early part of 2012.
The Federal Reserve faces a considerable challenge in
reducing the amount of liquidity in the financial system
in a way that supports the economic recovery but avoids
creating either inflationary or deflationary conditions. An
overly slow reduction in the amount of liquidity would
keep interest rates low for too long, overstimulating eco
nomic activity and contributing to higher inflation. Con
versely, an overly rapid reduction in liquidity would raise
interest rates too quickly, possibly stifling the economic
recovery and creating deflationary conditions. Balancing
those risks and choosing a course of action are difficult
because the Federal Reserve must of necessity act on the
basis of incomplete information and uncertain forecasts,
at times in response to rapidly changing circumstances.
The unprecedented nature of recent economic develop
ments and the central bank’s response to those occur
rences suggest that the potential for error in predicting
monetary policy is greater than usual. When the Federal
Reserve begins to withdraw excess liquidity from the
financial markets, it can choose different combinations of
reducing its asset holdings and raising the interest rate
that it pays on bank reserves. The central bank may
decide to sell some of its assets—in particular, its agency
MBSs—or it may simply allow those MBS holdings to
decline as the underlying mortgages are repaid. The speed
with which the Federal Reserve reduces those holdings,
however, will probably depend on conditions in the hous
ing market and in the market for those securities—a
faster recovery of such markets would encourage the cen
tral bank to reduce its MBS holdings more quickly.
The Federal Reserve could also tighten monetary policy
by increasing the interest it pays on excess reserves,
thereby encouraging banks to continue holding large
amounts on deposit. Such a policy would effectively
neutralize those funds (and the liquidity they represent)
because banks would not be loaning them out to the pri
vate sector.

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Nevertheless, because the Federal Reserve has never had
to manage such a large reduction in its asset holdings, it is
difficult to forecast the path that the central bank will
take. Any of the measures to reduce liquidity in the finan
cial markets would reduce the central bank’s net interest
income; the amount of the reduction would vary with the
course and extent of the action taken.
Composition of the Federal Reserve’s Asset Portfolio.
CBO expects that the Federal Reserve’s holdings of
agency debt and agency MBSs will account for a signifi
cant share of its asset portfolio over the next few years. By
the second half of the 2010–2020 projection period, the
Federal Reserve’s asset holdings will largely consist of
Treasury securities, in CBO’s view.
Expected Returns on the Federal Reserve’s Agency
Debt and Agency MBSs. CBO used market data to esti
mate the rates of return on the Federal Reserve’s pur
chases of agency debt and agency MBSs. Specifically, it
computed average returns for the central bank’s holdings
on the basis of the characteristics of the securities that the
Federal Reserve purchased and the market interest rates
for those securities at the time they were acquired.

Effects of Support for Systemically
Important Institutions

13

on the facilities’ portfolios of assets (see Appendix B).
(Unrealized gains and losses are determined by changes in
the fair values of those assets.) That definition of net
income follows from the particular accounting standards
that the Federal Reserve uses for those facilities.
CBO anticipates that over the lifetimes of the Maiden
Lane facilities (that is, from the inception of the programs
through fiscal year 2020), the Federal Reserve will gain
$200 million in income from its investment in the initial
Maiden Lane company (related to the Bear Stearns trans
action) and $2 billion each from its investments in
Maiden Lane II and Maiden Lane III (both related to
support for AIG). Those estimates include losses that
have already occurred. As of September 30, 2009, the
value of the assets in all of the Maiden Lane facilities had
dropped by $7.4 billion. Approximately half that loss—
$3.7 billion—has been allocated to the Federal Reserve.24
CBO expects positive returns from all three facilities
because the assets were purchased at their fair values.25
CBO assumed that each facility’s portfolio would have an
expected return of 6.5 percent and that the assets had
terms of between 2½ and 5 years. (CBO based its
assumption about expected returns on those earned by
securities bought and sold in the private markets.)

CBO estimates that the Federal Reserve’s support of insti
tutions whose failures might have threatened the stability
of the financial system will increase its net income by
about $17 billion over the fiscal year 2010–2020
period.23 That figure consists of a projected return of
$8 billion on the three Maiden Lane facilities and interest
of $9 billion on the line of credit to AIG. The contingent
loan arrangements with Citigroup and Bank of America
have been terminated.

Of course, the returns realized on asset backed securities
such as those in the Maiden Lane portfolios could deviate
significantly from what is expected, given the uncertainty
about the returns on the underlying assets. The actual
outcomes from the Maiden Lane investments depend on
what happens to the economy, and the Federal Reserve
could experience significant losses if the economy wors
ens. Also a possibility, though, is that it could reap large
gains if the market for asset backed securities turns
around more quickly than has been anticipated.

The Maiden Lane Facilities. The effect of the Maiden
Lane facilities on the Federal Reserve’s remittances to the
Treasury is measured by the facilities’ net income, which
comprises both realized and unrealized gains and losses

Line of Credit for the American International Group.
CBO estimates that the Federal Reserve will earn almost

23. That estimate incorporates the assumption that the facilities
remain on the central bank’s balance sheet until they are com
pletely wound down. However, the Treasury has announced its
intention to assume financial responsibility for the Maiden Lane
facilities “[i]n the longer term and as its authorities permit.” See
The Role of the Federal Reserve in Preserving Financial and Monetary
Stability: Joint Statement by the Department of the Treasury and the
Federal Reserve (March 23, 2009), available at www.treas.gov/
press/releases/tg66.htm. Such action would not change the finan
cial position of the federal government.

24. Of that $3.7 billion loss, $3.1 billion is attributable to the initial
Maiden Lane company and $600 million to Maiden Lane II. The
central bank has suffered no losses on its investment in Maiden
Lane III.
25. The investment advisers hired to value the assets of the Maiden
Lane facilities had to determine the fair value of the securities by
using valuation models that were based on uncertain projections
of future cash flows and the operative discount rate. The securities
had become highly illiquid: Very few transactions—and their
accompanying prices—were available for comparison, and the
prices that were observed showed substantial volatility.

CBO

14

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

$12 billion in interest over the lifetime of the loans made
to AIG under its line of credit. (The central bank had
earned $3 billion of that amount before the start of fiscal
year 2010.) That estimate is based on CBO’s projections
of the interest rate on the loan (the three month Libor
plus 3 percentage points), the loan’s outstanding balance,
and the fee of 0.75 percent on the unused portion of the
line of credit.26 CBO also judged that default losses on
the line of credit would be negligible (because the loan is
collateralized by all of the assets of AIG and its subsidiar
ies) and that the facility would cease operating, on sched
ule, in August 2013.
Contingent Loans to Bank of America and Citigroup.
CBO’s current projections do not incorporate the contin
gent lines of credit offered to Bank of America and Citi
group. In September 2009, Bank of America terminated
its provisional loan agreement with the Treasury, the
FDIC, and the Federal Reserve and paid an exit fee of
$57 million to the central bank. In December of that
year, Citigroup also terminated its agreement with those
parties and paid an exit fee of $50 million.

Estimates of Fair-Value Subsidies from
the Federal Reserve’s Actions

From an economic perspective, the higher rate of return
that CBO expects on the Federal Reserve’s riskier assets is
compensation for the central bank’s increased exposure to
the risks associated with those investments and not a true
gain of value to the Treasury. A more comprehensive
measure of the costs of the Federal Reserve’s activities
during the recent crisis that takes the value of risk bearing
into account is the economic, or fair value, subsidies that
the central bank provided to financial institutions in the
form of credit and guarantees. The concept of fair value
has been increasingly used to account for financial obliga
tions in the private sector; it is defined as the price that
would be received by selling an asset in an orderly trans
action between willing market participants on a specified
measurement date.
In general, a fair value subsidy arises whenever the Fed
eral Reserve accepts terms on the financing it is providing
that are less stringent than the terms that investors would
26. Libor is the London interbank offered rate, an indication of the
interest rate at which banks borrow unsecured funds from other
banks in the London interbank market. The rates are published
for different loan maturities and used as benchmarks for rates on
interbank loans worldwide.

CBO

demand for taking on comparable risks.27 The cost of
such subsidies is borne by taxpayers because the credit
assistance that the Federal Reserve chooses to provide
affects the size and timing of its remittances to the Trea
sury. For instance, the central bank’s activities create a
fair value subsidy when the principal amount of a loan it
makes exceeds the value to private investors of the prom
ised repayments from the loan. But when the Federal
Reserve acquires assets at their fair values, as it effectively
did through its Maiden Lane facilities, it does not confer
subsidies on the sellers of those assets because the assets’
purchase prices represented fair compensation for the
risks that the central bank was assuming. Similarly, the
Federal Reserve’s purchases of agency debt, agency MBSs,
and long term Treasury securities do not give rise to fair
value subsidies because those transactions all occurred in
the open market.
Economic subsidies can be defined more or less broadly.
For this analysis, CBO estimated only those subsidies
that arose from activities of the Federal Reserve that
exposed it to market risk—the risk that defaults will be
unusually high during times of stress in the economy.
Many of the central bank’s actions that were aimed at
increasing liquidity and lowering interest rates involved a
negligible risk of losses from default. However, some of
the Federal Reserve’s actions provided financial institu
tions with credit at a price lower than that available from
the markets and thus could be viewed as having conferred
a subsidy. For instance, the Federal Reserve’s actions
through its Term Auction Facility appear to have involved
very little default risk because the loans extended through
the TAF were highly secured. However, the terms that the
central bank offered on those loans were probably more
favorable to the borrowing banks than the terms they
could have obtained privately, as evidenced by the large
volume of lending (over $450 billion) through the TAF
at the height of the crisis. As a practical matter, it would
be extremely difficult to estimate those more broadly
defined subsidies, and CBO has not attempted to do so.
The central bank’s interventions took a number of forms
that exposed it to varying degrees of risk. CBO used sev
eral modeling approaches to estimate the fair value of the
27. In general, an economic subsidy can exist even though a program
has positive net income if the costs that are used to determine net
income are not comprehensive. The conceptual issues surround
ing estimates of economic subsidies for credit are described in
Congressional Budget Office, Estimating the Value of Subsidies for
Federal Loans and Loan Guarantees (August 2004).

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

assets of the different facilities, but all relied on data
about market prices to draw inferences about the cost of
the risks being assumed. On the basis of those models,
CBO estimated that when the programs were introduced,
the Federal Reserve conferred fair value subsidies totaling
approximately $21 billion. (Most of that amount—an
estimated $13 billion—is attributable to the Term Asset
Backed Securities Loan Facility.) The Federal Reserve will
realize actual gains or losses from those programs that will
almost certainly differ from CBO’s estimates of the fair
value subsidies, which reflect the wide range of outcomes
that were possible when the programs were initiated.

Methodological Considerations
The idea that investors require compensation for assum
ing certain risks is central to the concept of fair value.
Investors require a return that compensates them for the
“time value of money”—that a dollar today is worth more
than a dollar in the future because it can earn interest—
and that covers the losses expected from default. In addi
tion, investors require a “risk premium”—an expected
return in excess of the risk free rate—that compensates
them for bearing certain types of risk, such as market
risk.28 CBO and the Office of Management and Budget
use a subsidy measure that includes the cost of market
risk to estimate the budgetary cost of the Troubled Asset
Relief Program, as specified by the Emergency Economic
Stabilization Act of 2008.29 CBO calls such subsidies fair
value subsidies in part to distinguish them from those
that CBO and OMB calculate to estimate the budgetary
cost of federal credit programs, as specified in the Federal
Credit Reform Act of 1990. Subsidies calculated under
the requirements of that law take into account the time
value of money and expected losses but not the cost of
market risk. Specifically, the act specifies that expected
cash flows should be discounted at the interest rates of
maturity matched Treasury securities. As a result, such
subsidy measures do not include a charge for the cost
of risk.
28. A fuller explanation of the market risk premium and how it
affects the price of assets and their expected returns can be found
in any standard textbook on corporate finance. See, for example,
Chapter 9 in Richard A. Brealey, Stewart C. Myers, and Franklin
Allen, Principles of Corporate Finance, 9th ed. (New York:
McGraw Hill/Irwin, 2008).
29. See, for example, Congressional Budget Office, The Troubled Asset
Relief Program: Report on Transactions Through December 31, 2008.
Discounting expected future cash flows to the present with a dis
count rate that takes into account the market risk premium is a
common approach to estimating the fair value of a financial asset.

15

The fair value of an asset is generally the same as its mar
ket price when the asset is traded in a market that is func
tioning normally. However, when few or no similar pri
vate transactions occur or when there is no comparable
private contract, then fair values must be approximated.
During the financial crisis, private investors clearly
viewed the risk of default as extremely costly, as evidenced
by the marketwide decline in the price of securities that
carried even moderate amounts of default risk. For most
of the Federal Reserve’s programs that are evaluated here,
CBO used comparable market interest rates to impute
market risk premiums and thus calculate the fair value
subsidies that the central bank was providing. When
comparable rates were not available, CBO approximated
risk premiums by using historical relationships and avail
able market data on related transactions.
In valuing assets, fair value accounting does not generally
distinguish between the effect of market risk and the
effect of liquidity risk—the risk that selling an asset in an
inactive market could require a significant concession by
the seller on its price—although exceptions have recently
been made.30 It is hard to draw a clear distinction, either
in theory or in practice, between a premium to compen
sate an investor for market risk and a premium to com
pensate for liquidity risk. In fact, some analysts view the
liquidity premium as a component of the market risk pre
mium rather than as an addition to it because investors
place a high value on liquidity during times of market
stress, when a lack of liquidity can be costly. In general,
attempts by researchers to identify a separate liquidity
premium have produced inconsistent results. CBO did
not attempt such a decomposition; its measure of the risk
premium includes any liquidity premium. In addition,
CBO did not adjust its results for any administrative
costs in excess of the fees that were collected, because it
expects such amounts to be relatively small.
A basic principle in valuing assets is that the cost of capi
tal for a particular activity is based on the risk of the
activity itself but is largely independent of how it is
financed. Following that principle, the discount rates
CBO used in calculating fair value subsidies reflect the
30. On April 2, 2009, the Financial Accounting Standards Board
voted to revise its Statement of Financial Accounting Standards
No. 157 to account for fair value calculations when a market is
inactive. The effect of the revision is that in such circumstances,
banks have more leeway to use their own judgment to determine
whether an asset has suffered a decline in its fair value.

CBO

16

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

risk associated with the assets under consideration, not
the Federal Reserve’s cost of borrowing. Borrowing costs
are not in themselves a measure of the cost of capital for
any specific activity but instead depend on the totality of
the central bank’s activities. Associating the cost of capital
with the riskiness of the acquired assets is analogous to
the way CBO estimates subsidies under the TARP: Such
subsidies are based on the riskiness of the assets that the
Treasury has acquired and not simply on its low cost of
borrowing (stemming from the government’s ability to
raise taxes to cover the debt).
Considerable uncertainty surrounds CBO’s estimates of
fair value subsidies, which rely on assumptions about fac
tors that are difficult to quantify, such as the probability,
at the time the policies were implemented, that the crisis
would deepen or abate, the amount that would be bor
rowed and the interest rates on that borrowing at such
times, and the severity of any realized losses. The uncer
tainty associated with the estimates is asymmetric—that
is, there is a high probability that the Federal Reserve
will experience negligible losses or realize gains and a
much smaller chance that it will experience significant
losses. The possibility of such losses in part reflects the
increase in borrowing that could occur under the Federal
Reserve’s riskier programs: For some of those programs,
the central bank announced borrowing limits, but for
others, no explicit limits were set.31 As it turned out, in
the months after those programs were introduced, the
amounts lent by the riskiest facilities rose rapidly to total
about $500 billion in December 2008. A few months
later, however, such lending had begun a gradual decline
as market conditions improved (see Figure 3).
For each of the Federal Reserve’s stabilization programs,
CBO reports the cost of fair value subsidies at the pro
gram’s inception date. Those estimates capture the full
value of the Federal Reserve’s commitments at the time
they were made, taking into account all future cash flows
over the life of the program and the uncertainty sur
31. No upper bounds were set on lending through the Primary Dealer
Credit Facility, the Commercial Paper Funding Facility, or the
Asset Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility. Caps of $540 billion and $200 billion were
placed on lending through the Money Market Investor Funding
Facility and the Term Asset Backed Securities Loan Facility,
respectively. (For additional detail, see Appendix A.) Lending in
support of specific institutions was initially $85 billion for AIG,
$220 billion for Citigroup, and $87 billion for Bank of America.

CBO

rounding them. The Federal Reserve made significant—
and in several cases repeated—changes to some of the
programs as conditions in the markets changed. However,
for this analysis, CBO based each set of its estimates on
the information available at the time the program was
created and did not adjust the estimates for subsequent
changes that it could not have anticipated.

Subsidy Estimates
In CBO’s estimation, the total amount of fair value subsi
dies conferred by the Federal Reserve’s new emergency
facilities at the time that the programs were created was
about $21 billion (see Table 1 on page 8). Subsidy
amounts varied considerably by program, but for the
most part, they were modest. Several programs involving
loans that were backed only by risky collateral, that had
interest rates that were administratively set by the Federal
Reserve, and that would extend over months or years gave
rise to most of the subsidy costs. For other programs that
were structured to pose very little risk to the central bank
or that explicitly extended credit by using a competitive
auction or a fair value basis, economic subsidies were
judged to be negligible.
The Federal Reserve’s emergency programs as well as the
actions taken by the Treasury under the TARP involved
subsidies conferred on financial institutions by the federal
government. However, the total amount of subsidies pro
vided by the Federal Reserve is much smaller than the
subsidy arising from the TARP, which CBO estimated to
be $189 billion at the program’s inception. By design, the
TARP encompassed a much greater assumption of risk by
the government and some purchases of assets at prices sig
nificantly above their fair values.
Expanded Lending to Depository Institutions. In CBO’s
view, the expanded use of the Federal Reserve’s discount
window, lending by the Term Auction Facility, and,
before 2009, the increased use of repurchase agreements
did not create significant subsidies. The reciprocal cur
rency arrangements (dollar swaps) that the central bank
engaged in at various times throughout the crisis were
struck at terms favorable to the Federal Reserve and thus
had negative subsidies—they created profits for the
government.
CBO judges the fair value subsidies conferred by the
expanded use of the discount window and repurchase
agreements to be negligible. That broader use is an

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

17

Figure 3.

Funding Provided Through Selected Federal Reserve Programs
(Billions of dollars)
500
450

Maiden Lane

400
350

Maiden Lane II

300
250

Maiden Lane III

200
150

AMLF

100

AIGa

CPFF

50

TALF

0
June
2008

Sept.
2008

Dec.
2008

March
2009

June
2009

Sept.
2009

Dec.
2009

Source: Congressional Budget Office based on data from the Federal Reserve.
Notes: Further information on the programs can be found in Appendix A.
TALF= Term Asset-Backed Securities Loan Facility; AMLF = Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility; CPFF = Commercial Paper Funding Facility.
a. The data for the American International Group (AIG) comprise the outstanding balance on the line of credit plus equity holdings in AIA
Aurora Limited Liability Company (LLC) and ALICO Holdings LLC.

extension of the Federal Reserve’s normal lending activi
ties, which are structured to minimize the risk of loss.
The loans and agreements have short terms and are well
collateralized; moreover, the loans from the discount win
dow are recourse loans—that is, in case of default, the
Federal Reserve has recourse to the assets of borrowers
beyond the collateral that has been provided. On repur
chase agreements, borrowers pay market rates of interest.
CBO has also concluded that the subsidies associated
with the TAF are negligible. In principle, the longer
maturity loans offered under the facility exposed the Fed
eral Reserve to greater risk of loss than does its traditional
overnight lending through the discount window. How
ever, the TAF’s requirements for large amounts of collat
eral up front to secure the loans made losses unlikely.
Moreover, a TAF loan by design carried a market based
interest rate because the rate was determined through a
competitive auction (the minimum rate was 0.25 per
cent). Another reason to believe that the TAF offered lit
tle if any subsidy is that the facility’s auctions were consis
tently undersubscribed after the height of the crisis,
suggesting that many potential borrowers did not find

the funds attractive even when they carried the minimum
allowable rate under the facility.
The dollar swaps with foreign central banks have resulted
in gains for the Federal Reserve. However, CBO did not
have enough information about the terms on the swaps at
the time the program was announced to estimate the pro
spective value of those commitments. As it turned out,
the swaps exposed the Federal Reserve to very little risk of
default because the other parties to the arrangements
were foreign central banks, not the foreign private banks
that borrowed the dollar denominated funds from their
central banks. Nevertheless, the Federal Reserve received
interest payments on the swaps that included compensa
tion for the risk associated with the private foreign banks
that ultimately borrowed the funds.32 As a result, the
interest rates charged on the swaps more than compen
sated the Federal Reserve for its risk exposure.
32. The interest rates that the Federal Reserve received on the swaps
were determined in competitive auctions whose participants were
the private foreign banks.

CBO

18

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

New Liquidity Programs for Nondepository Financial
Institutions and Other Market Participants. The Federal
Reserve created several programs to provide liquidity to
nondepository institutions. Some of the facilities were
designed to protect the central bank entirely from losses
as a result of defaults or to compensate it at near market
rates for the risks associated with such lending. But other
facilities that the Federal Reserve established exposed it to
risk that was not fully counterbalanced by higher interest
rates or some other type of protection, such as collateral.
In those cases, the Federal Reserve provided a subsidy to
borrowers.
The Primary Dealer Credit Facility. With this facility, the
Federal Reserve extended the use of its discount window
to primary dealers—large financial institutions that are
authorized to trade directly with the Federal Reserve
System. As with traditional loans from the discount
window, the Federal Reserve’s risk of losses on loans to
primary dealers was minimal because the loans were for
short terms and were well collateralized; in addition, the
Federal Reserve had recourse to the borrowers’ assets in
the event of their default. Hence, CBO estimates that the
amount of the fair value subsidies provided on loans from
this facility was negligible.
The Term Securities Lending Facility. The Federal Reserve
created the Term Securities Lending Facility early in 2008
to strengthen the financing position of primary dealers
and generally improve conditions in the financial mar
kets. Through the facility, it lent Treasury securities to
primary dealers for terms of 28 days; the loans were
backed by dealers’ pledged collateral of high grade securi
ties. Dealers paid interest on the loaned securities at a rate
determined in competitive auctions, and as a result, CBO
has estimated that the loans were unsubsidized.
The Asset Backed Commercial Paper Money Market Mutual
Fund Liquidity Facility and the Money Market Investor
Funding Facility. The Federal Reserve created these pro
grams to increase liquidity in the market for asset backed
commercial paper and to assure investors that money
market mutual funds would have sufficient liquidity to
meet the elevated demand that the financial crisis might
generate for the redemption of shares in the funds. (Large
redemptions from money market funds are extremely rare
except during periods of severe financial distress.) Under
the terms of the AMLF, the Federal Reserve provided
loans to depository institutions to purchase highly rated
asset backed commercial paper from money market
mutual funds at a fixed interest rate—the primary credit
CBO

rate.33 The commercial paper that was purchased served
as collateral for the loan, and the Federal Reserve had no
further recourse to the borrowers’ assets in the event of
default on the loan.
The MMIFF was a related facility that effectively supple
mented the AMLF. CBO judged that the MMIFF would
be used only in times of extreme distress; as a result, it
estimated a negligible cost arising from the facility’s activ
ities. In fact, the MMIFF was never used and was dis
continued on October 30, 2009.
Two factors suggest that the AMLF provided a subsidy to
participants in the financial markets by charging a rate of
interest that did not fully cover the riskiness of the collat
eral (the commercial paper) it was accepting on its loans.
First, had the crisis worsened, the market value of the col
lateral would probably have fallen below the principal
owed on the loans, leaving the Federal Reserve exposed to
losses. Second, although only highly rated commercial
paper was eligible as collateral, credit ratings became less
informative during the financial crisis, and money market
mutual funds had an incentive to sell the AMLF their
holdings of highly rated but relatively risky and illiquid
paper, because there was no penalty for doing so.34 CBO’s
estimates of fair value subsidies take into account the
heightened level and volatility of commercial paper rates
as well as the likelihood of additional borrowing from the
facility in the event of a crisis (see Appendix B).
CBO estimates that at the inception of the AMLF, in
September 2008, fair value subsidies totaled about
$2 billion, reflecting the highly distressed market condi
tions prevailing at the time.
The Commercial Paper Funding Facility. The Federal
Reserve designed the Commercial Paper Funding Facility,
like the AMLF, to relieve stress in the money markets by
increasing the liquidity of high quality commercial paper.
The CPFF was a limited liability company authorized to
buy highly rated, three month dollar denominated com
mercial paper (including asset backed commercial paper)
33. The primary credit rate is the interest rate at which an eligible
depository institution may borrow funds, typically for a short
period, directly from the discount window at a Federal Reserve
Bank.
34. Considerable variation can be found in the quality of the securities
within a rating class, including the class that comprises highly
rated commercial paper. Variation was even greater during the
crisis, when the financial condition of issuers of the paper was
changing rapidly.

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

using financing provided by the Federal Reserve. The
commercial paper that it purchased served as collateral
for that financing, and the Federal Reserve had recourse
only to the assets of the facility.

commercial and consumer credit, such as commercial
mortgages, auto loans, and credit cards. The facility was
not actually opened until March 3, 2009, which CBO
treats as the date of the program’s inception.

The CPFF generated a subsidy because it provided partic
ipants in the financial markets with the option of borrow
ing money against risky collateral at terms that did not
adjust with changes in conditions in the markets. The
Federal Reserve charged an interest rate on loans through
the CPFF that was high enough to discourage use of the
facility under normal market conditions but that made its
use attractive during times of extreme financial distress.35
It is exactly at those times that the market value of the
collateral for such loans would be at the greatest risk of
falling short of the loans’ principal, leaving the Federal
Reserve at risk for losses. CBO’s estimate of fair value
subsidies for the CPFF takes into account the heightened
level and volatility of rates during the crisis, but it also
factors in the assumption that conditions will tend to
revert to normal over time (see Appendix B).

19

The TALF exposes the Federal Reserve to the risk of
losses from defaults because it provides multiyear funding
against risky asset backed securities. At the inception of
the program, the TALF offered three year loans; shortly
thereafter, it extended the term to five years for loans
against some types of collateral, such as securities backed
by student loans or commercial mortgages. Loans from
the TALF carry administratively set interest rates that dif
fer for various types of qualifying collateral and loan
maturities.

CBO estimates that at the inception of the CPFF, in
October 2008, the facility created a subsidy of about
$2 billion. (At that point, the CPFF was scheduled
to operate only until April 30, 2009, but the Federal
Reserve later extended its operations to February 1, 2010.
However, because CBO’s analysis is intended to indicate
the subsidy provided at the program’s inception, the
estimate does not take the cost of that extension into
account.) As in the case of the other emergency facilities,
the initial subsidy reflected conditions in the financial
markets at that time.
The Term Asset Backed Securities Loan Facility. The finan
cial crisis also caused a severe and protracted decline in
the availability of financing for longer term asset backed
securities. In November 2008, the Federal Reserve
announced that it was creating the TALF to support seg
ments of the asset backed securities market that provide a
significant portion of the funding for certain types of
35. The interest rate on the paper being purchased was the three
month overnight indexed swap rate plus 1 percentage point (for
unsecured paper) and 3 percentage points (for asset backed
paper). (The three month overnight indexed swap rate is a mea
sure of the average federal funds rate that market participants
expect over the next three months.) There was also a surcharge of
1 percentage point on unsecured paper, and each borrower paid a
facility fee equal to 10 basis points (a basis point is one hundredth
of a percentage point) of the maximum amount of its commercial
paper that the CPFF might own.

Despite the riskiness of the collateral backing the loans
and their extended maturities (which leave lenders vul
nerable to changes in economic conditions), three factors
mitigate but do not eliminate the default risk that the
Federal Reserve assumes when it makes such loans. First,
the Treasury has provided the central bank with “first loss
protection” on the loans, whereby the Treasury absorbs
the first $20 billion of realized losses through the TARP.
Second, the accumulated interest income on the TALF
loans can be used to cover losses. Third, the Federal
Reserve imposes “haircut” provisions that limit the
amount of a loan to less than the full value of the collat
eral backing it. The riskier the class of assets backing the
loan, the larger is the haircut that the central bank
requires. CBO’s estimate of the fair value subsidy from
the TALF takes those three types of protection into
account (see Appendix B).
In CBO’s estimation, a subsidy of roughly $13 billion
was generated at the inception of the TALF. Although the
volume of lending under the program was initially small
and increased only slowly, the subsidy that CBO calcu
lated at the program’s inception reflects the possibility
that financial conditions might have worsened, leading to
greater participation in the facility (as other alternatives
became more expensive or unavailable) as well as losses
that would have exceeded the amount of protection pro
vided by the TARP.
Open-Market Purchases of Securities. Securities that the
Federal Reserve purchases in the open market or in com
petitive auctions, in CBO’s estimation, are acquired at
prices that reflect their fair value. That reasoning applies
to mortgage backed securities, agency debt, and Treasury
CBO

20

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

securities. As such, no fair value subsidy is associated with
those transactions.
Nevertheless, such transactions confer valuable benefits
on participants in the financial markets that might be
considered subsidies under a more comprehensive defini
tion of the term. The Federal Reserve’s purchases of secu
rities boost the demand for them, thereby increasing their
liquidity, pushing up their prices (and benefiting the
securities’ existing owners), and lowering their associated
interest rates (which in the mortgage markets benefits
home buyers).36 However, the central bank’s purchases
also impose costs. For example, lower interest rates in
general reduce the interest income of savers, whereas
lower rates on mortgages increase the rate at which home
owners prepay their mortgages, which diminishes the
stream of income that owners of existing mortgage
backed securities receive.
Support for Systemically Important Financial Institutions. Despite the serious financial problems that led the
Federal Reserve to create facilities to support financial
institutions it identified as systemically important—such
as AIG and Citigroup—the central bank initially pro
vided either no subsidy or only a small one to those insti
tutions, in CBO’s estimation. In the case of the Maiden
Lane facilities, which were established to facilitate the
Bear Stearns and AIG transactions, the Federal Reserve
initially provided support on fair value terms. Its bolster
ing of Citigroup and Bank of America was structured so
that the risk of losses was primarily borne by other federal
entities, such as the Treasury (using funding from the
TARP) and the FDIC.
The Maiden Lane Facilities. CBO estimates that no eco
nomic subsidies were associated with these facilities at
their inception because the Federal Reserve reported that
36. The impact of the Federal Reserve’s purchases in the market is
analogous to the impact of foreign official purchases in the market
for U.S. Treasury debt. A study that found evidence suggesting
that those foreign purchases had a large effect on the prices of
Treasury securities was Ben S. Bernanke, Brian P. Sack, and Vin
cent R. Reinhart, “Monetary Policy Alternatives at the Zero
Bound: An Empirical Assessment,” Brookings Papers on Economic
Activity, no. 2 (2004). The impact on prices in the bond markets
from large sized transactions and a high frequency of purchases
was examined by Michael Fleming in “Measuring Treasury Mar
ket Liquidity,” Federal Reserve Bank of New York Economic Policy
Review (September 2003), and by Michael Brandt and Kenneth
Kavajecz in “Price Discovery in the U.S. Treasury Market: The
Impact of Orderflow and Liquidity on the Yield Curve,” Journal
of Finance, vol. 59, no. 6 (December 2004).

CBO

it had acquired portfolios of risky securities equal in fair
value terms to the principal amounts of the loans that it
extended. (In other words, there was an equal exchange of
value.)
Line of Credit to the American International Group. The
Federal Reserve initially extended an $85 billion line of
credit to AIG to help it meet its obligations and restruc
ture its operations with minimal disruption to the econ
omy. CBO’s estimate of the subsidy conferred at the
inception of the program, when the line of credit was
established, is about $2 billion. That estimate, however, is
considerably more uncertain than estimates for the Fed
eral Reserve’s other programs because very little informa
tion was available about AIG’s financial condition. A
measure that is sometimes informative is the rates that
other lenders offer on financing. However, in this case,
such rates are not valid points of comparison because they
take into account the government’s backing, without
which AIG would have failed. The Federal Reserve
charged AIG very high interest rates on the loans, but the
fact that AIG relied heavily on the line of credit and con
tinues to draw on it suggests that the central bank’s terms
have continued to be more favorable than those available
from private lenders.
Contingent Loans to Citigroup and Bank of America. The
contingent loans to Citigroup and Bank of America ini
tially provided small subsidies, in CBO’s estimation. For
the Citigroup portfolio, CBO estimated fair value subsi
dies of about $2 billion at the inception of the program.
That amount is sensitive to assumptions about the size of
the risk premium (among other factors), which CBO
estimated to be 8 percent. If the risk premium was
assumed to be 6 percent, then the subsidy at the incep
tion of the program would be about $4 billion; if the
risk premium was assumed to be 10 percent, then the
subsidy would be about $8 billion.
The Federal Reserve was less exposed to losses from the
Citigroup program than were the Treasury and the FDIC
because those latter organizations had to absorb losses
before the Federal Reserve suffered any. In addition, the
central bank benefited from a relatively high rate of inter
est on the contingent loan—the three month overnight
indexed swap rate plus 300 basis points—even though its
risk was fairly limited.
On Bank of America’s contingent loan, the subsidy that
the Federal Reserve provided at the program’s inception
was less than $1 billion, in CBO’s judgment.

APPENDIX

A
Programs Created by the Federal Reserve
During the Financial Crisis

D

uring the past several years, the Federal Reserve
significantly expanded the amount and availability of its
lending to a broad range of financial institutions. It did so
by invoking its authority under section 13(3) of the Fed
eral Reserve Act of 1913 to lend “[i]n unusual and exi
gent circumstances” to “any individual, partnership, or
corporation . . . unable to secure adequate credit accom
modations from other banking institutions.”1

Using that authority, the central bank expanded existing
lending programs that provide liquidity to depository
institutions, such as banks and credit unions, whose lia
bilities largely consist of checking and savings accounts
and other deposits.2 It also created new programs to pro
vide liquidity to nondepository financial institutions and
other market participants, such as brokers and dealers in
securities and money market mutual funds; purchased
mortgage related securities on the open market to try to
help lower medium and long term interest rates and
improve the flow of credit in the market for home mort
gages; and extended direct loans and other support to
certain “systemically important” financial institutions—
those whose failures the central bank believed could
lead to a systemic collapse of financial markets and
institutions.
Now that the turmoil in the financial markets has sub
sided and most of the liquidity programs have ended, the
Federal Reserve’s holdings of mortgage related securities
and its support of systemically important financial insti
1. Further information about the law is available at www.
federalreserve.gov/aboutthefed/fract.htm.
2. The Federal Reserve can increase liquidity in a market—essen
tially make it easier to convert assets to cash—by standing ready to
buy securities or to lend against them as collateral.

tutions remain on its balance sheet. (The lending pro
grams are summarized in Table A 1.)

Expanded Lending to Depository
Institutions

The Federal Reserve’s earliest actions to address the finan
cial crisis, apart from the reduction in its target for the
federal funds rate (the interest rate that banks charge each
other for overnight loans of their spare reserve balances
and that figures in the Federal Reserve’s conduct of mon
etary policy), focused on providing liquidity to deposi
tory institutions.3 The central bank eased the terms on
which depository institutions could borrow from its so
called discount window, increased its use of repurchase
agreements to add liquidity to the banking system,
expanded its currency swap lines with foreign central
banks, and created the Term Auction Facility (TAF) to
provide loans with longer terms through the discount
window.

Expansion of Lending Through the Discount
Window
The Federal Reserve extends credit directly to depository
institutions through its discount window program, or
facility. The discount window operates as a backup source
of liquidity for individual depository institutions that
3. Monetary policy comprises the actions of a central bank to influ
ence the availability and cost of money and credit as a means of
helping to promote the goals of maximum employment, stable
prices, and moderate long term interest rates. The traditional
tools of monetary policy include open market operations, direct
lending to depository institutions, and reserve requirements for
certain deposit liabilities of depository institutions. (Reserves are
an amount of funds held back from investment by a bank to meet
probable or possible demands.) For additional information, see
Box 2 on page 6.

CBO

22

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Table A-1.

Overview of the Federal Reserve’s Lending Programs During the Financial Crisis
Participants

Collateral

Collateral “Haircuts”a

Loan Term

Interest Rates

Recourseb

Discount
Window

Depository
institutions

Full range of discountwindow collateral (most
loans that are not past
due and most highly
rated securities)

Haircuts for securities are
between 1 percent and
18 percent of estimated
fair market values;
haircuts for loans are
between 4 percent and
56 percent.

Typically
overnight but
up to 90 days
during the
financial crisis

Set as a spread over the
target for the federal funds
rate (the rate banks charge
each other for overnight
loans of their spare
reserve balances)

Yes

Reciprocal
Currency
Arrangements

Selected
central banksc

Foreign currency and
eligible collateral in the
central bank’s
jurisdiction

No

Overnight to
3 months

Equal to the rate earned by
the foreign central banks
on their loans to private
banks

No

Term Auction
Facility

Sound
depository
institutions

Full range of discountwindow collateral (most
loans that are not past
due and most highly
rated securities)

The same haircuts as for
discount-window lending

Initially 28 days
or 84 days

Set by auction. The
minimum bid rate is the
rate of interest that
Federal Reserve Banks pay
on excess reserve
balances.

Yes

Primary Dealer
Credit Facility

Primary
dealersd

Full range of collateral
accepted for triparty
repurchase agreements
(those in which a
custodian bank or
international clearing
organization acts as an
intermediary between
the two parties to the
agreement)

For collateral that is
eligible for the Federal
Reserve’s open market
operations (OMOs)—that
is, Treasury securities,
agency debt, and agency
mortgage-backed
securities—the haircuts
are those used for OMOs.
For non-OMO-eligible
collateral, haircuts are
based on the riskiness of
the asset and are generally
higher than for OMOeligible collateral.

Overnight

Equal to the primary credit
rate (the rate that sound
banks pay on loans from
the discount window) in
effect at the Federal
Reserve Bank of New York

Yes

Continued

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APPENDIX A

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Table A-1.

23

Continued

Overview of the Federal Reserve’s Lending Programs During the Financial Crisis
Collateral

Collateral “Haircuts”a

Loan Term

Interest Rates

Treasury securities,
agency debt, and agency
mortgage-backed
securities, and all
investment-grade debt
securities

For collateral that is
eligible for the Federal
Reserve’s open market
operations (OMOs)—that
is, Treasury securities,
agency debt, and agency
mortgage-backed
securities—the haircuts
are those used for OMOs.
For non-OMO-eligible
collateral, haircuts are
based on the riskiness of
the asset and are generally
higher than for OMOeligible collateral.

28 days

Set in an auction process
subject to a minimum bid
rate of 10 or 25 basis
points, depending on the
type of collateral used in
the auction

No

Highly rated assetbacked commercial
paper

No

Maturity date of
the asset-backed
commercial
paper but a
270-day
maximum

Equal to the primary credit
rate (the rate that sound
banks pay on loans from
the discount window) in
effect at the Federal
Reserve Bank of Boston at
the time the advance is
made

No

U.S. dollar-denominated
certificates of deposit,
bank notes, and
commercial paper
issued by highly rated
financial institutions

No

Overnight

Equal to the primary credit
rate (the rate that sound
banks pay on loans from
the discount window) in
effect at the Federal
Reserve Bank of New York

Yes

Eligible issuers Newly issued 3-month
of commercial unsecured and assetbacked commercial
paper
paper from eligible U.S.
issuers

No

3 months

The lending rate on assetbacked commercial paper
is the 3-month overnight
indexed swap (OIS) rate
plus 300 basis points; for
unsecured commercial
paper, the rate is the
3-month OIS rate plus
100 basis points and an
unsecured-credit
surcharge of 100 basis
points.

Yes

Participants

Term Securities Primary
Lending Facility dealersd

Asset-Backed
Commercial
Paper Money
Market Mutual
Fund Liquidity
Facility

Depository
institutions,
bank holding
companies,
and U.S.
branches and
agencies of
foreign banks

Money Market Eligible money
market mutual
Investor
Funding Facility funds and
other money
market
investors
Commercial
Paper Funding
Facility

Recourseb

Continued

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24

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Table A-1.

Continued

Overview of the Federal Reserve’s Lending Programs During the Financial Crisis
Participants

Term AssetBacked
Securities Loan
Facility

Collateral

Collateral “Haircuts”a

Loan Term

Interest Rates

Investors in
the United
States who
own eligible
collateral

Recently originated U.S.
dollar-denominated
AAA-rated asset-backed
securities and
commercial mortgagebacked securitiese

Haircuts vary from
5 percent to 16 percent,
depending on the class of
assets and a security’s
average life but not on the
borrower.

3 or 5 years

Varies by the type of
collateral securing the loan
(and in some cases by the
term of the loan)

Recourseb

No

Source: Congressional Budget Office.
Notes: See the text for further information on the programs in the table.
A basis point is one-hundredth of a percentage point.
a. The percentage of the collateral’s value that cannot be used to back a loan.
b. In the event of a borrower’s defaulting on a loan, the Federal Reserve has the right to collect the unpaid balance from the borrower.
c. European Central Bank, Bank of England, Swiss National Bank, Bank of Japan, Reserve Bank of Australia, Banco Central do Brasil, Bank of
Canada, Danmarks Nationalbank, Bank of Korea, Bank of Mexico, Reserve Bank of New Zealand, Norway’s Norges Bank, Monetary Authority of Singapore, and Sweden’s Sveriges Riksbank.
d. Primary dealers are commercial banks and broker-dealers in securities that trade U.S. government and selected other securities with the
Federal Reserve.
e. Underlying assets on the AAA-rated securities include auto loans, student loans, credit card loans, small business loans guaranteed by the
Small Business Administration, mortgage-servicing advances, business equipment-related loans or leases, vehicle fleet leases, “floorplan”
loans, and commercial mortgages.

are experiencing a temporary shortfall of reserves. The
terms of loans from the window are very short, typically
overnight, and the loans are backed by collateral. The
interest rate on such loans—known as the discount
rate—is usually set higher than the Federal Reserve’s
target for the federal funds rate.
Before the financial crisis, the total amount of borrowing
from the discount window was small, for two main rea
sons: The Federal Reserve discouraged depository institu
tions from using the window as a regular source of funds,
and a stigma attached to banks that borrowed from the
window at a rate of interest that was higher than prevail
ing market rates (because such borrowing gave rise to sus
picions that the banks might be in financial trouble).4
Early in the crisis, the Federal Reserve sought to encour
age borrowing from the window as a way of providing
additional liquidity, and so it increased the term for bor
rowing to a maximum of 90 days and lessened the differ
ence—known as the spread—between the discount rate
4. See William C. Dudley, Executive Vice President, Federal Reserve
Bank of New York, “May You Live in Interesting Times” (remarks
at the Federal Reserve Bank of Philadelphia, October 17, 2007).

CBO

and the federal funds rate.5 The Federal Reserve extended
the maturity on loans and lowered the cost of borrowing
through the discount window several times during the
crisis.
The outstanding amount of lending through the discount
window (excluding lending for exceptional but predict
able seasonal needs) spiked as the financial crisis
unfolded, and it remained very high, by historical stan
dards, at the end of 2009. Such credit increased from
$3 million in July 2007 to $4.5 billion at the end of
2007; it peaked at almost $111 billion at the end of
October 2008. The amount of outstanding loans from
the discount window fell to about $49 billion by the end
of June 2009 and to $20 billion by the end of last year.
5. As the financial crisis subsided, the Federal Reserve has begun to
normalize the terms for borrowing from the discount window.
The maximum term of primary credit loans—loans to generally
sound depository institutions—from the discount window fell to
28 days in January 2010 and to overnight in March (before the
crisis, the typical term for such credit). In addition, in February of
this year, the Federal Reserve raised the interest rate on primary
credit from 0.5 percent to 0.75 percent.

APPENDIX A

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

Expanded Use of Repurchase Agreements
The Federal Reserve provided additional liquidity to
depository institutions by increasing the amount of its
repurchase agreements (“repos”) with its primary dealers.6
A repurchase agreement is similar to a collateralized loan.
The Federal Reserve simultaneously agrees to buy a secu
rity and sell it back to the dealer on an agreed upon
day—typically the following day but sometimes many
days later. The difference between the price paid by the
dealer to buy back the security and the price originally
paid for it by the Federal Reserve is the interest that the
primary dealer pays to the central bank for the term of
the agreement. The interest rate depends on the riskiness
of the collateral (that is, the security used in the agree
ment) and the creditworthiness of the borrower. Repur
chase agreements increase reserves in the banking system
until the dealer buys back the security because dealers
deposit the proceeds of such sales in their banks.

25

financial markets improved, the Federal Reserve gradually
reduced its repurchase transactions, and the amount out
standing reached zero in early 2009.

Extension of Reciprocal Currency Arrangements
In conjunction with other central banks, the Federal
Reserve authorized reciprocal currency arrangements, also
known as liquidity swap lines, to make available liquidity
that was denominated in a foreign currency when it was
temporarily needed. In the case of dollar swaps, the Fed
eral Reserve makes a collateralized loan of U.S. dollars to
a foreign central bank; because the responsibility to repay
the loan rests with that bank, the credit risk that the Fed
eral Reserve assumes (the risk that economic loss will
result from the borrowers’ failure to repay the loan) is
exceedingly small.

6. Primary dealers—commercial banks as well as brokers and dealers
in securities who buy and sell U.S. government and other securi
ties in the private financial markets—trade with the Federal
Reserve. Such firms must meet requirements set by the central
bank for liquidity and capital as well as for other aspects of their
operations.

Dollar Swap Lines. In December 2007, the Federal
Reserve authorized the establishment of U.S. dollar swap
lines to help the European Central Bank and the Swiss
National Bank provide dollar denominated liquidity to
foreign private banks in maturities ranging from over
night to three months. The foreign central banks
obtained dollars to lend to institutions in their jurisdic
tions, and the Federal Reserve received assets denomi
nated in euros and Swiss francs. Those arrangements ini
tially provided dollars in amounts of up to $20 billion
and $4 billion to the European Central Bank and the
Swiss National Bank, respectively.9 Because the demand
for dollar funding continued to grow, the Federal Reserve
set up swap lines with other central banks, and it
increased the size and lengthened the terms of its existing
lines with the European Central and Swiss National
Banks. In the fall of 2008, the Federal Reserve eliminated
the formal limits on the amounts of those lines as well as
on the swap lines that had been set up with the Bank of
Japan and the Bank of England, and it authorized new
liquidity swap lines with 10 other central banks.10 At the
end of June 2009, the total amount of swaps outstanding
was $119 billion, considerably less than the peak amount

7. A mortgage backed security is a claim on the cash flows of a pool
of mortgages. In this context, the “agencies” are Fannie Mae, Fred
die Mac, Ginnie Mae, and the Federal Home Loan Banks. All of
those entities issue debt to fund their operations, and all but the
Federal Home Loan Banks guarantee mortgage backed securities.

9. Board of Governors of the Federal Reserve System, Monetary
Policy Report to the Congress (February 24, 2009), p. 48, available
at www.federalreserve.gov/monetarypolicy/files/20090224_
mprfullreport.pdf.

8. Federal Reserve Bank of New York, Domestic Open Market Opera
tions During 2008: A Report Prepared for the Federal Open Market
Committee by the Markets Group of the Federal Reserve Bank of New
York (January 2009), p. 11, footnote 7, available at www.
newyorkfed.org/markets/omo/omo2008.pdf.

10. Those banks were the Reserve Bank of Australia, the Banco Cen
tral do Brasil, the Bank of Canada, the Danmarks Nationalbank,
the Bank of Korea, the Bank of Mexico, the Reserve Bank of New
Zealand, Norway’s Norges Bank, the Monetary Authority of Sin
gapore, and Sweden’s Sveriges Riksbank.

In March 2008, to address strains in the markets for
agency debt and agency guaranteed mortgage backed
securities (MBSs), the Federal Reserve significantly
increased its use of repurchase agreements by initiating
the Single Tranche Open Market Operations Program.7
The agreements had terms of 28 days, and the securities
eligible for repurchase included agency debt and MBSs
guaranteed by the agencies. Near the end of 2008, for
example, agency MBSs made up 89 percent of the collat
eral for those agreements.8
The total amount of the repurchase agreements involving
the Federal Reserve doubled to almost $110 billion after
the Single Tranche Program began, and it remained high
throughout the summer of 2008. As conditions in the

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26

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

of $583 billion at the end of 2008. The Federal Reserve
terminated those swap lines on February 1, 2010.
Foreign-Currency Swap Lines. In April 2009, the Federal
Reserve announced that foreign currency swap lines had
been set up with the Bank of England, the European
Central Bank, the Bank of Japan, and the Swiss National
Bank. Those liquidity lines were designed to give the Fed
eral Reserve the capacity to provide U.S. financial institu
tions with liquidity denominated in foreign currencies.
Through the swap lines, the Federal Reserve had access to
sterling in amounts of up to £30 billion (approximately
$44 billion at the time of the announcement), to euros in
amounts of up to €80 billion (about $100 billion), to yen
in amounts of up to ¥10 trillion (about $100 billion),
and to Swiss francs in amounts of up to CHF40 billion
(about $35 billion). The Federal Reserve did not draw on
those lines, and they expired on February 1, 2010.

Establishment of the Term Auction Facility
The Federal Reserve created the Term Auction Facility in
December 2007 as an extension of the discount win
dow.11 At two week intervals, the central bank initially
auctioned a fixed amount of funds, secured by qualifying
collateral, for terms of 28 or 84 days to depository insti
tutions that were eligible to borrow under the primary
credit program of the discount window.12 The funds were
not available to the borrowing institution immediately
but were disbursed three days after the auction. Those
features of the TAF meant that it was not suited to insti
tutions that were experiencing a sudden need for liquid
ity, and thus borrowing from the TAF was less likely to
raise concerns in the market about an institution’s viabil
ity. As a result, depository institutions were expected to
be more inclined to borrow through the TAF than
through the normal discount window.
Indeed, term auction credit accounted for the majority of
the Federal Reserve’s lending to depository institutions
during the crisis. At the peak of such lending, in early
March 2009, loans through the TAF amounted to
$493 billion, or almost 90 percent of total borrowing by
depositories. By mid 2009, as the strains in the financial
11. The Federal Reserve has indicated that the TAF could become a
permanent addition to its tools for implementing monetary
policy.
12. In contrast, primary credit is available on a very short term basis,
typically overnight.

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markets eased, banks’ use of the TAF fell off sharply, and
loans by the facility amounted to $283 billion. Conse
quently, the central bank has reduced the amount and
maturity of the credit available at the auctions.13 By the
end of 2009, the amount of TAF loans had dropped to
$76 billion.

New Programs for Nondepository
Financial Institutions and Other
Market Participants

As the financial crisis deepened, the Federal Reserve cre
ated new programs to provide liquidity directly to other
financial institutions and market participants—in partic
ular, primary dealers, money market mutual funds, and
participants in the markets for commercial paper and
asset backed securities.

The Primary Dealer Credit Facility
Exercising its emergency authority in March 2008, the
Federal Reserve extended the privilege of discount
window borrowing to primary dealers through its new
Primary Dealer Credit Facility (PDCF). Many dealers
faced difficulties in financing their holdings of mortgage
backed and other securities. In more normal circum
stances, they would have funded a significant portion of
those holdings through repurchase agreements, with
more than half of the contracts having overnight maturi
ties.14 But the prices of securities backed by subprime and
other risky mortgages (loans made to borrowers with
poorer than average credit) fell as losses on the under
lying loans mounted, and the dealers had trouble finding
counterparties (the legal and financial term for the other
parties to the dealers’ contracts) who would accept those
securities as collateral for repurchase agreements. Many
dealers faced the prospect of selling some of their securi
ties at a substantial loss, which would have put further
downward pressure on prices and possibly threatened
some dealers with insolvency.
13. The last auction was on March 8, 2010, and the minimum rate
was 0.5 percent, up from the previous minimum of 0.25 percent.
14. For more information on the repo market, see Tobias Adrian,
Christopher R. Burke, and James J. McAndrews, “The Federal
Reserve’s Primary Dealer Credit Facility,” Current Issues in Eco
nomics and Finance, Federal Reserve Bank of New York, vol. 15,
no. 4 (August 2009); and Peter Hördahl and Michael R. King,
“Developments in Repo Markets During the Financial Turmoil,”
BIS Quarterly Review (Bank for International Settlements, Decem
ber 2008), pp. 37–53.

APPENDIX A

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

The amount of borrowing under the PDCF fluctuated
markedly in 2008 but wound down to zero in 2009. By
March 26, 2008, less than two weeks after the facility’s
creation, borrowings had climbed to more than $37 bil
lion. The outstanding amount of loans from the PDCF
began to fall steadily after that, and by the beginning of
July, the facility was little used. When the turmoil in the
financial markets intensified in September 2008, the
PDCF’s balance soared from zero to almost $147 billion
on October 1. Since then, the need for the facility has
diminished, and by the end of May 2009, lending by the
PDCF had halted. The Federal Reserve terminated the
facility on February 1, 2010.

The Term Securities Lending Facility
The Federal Reserve created the Term Securities Lending
Facility (TSLF) in March 2008 to strengthen the financ
ing position of primary dealers and, more generally, to
foster improved conditions in the financial markets.15
Through the TSLF, the Federal Reserve loaned U.S. Trea
sury securities to primary dealers in two types of auctions
that differed by the collateral that dealers could offer in
exchange for the loans.16 The Federal Reserve made avail
able up to $200 billion of Treasury securities to lend to
primary dealers for terms of 28 days.
In July 2008, the Federal Reserve created the TSLF
Options Program to auction options to obtain shorter
term TSLF loans on future dates. The options program
was intended to enhance the effectiveness of the TSLF by
offering liquidity during periods when the demand for
short term funds was high, such as at the end of a quarter.
By the last quarter of 2008, the amount of borrowing
under the TSLF was close to the maximum. However, as
conditions in the markets improved, borrowing dimin
ished until outstanding loans totaled $27 billion at the
15. The TSLF is an expanded version of the SOMA (System Open
Market Account) securities lending program that the Federal
Reserve has offered since 2002. That program provides primary
dealers with overnight loans of particularly sought after Treasury
securities in exchange for other Treasury securities as collateral.
Just before the TSLF was created, lending under the SOMA secu
rities lending program averaged about $15 billion.
16. The two types of auctions were known as Schedule 1 and Sched
ule 2. In the first, loans could be collateralized by Treasury securi
ties, agency debt, and agency MBSs; in the second, they could be
backed by the collateral eligible for Schedule 1 auction loans as
well as by highly rated corporate, municipal, mortgage backed,
and asset backed securities.

27

end of May 2009. Consequently, in June of that year, the
Federal Reserve announced that it was scaling back the
program, and activity had ceased by the end of August.
The facility expired on February 1, 2010.

The Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility
Money market mutual funds typically invest in short
term debt, such as Treasury bills, certificates of deposit,
and commercial paper (unsecured short term promissory
notes issued primarily by corporations).17 With those
investments, money market funds provide a significant
amount of financing for the asset backed commercial
paper market, on which some financial institutions
depend for short term loans. Unexpected losses at one
such fund as a result of the bankruptcy of the Lehman
Brothers investment bank in the fall of 2008 triggered a
run by the fund’s investors. That brought about a loss of
confidence in the safety of money market funds more
generally and led many investors to redeem their shares.
The Federal Reserve created the Asset Backed Commer
cial Paper Money Market Mutual Fund Liquidity Facility
(AMLF) on September 19, 2008, to help money market
funds meet spikes in the demand for redemptions and to
foster confidence in the markets for asset backed com
mercial paper and in the broader money markets.18 The
AMLF provided funding to depository institutions and
bank holding companies to finance their purchases of
high quality asset backed commercial paper from money
market funds under certain conditions.19
Lending through the AMLF began the week of Septem
ber 22, 2008; by the beginning of October, the facility’s
balance had shot up to $152 billion. The balance steadily
17. Money market mutual funds are a significant source of short term
funding for financial institutions as well as for some corporations
and government entities. For investors, the funds are an alterna
tive to bank deposits: They pay a slightly higher rate of interest,
but they expose investors to greater risk because they are not
insured.
18. In addition, on September 29, the Treasury began a temporary
guarantee program, funded under the Troubled Asset Relief Pro
gram, to protect shareholders of money market mutual funds
from losses. The program ended as scheduled on September 18,
2009.
19. A bank holding company is broadly defined as any company that
has control over a bank. Becoming a bank holding company pro
vides a corporate and legal status that in many cases brings greater
financial flexibility and makes it easier for banks to raise capital.

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28

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

declined to less than $1 billion in April 2009, but it tem
porarily rose to almost $29 billion in early May and then
fell to less than $16 billion at the end of June 2009.20
With liquidity in the money markets improving signifi
cantly, the Federal Reserve announced in June 2009 that
it would restrict participation in the AMLF to money
market mutual funds that were experiencing “material”
withdrawals of funds. The program expired on
February 1, 2010.

strain—which was exacerbated by the bankruptcy of
Lehman Brothers—because money market mutual funds
and other investors that needed liquidity became increas
ingly reluctant to purchase commercial paper, especially
at maturities that extended beyond overnight. As a result,
the volume of outstanding commercial paper diminished,
interest rates on longer term commercial paper rose sig
nificantly, and an increasingly large percentage of out
standing paper had to be refinanced each day.22

The Money Market Investor Funding Facility

The Federal Reserve created the Commercial Paper Fund
ing Facility (CPFF) in October 2008 to address the diffi
culties in the commercial paper market. The facility
bought highly rated, three month dollar denominated
commercial paper (including asset backed commercial
paper) using financing provided by the Federal Reserve.
The central bank set the borrowing terms so as to dis
courage the use of the facility except when the spreads
between the interest rates on commercial paper and those
on relatively risk free securities (in general, Treasury secu
rities) reached abnormally high levels. The interest rate
on the paper was set at the three month overnight
indexed swap rate plus 1 percentage point for unsecured
paper and 3 percentage points for asset backed paper.23 A
surcharge of 1 percentage point was also levied on unse
cured paper, and each issuer was required to pay a fee to
the facility equal to 10 basis points (a basis point is one
hundredth of a percentage point) of the maximum
amount of the issuer’s commercial paper that the CPFF
might own.24

To ensure that money market funds had sufficient backup
liquidity to pay investors in the event of a run, the Fed
eral Reserve created the Money Market Investor Funding
Facility in October 2008. The program was initially
structured to provide financing to five special purpose
vehicles (SPVs). SPVs are legal entities that are created to
serve a particular function; the SPVs in this case were
authorized to purchase dollar denominated certificates of
deposit, bank notes, and commercial paper from eligible
participants in the money markets.21 (The commercial
paper that the SPVs bought had to be issued by highly
rated financial institutions and have remaining maturities
of at least 7 days and no more than 90 days.) The Federal
Reserve set the maximum amount of purchases by all of
the SPVs at $600 billion. However, the backup facility
was never used, and its authority expired on
October 30, 2009.

The Commercial Paper Funding Facility
The market for commercial paper is an important
source of short term funding for financial institutions
and for some commercial firms. In the fall of 2008, the
commercial paper market was under considerable
20. The temporary increase in May in the amount borrowed through
the AMLF occurred at about the time of the release of the results
of the Federal Reserve’s Supervisory Capital Assessment Program
(commonly known as the bank stress tests), which measured the
adequacy of the capital of major financial institutions. See Board
of Governors of the Federal Reserve System, Federal Reserve
System Monthly Report on Credit and Liquidity Programs and the
Balance Sheet (June 2009), available at www.federalreserve.gov/
monetarypolicy/files/monthlyclbsreport200906.pdf.
21. Institutions that were eligible to sell assets to the SPVs included
money market funds and other investors in the money markets,
such as U.S. based securities lenders and investment funds that
operate in a manner similar to money market funds—for example,
certain local government investment pools, common trust funds,
and collective investment funds.

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Use of the facility increased rapidly. By the end of 2008,
net holdings in the CPFF’s portfolio amounted to
22. See Board of Governors of the Federal Reserve System, “2008
Monetary Policy Releases: October 7, 2008” (press release), avail
able at www.federalreserve.gov/newsevents/press/monetary/
20081007c.htm.
23. The three month overnight indexed swap rate is a measure of the
average federal funds rate that market participants expect over the
next three months.
24. The maximum amount of a single issuer’s commercial paper that
the CPFF might own at any time was the greatest amount of
U.S. dollar denominated commercial paper that the issuer had
outstanding on any day between January 1 and August 31, 2008.
Once the total amount of an issuer’s outstanding commercial
paper held by all investors (including the CPFF) equaled or
exceeded the issuer’s limit, the CPFF would not purchase
additional commercial paper from that issuer. See www.
newyorkfed.org/markets/cpff_terms_conditions.html.

APPENDIX A

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

$334 billion. By the end of June 2009, the facility’s hold
ings had fallen to $124 billion. Some of that decline,
according to the Federal Reserve, can be traced to the lack
of renewal of a significant portion of the maturing issues,
possibly because improvements in overall market condi
tions may have allowed some borrowers to secure funding
from other sources.25 By the end of 2009, the facility held
$14 billion in loans. Like many of the other lending facil
ities that the Federal Reserve created during the crisis, the
CPFF expired on February 1, 2010.

The Term Asset-Backed Securities Loan Facility
In addition to its effects on short term financing, the
financial crisis caused a severe decline in the availability of
financing for longer term asset backed securities. In
November 2008, the Federal Reserve created the Term
Asset Backed Securities Loan Facility (TALF) to support
segments of the market for asset backed securities that
provide a significant portion of the funding for certain
types of commercial and consumer credit. Under the pro
gram, the Federal Reserve was prepared to lend up to
$200 billion to holders of certain AAA rated asset backed
securities (that is, those assigned the highest possible
commercial rating and hence the least risk of default)
whose underlying assets consisted of recently originated
qualifying loans.26 (Included were auto loans, student
loans, credit card loans, equipment loans, “floorplan”
loans, insurance premium finance loans, loans guaranteed
by the Small Business Administration, and residential
mortgage servicing advance receivables.)27 Also eligible
as collateral were certain high quality commercial
25. See Board of Governors of the Federal Reserve System, Federal
Reserve System Monthly Report on Credit and Liquidity Programs
and the Balance Sheet, p. 9.
26. The Federal Reserve announced in February 2009 (see www.
federalreserve.gov/monetarypolicy/20090210b.htm) that it was
prepared to increase the size of the program to as much as
$1 trillion.
27. Floorplan loans include revolving lines of credit to finance the
inventories of motor vehicle dealers. Insurance premium finance
loans include loans originated for the purpose of paying premiums
on property and casualty insurance; they do not include deferred
payment obligations acquired from insurance companies. Eligible
mortgage servicing advance receivables include receivables created
by principal and interest, tax and insurance, and corporate
advances made by residential mortgage servicers approved by
Fannie Mae or Freddie Mac under pooling and servicing agree
ments or similar servicing agreements. For more information, see
www.newyorkfed.org/markets/talf_terms.html.

29

mortgage backed securities issued before January 1,
2009. Loans from the TALF are limited to terms of three
or five years and carry administratively set interest rates
that differ for various types of qualifying collateral and
loan maturities.28
Lending under the TALF has gradually increased since
the facility began operating in March 2009, rising from
less than $5 billion during that month to more than
$25 billion at the end of June and almost $48 billion at
the end of the year. Unless the Federal Reserve extends
the deadlines, the TALF is scheduled to stop making
loans against newly issued commercial mortgage backed
securities on June 30, 2010; it stopped making loans
against all other collateral on March 31, 2010.

Open-Market Purchases of Securities

The Federal Reserve began purchasing securities in late
2008 in an effort to lower medium and long term inter
est rates, including mortgage rates, and thereby support
the housing market and the broader economy. Fannie
Mae and Freddie Mac—the two government sponsored
enterprises that together accounted for about one half of
the outstanding amount of home mortgages—had had
trouble raising funds as their losses mounted in 2008,
and their difficulties continued after they were put into
conservatorship (placed under government control)
by their regulator, the Federal Housing Finance Agency,
in September 2008.29 In addition, the demand for
mortgage backed securities guaranteed by the two com
panies fell as investors worried about the companies’
ability to honor their guarantees on the MBSs. Conse
quently, the Federal Reserve began purchasing the securi
ties (agency debt) issued by Fannie Mae, Freddie Mac,
and the Federal Home Loan Banks as well as mortgage
28. Five year terms may be used for loans secured by Small Business
Administration (SBA) Pool Certificates or by SBA Development
Company Participation Certificates, or for securities backed by
student loans or commercial mortgage loans.
29. Fannie Mae and Freddie Mac were originally created as federally
chartered institutions but were privately owned and operated.
Designed to facilitate the flow of investment funds to the housing
market, they pool mortgages purchased from mortgage lenders
and sell them as mortgage backed securities, collecting annual
guarantee fees on the mortgages they securitize. In return, Fannie
Mae and Freddie Mac cover any losses that occur if the underlying
mortgage loans default. The companies also hold mortgage loans
in their portfolios and purchase mortgage backed securities (their
own or those of other institutions), from which they earn a return.

CBO

30

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

backed securities guaranteed by Fannie Mae, Freddie
Mac, and Ginnie Mae (agency MBSs).30 The central bank
also purchased long term Treasury securities in 2009.

Agency Debt
The Federal Reserve began purchasing the debt of Fannie
Mae, Freddie Mac, and the Federal Home Loan Banks at
auction in September 2008. At first, it purchased only
short term debt, with maturities of one year or less.
Then, in November of that year, the central bank
announced that it would acquire up to $100 billion in
agency debt, and it began purchasing debt with longer
terms in December. In March 2009, the central bank
announced that it had increased to $200 billion the max
imum amount of agency debt that it would purchase, but
in early November, it stated that it would instead pur
chase a total of about $175 billion by the end of March
2010. By the end of 2009, it had purchased almost
$160 billion in agency debt.

Agency Mortgage-Backed Securities
Initially, the Federal Reserve announced plans to buy up
to $500 billion in agency MBSs, and it began making
those purchases in mid January 2009. In March, the cen
tral bank raised the planned amount of purchases to
$1,250 billion. At the beginning of July 2009, the Fed
eral Reserve owned $462 billion in those securities. At
the end of 2009, it owned $908 billion.

Medium- and Long-Term Treasury Securities
At the end of July 2007, before the financial crisis began,
the Federal Reserve owned $514 billion in Treasury notes
and bonds.31 That amount had fallen to $457 billion
by mid 2008. In March 2009, the Federal Reserve
announced its intention to purchase up to $300 billion in
notes and bonds over the following six months. By the

end of October of that year, the central bank had com
pleted those purchases, bringing the amount of its hold
ings of notes and bonds to just over $756 billion.

Support for Systemically Important
Financial Institutions

In conjunction with the Treasury and the Federal Deposit
Insurance Corporation (FDIC), the Federal Reserve has
provided substantial additional support to four institu
tions whose financial problems were believed to seriously
threaten the stability of the financial system. That sup
port included lending to the first Maiden Lane facility
(related to the sale of the investment bank Bear Stearns),
a line of credit to the American International Group
(AIG), lending to the Maiden Lane II and Maiden Lane
III facilities (which own certain assets formerly owned by
AIG), and so called contingent lines of credit (compo
nents of the asset guarantees, which can be drawn on as
needed) to Citigroup and Bank of America.

Lending Related to the Sale of the Bear Stearns
Companies
In mid March 2008, the large investment bank Bear
Stearns informed the Federal Reserve, the Treasury, and
the Securities and Exchange Commission that it might
soon be unable to roll over (or refinance) its liabilities
related to repurchase agreements. That possibility raised
the concern that the sudden failure of Bear Stearns might
have a chaotic effect on key financial markets, creating
turmoil that could have severely undermined confidence
and cast doubt on the financial stability of other major
financial firms.

30. The Federal Home Loan Banks are government sponsored enter
prises that lending institutions use to obtain low cost financing
through “advances,” which are loans backed by high quality col
lateral. Ginnie Mae is a government owned corporation that guar
antees securities backed by federally insured loans—mainly loans
insured by the Federal Housing Administration and the Depart
ment of Veterans Affairs.
31. The Treasury issues notes with maturities that range from 2 to
10 years and bonds with maturities of 30 years. (At the end of
July 2007, the Federal Reserve also held more than $277 billion in
short term Treasury bills.)

CBO

To prevent the adverse economic consequences that could
have been triggered by a disorderly failure of Bear Stearns,
the Federal Reserve, in consultation with the Treasury,
agreed to extend funding to Bear Stearns through JPMor
gan Chase & Company, to provide some time to resolve
Bear Stearns’ problems.32 JPMorgan Chase subsequently
agreed to purchase Bear Stearns and assume its financial
obligations; the acquisition was completed on June 26,
2008. However, JPMorgan Chase did not acquire all of
32. The Federal Reserve extended a loan of $13 billion through the
discount window to JPMorgan Chase on March 14, 2008. That
loan was repaid three days later with almost $4 million of interest.

APPENDIX A

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

the nearly $400 billion in assets in Bear Stearns’ portfolio.
As part of the agreement, mortgage related assets from
Bear Stearns valued at approximately $30 billion were
segregated into a newly formed limited liability company
(LLC) called Maiden Lane.33 Maiden Lane’s assets were
financed by loans of nearly $29 billion from the Federal
Reserve Bank of New York and $1 billion from JPMor
gan Chase, with JPMorgan Chase liable for the first
$1 billion of any losses sustained by Maiden Lane. (The
overall portfolio is managed and will be liquidated by
BlackRock, an investment management firm retained by
the Federal Reserve Bank of New York.)
That arrangement is a significant shift from the Federal
Reserve’s usual policy of extending loans that not only
have recourse provisions—in the event of default, the
central bank has recourse to the assets of borrowers
beyond the collateral provided—but also protection
through collateral requirements. Although the financing
takes the form of a loan from the Federal Reserve Bank of
New York to Maiden Lane, the Federal Reserve essentially
has acquired the underlying assets—that is, it has taken
on all of the risk of those assets (with the exception of the
$1 billion from JPMorgan Chase) and has control of the
Maiden Lane facility.

Support to American International Group
AIG, a large and diversified financial institution, experi
enced serious financial problems in September 2008
stemming from one of its subsidiaries’ involvement in the
market for subprime residential mortgage loans. AIG suf
fered large losses on its investments in securities backed
by subprime mortgages and on the credit default swaps—
essentially insurance policies—it sold on such securities.34
AIG faced a crisis as its lenders, worried about its capacity
to meet its debts, refused to continue to provide financ
ing. With slightly more than $1 trillion in consolidated
assets at the end of September 2008, AIG was an impor
tant firm with dealings around the world. Its collapse
would have created problems for its counterparties and
33. An LLC offers protection from personal liability for business
debts, just as a corporation does. The profits and losses of the
business pass through to its owners, as they would if the business
were a partnership or sole proprietorship.
34. For a detailed explanation of AIG’s financial problems, see
William K. Sjostrom Jr., “The AIG Bailout,” Washington and
Lee Law Review, vol. 66 (November 1, 2009), available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=1346552.

31

for other financial institutions at a time when the finan
cial markets had been badly shaken by the failure of
Lehman Brothers a few days earlier.
The assistance that the Federal Reserve provided to AIG
was channeled through four distinct facilities: a line of
credit, the Securities Borrowing Facility, Maiden Lane II,
and Maiden Lane III.
The line of credit to AIG is a facility that has been modi
fied significantly since it was initiated on September 16,
2008. At that time, the Federal Reserve agreed to lend
AIG up to $85 billion to help it meet its obligations and
sell some of its businesses with the least possible disrup
tion to the overall economy. As part of the arrangement,
the U.S. government received warrants (a warrant pro
vides the option but not the obligation to purchase stock
at a fixed price) for a 79.9 percent ownership stake in
AIG and the right to veto the payment of dividends to
common and preferred shareholders. On October 8, fol
lowing the revelation of additional problems at AIG, the
Federal Reserve announced the creation of the Securities
Borrowing Facility, under which it would lend up to
about $38 billion against investment grade debt securi
ties held by AIG. (“Investment grade” is a rating that
indicates that a municipal or corporate bond has a rela
tively low risk of default.)
In November 2008, the arrangement with AIG was again
modified to provide additional federal support. The Trea
sury announced that it would purchase $40 billion of
newly issued AIG preferred shares under the TARP,
which allowed the Federal Reserve to reduce the total
amount available under the line of credit from $85 bil
lion to $60 billion. The central bank also lengthened the
maximum term of its loans under the line of credit to five
years and lowered the interest rate on the outstanding
balances as well as the fee charged on the unused portion
of the credit line.35
35. As of November 5, 2008, AIG had approximately $61 billion out
standing under the line of credit and $19.9 billion in outstanding
advances under the Securities Borrowing Facility. See Board of
Governors of the Federal Reserve System, Report Pursuant to
Section 129 of the Emergency Economic Stabilization Act of 2008:
Restructuring of the Government’s Financial Support to the
American International Group, Inc., on November 10, 2008,
available at www.federalreserve.gov/monetarypolicy/files/
129aigrestructure.pdf.

CBO

32

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

In November as well, the Federal Reserve announced
plans to restructure its lending related to AIG by extend
ing credit to two newly formed limited liability
companies:
B

The first, Maiden Lane II LLC, received a loan of
$22.5 billion from the Federal Reserve and a subordi
nated loan—a loan that is repaid after the loan from
the Federal Reserve—of $1 billion from AIG, with
which Maiden Lane purchased residential mortgage
backed securities from AIG. As a result of those
actions, the Securities Borrowing Facility established
on October 8 was subsequently repaid and
terminated.

B

The second new company, Maiden Lane III LLC,
received a loan of $30 billion from the Federal Reserve
and a subordinated loan of $5 billion from AIG. With
those funds, it purchased certain securities as part of
an arrangement to terminate related credit default
swap contracts that AIG had written.

Under Maiden Lane II and Maiden Lane III, the Federal
Reserve essentially acquired mortgage backed securities
at prices judged to represent fair values—that is, the
prices that would be received by selling the assets in
orderly transactions between market participants. Ulti
mately, the central bank will realize gains or losses on
those securities, depending on the underlying loans’ per
formance over time.
In June 2009, the Federal Reserve agreed to reduce the
line of credit to AIG by $25 billion in exchange for pre
ferred shares in two of AIG’s largest life insurance units
outside of the United States: American International
Assurance and American Life Insurance Company. That
transaction was completed in December 2009.
The assistance to AIG from federal sources totaled
approximately $128 billion outstanding at the end of
2009. Of that amount, $81 billion had been provided by
the Federal Reserve, and $47 billion had come from the
TARP.

Contingent Loan to Citigroup
The financial condition of Citigroup, the largest com
mercial bank in the United States at the beginning of
2008, deteriorated near the end of that year, raising ques
tions about the bank’s solvency. On November 23, 2008,

CBO

the Treasury and the FDIC arranged a guarantee (against
losses) on $301 billion of Citigroup’s assets, more than
half of which were residential and commercial real estate
loans. The guarantee on the bank’s residential assets was
to last for 10 years; the guarantee on its nonresidential
assets was for 5 years. Under that arrangement, the first
$39.5 billion in losses would be absorbed by Citigroup.
Additional losses (subject to loss sharing of 10 percent by
Citigroup) would be absorbed first by the Treasury (up to
$5 billion), then by the FDIC (up to $10 billion), and
finally by the Federal Reserve (the remainder). In the
event that losses exceeded the resources pledged by Citi
group, the Treasury, and the FDIC, the Federal Reserve
would be obligated to issue a nonrecourse loan to Citi
group, backed by the remaining assets, with an interest
rate tied to an overnight borrowing rate plus 3 percentage
points. Effectively, if that contingency had arisen, the
assets would have been sold to the central bank at their
current values.
In December 2009, Citigroup terminated its agreement
with the Treasury, the Federal Deposit Insurance Corpo
ration, and the Federal Reserve and paid an exit fee of
$50 million to the central bank. The Federal Reserve
experienced no losses on this guarantee because Citigroup
never used the line of credit.

Contingent Loan to Bank of America
Bank of America experienced intense borrowing prob
lems early in 2009, when it announced losses on its busi
ness operations in the fourth quarter of 2008. The Trea
sury and the FDIC agreed to guarantee $118 billion of
the bank’s assets under terms similar to those extended to
Citigroup. The guarantee on the bank’s residential assets
was to last 10 years; the guarantee on its nonresidential
assets was for 5 years. Under the guarantee agreement, the
first $10 billion in losses would be absorbed by Bank of
America. Additional losses (subject to loss sharing of
10 percent by the bank) would be absorbed by the Trea
sury (up to $7.5 billion) and the FDIC (up to $2.5 bil
lion). If the backing to be provided by those two entities
was exhausted, the Federal Reserve would be obligated to
lend Bank of America up to a maximum of $87.2 billion
with the bank’s remaining assets as collateral. Bank of
America did not request activation of the guarantee and
in September 2009 paid an exit fee of $57 million to the
Federal Reserve to terminate the arrangement.

APPENDIX

B
CBO’s Fair-Value Models

S

ome of the Federal Reserve’s programs to provide
credit to financial institutions during the financial crisis
offered terms that were more favorable than the terms
those borrowers could have obtained from private inves
tors—thereby providing fair value subsidies on that
credit. To estimate such subsidies, the Congressional
Budget Office (CBO) developed a stochastic simulation
model for each major program. In general, under that
approach, CBO projected probability distributions of
future cash flows associated with each program and then
discounted the cash flows to their present value using
rates that reflected the risk associated with the particular
flows.1 The probability distribution of a program’s cash
flows depended on several factors: the program’s rules and
structure; the probability distributions of interest rates,
default rates, and recovery rates on defaults; and how the
demand for a program was affected by those variables.
CBO used such models to estimate the fair value subsi
dies provided by the Asset Backed Commercial Paper
Money Market Mutual Fund Liquidity Facility (AMLF),
the Commercial Paper Funding Facility (CPFF), and the
Term Asset Backed Securities Loan Facility (TALF).
CBO also used a similar approach to evaluate the subsi
dies provided by the contingent loan programs that the
Federal Reserve extended to Citigroup and Bank of
America. (For additional information on the programs,
see Appendix A.)
1. Each discount rate reflects a premium over the rate on a Treasury
security that accounts for the “market risk” associated with the
programs—the risk that losses will be largest when the economy is
weak and the economic cost of the losses is greatest.

The Asset-Backed Commercial Paper
Money Market Mutual Fund Liquidity
Facility

CBO’s estimate of the subsidies provided by the AMLF is
based on a model of the probability distribution of future
spreads, or differences, between the interest rates on
three month AA rated asset backed commercial paper
and the primary credit rate and a rule for when and how
much depositories will borrow to fund their commercial
paper purchases. The model uses historical data on those
spreads, which are a measure of stress in the market for
commercial paper. In addition, the model accounts for
the heightened level and volatility of commercial paper
rates during a crisis.
In the model, new borrowing through the facility occurs
when the spread rises above its long run level by two or
more standard deviations. At such a time, some money
market funds may experience a surge in the demand for
redemptions that could result in new borrowing under
the facility. CBO assumed that new borrowing would
equal, on average, 2 percent of outstanding balances in
U.S. money market mutual funds. It also assumed that
the new loans and their underlying collateral would have
average maturities of 90 days and that once the loans
matured, additional borrowing would not occur unless
crisis conditions continued or reemerged.2
2. The maturity of the collateral (the commercial paper) for such
borrowing may extend in some cases to 270 days, but because
shorter loan terms are more common for commercial paper, CBO
assumed that the average maturity backing the loans was 90 days.
Assuming a longer (or shorter) maturity would increase (or
decrease) the estimated subsidy.

CBO

34

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

CBO calculated the monthly value of the subsidies pro
vided by the facility in two steps. First, it multiplied the
facility’s outstanding balances by 1 percent or the spread
between the commercial paper and the primary credit
rate, whichever was larger. It then discounted those
monthly values back to September 2008, the date of the
program’s inception. The subsidies are based on averages
calculated from more than 5,000 stochastic simulations.

The Term Asset-Backed Securities Loan
Facility

CBO’s approach to estimating the economic subsidy cre
ated by the Federal Reserve’s activities through the TALF
is based on several factors:
B

The type of securities that serve as collateral and the
risk associated with them;

B

The effect of protection against losses provided by the
Troubled Asset Relief Program (TARP) and the Fed
eral Reserve’s “haircut” provisions, which restrict the
amount of a loan to less than the value of the posted
collateral;

B

The prevailing market rates for loans backed by simi
lar collateral; and

B

The projected volume of future lending, which is
based on CBO’s 10 year (2011 to 2020) baseline bud
get projections for the program.

The Commercial Paper Funding
Facility

CBO’s estimate of the subsidies provided through the
CPFF, like its estimate for the AMLF, is based on a sto
chastic model of commercial paper spreads and a rule for
when and how much commercial paper will be sold to
this facility. CBO calibrated the model of commercial
paper spreads by using historical data, taking into
account the heightened level and volatility of rates during
the crisis.
CBO assumed that new borrowing under the facility
would occur only when rate spreads increased above their
average precrisis level by two or more standard deviations.
It also assumed that the amount of the facility’s new bor
rowing would respond to interest rate conditions simi
larly to the way such borrowing responded in the early
months of the program.
CBO calculated the monthly subsidy value by multiply
ing the facility’s outstanding balances by the maximum of
1 percent or the difference between an interest rate on
three month AA rated commercial paper (calculated as
one third of the rate on financial paper plus two thirds of
the rate on asset backed paper) and the rate charged to
borrowers under the facility by the Federal Reserve.3 It
then discounted those monthly values back to October
2008, when the program was created. CBO’s estimates
are based on averages calculated over 5,000 simulations of
the stochastic model.
3. The rate charged by the Federal Reserve depends on whether the
commercial paper serving as collateral is backed by assets. The rate
is set at a spread over the three month overnight indexed swap
rate, which is closely related to other overnight bank rates, such as
the federal funds rate and the overnight Libor rate.

CBO

In estimating subsidies generated by the TALF’s activities,
CBO used market rates to calibrate a stochastic pricing
model for each type of asset backed security that was used
as collateral for a loan; it then used the model to estimate
the fair value of the TALF’s cash flows to the Federal
Reserve, taking into account the protection against losses
that various features of the facility afforded. The amount
of protection offered by the Treasury was uncertain. It
was initially set at $20 billion and was not explicitly
raised when the Federal Reserve announced that it would
consider expanding the size of the facility from $200 bil
lion to $1 trillion. In calculating subsidies, CBO consid
ered it likely that additional TARP protection would have
been advanced had the volume of borrowing or the
amounts of losses increased, and thus it assumed that the
TARP would also cover 70 percent of any losses by the
TALF in excess of the $20 billion that was explicitly pro
vided. CBO based its subsidy calculations on projections
of the amount of TALF lending that would be outstand
ing over time—CBO assumed $40 billion in new activity
each month over the life of the facility.

Contingent Loans to Citigroup and
Bank of America

The Federal Reserve offered Citigroup and Bank of
America contingent loans that provided the banks with

APPENDIX B

THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE’S ACTIONS DURING THE FINANCIAL CRISIS

the option of drawing funds at a future date at a preset
interest rate, with the funds to be secured only by risky
collateral. Those contracts gave the banks a valuable
funding alternative but one that they would be likely to
use only if the terms were more attractive than what was
available in the open market. To the extent that the fair
value of the option exceeded the value of the fees and the
interest that the Federal Reserve could expect to receive,
the option provided a fair value subsidy to the banks.
CBO calculated the subsidy using a stochastic model of
the Federal Reserve’s expected cash flows under those

35

arrangements. The model used projected future interest
payments, repayments of principal, losses from default,
and the value of the collateral assets.4 CBO assumed, on
the basis of the riskiness of the various classes of assets
that could serve as collateral, that at the time the contin
gent loans were set up, the fair value of that collateral
was significantly less than the amount that could be
borrowed.
4. CBO modeled those cash flows using an expected net charge off
rate (loan losses minus recoveries, as a percentage of outstanding
loans) each period that was consistent with its economic forecast.

CBO


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102