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FEDERALRESERVE
The Fed’s Emergency Lending Evolves
The Fed is using emergency lending powers it invoked during the Great
Recession to respond to COVID-19 — but it cast a wider net this time
By T i m S a b l i k

A

s COVID-19 swept through the United States, the
Fed reached for its playbook from the last major
crisis in 2008-2009. Now, just as then, the central bank’s actions have been aimed at restoring markets
to normal functions during a major economic shock. In
an emergency meeting on Sunday, March 15, the Federal
Open Market Committee lowered the Fed’s interest rate
target to effectively zero and pledged to use its “full range
of tools to support the flow of credit to households and
businesses.”
“The cost of credit has risen for all but the strongest
borrowers, and stock markets around the world are down
sharply,” Fed Chair Jerome Powell told reporters in a press
conference following the meeting. “Moreover, the rapidly
evolving situation has led to high volatility in financial
markets as everyone tries to assess the path ahead.”
Many firms, both financial and nonfinancial, rely
on short-term debt to keep their operations running
smoothly. In a crisis, the normal market for credit can
grind to a halt — and with it, the ability of these firms to
borrow. Lenders find it difficult to assess the credit risk
of borrowers when the economy is changing rapidly, and
they have an incentive to hold onto liquid assets as insurance against uncertainty. To prevent a credit crunch from
rippling throughout the economy, central banks often
step in to act as a “lender of last resort” during crises — an
emergency source of credit for otherwise solvent firms
until normal credit market functions are restored.
In keeping with this role, the Fed announced it would
create several special lending facilities in the days following
its March 15 meeting. Some of these were first used during
the Great Recession of 2007-2009 and retired after the
recovery. The Fed also announced new facilities to lend
to corporations, small businesses, and municipalities. (See
table.)
“It took years for the Fed to develop the tools during the
2007-2009 crisis necessary to ensure the adequate provision
of liquidity and to manage threats to the financial system,”
says Kim Schoenholtz of New York University’s Stern
School of Business. “What’s remarkable this time around
is how, almost instantaneously, the Fed not only revived
all of the critical liquidity tools that were developed in the
previous crisis, but also added to them.”
For each of these programs, the Fed invoked section
13(3) of the Federal Reserve Act, which authorizes the Fed
to lend to a broader set of recipients during a crisis — or
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as Congress put it, in “unusual and exigent circumstances.”
Few would argue that the pandemic does not qualify as
unusual, but deciding when and to whom the Fed should
lend has been a debate among policymakers and economists that stretches back to the Fed’s founding.
Lender of Last Resort … for Whom?
The Fed was originally created to solve a problem of liquidity in the banking system. Seasonal demands for cash placed
a strain on banks, leading to periodic banking panics. (See
“Liquidity Requirements and the Lender of Last Resort,”
Econ Focus, Fourth Quarter 2015.)
The framers of the Federal Reserve Act sought to solve
this problem by creating a system of regional Reserve
Banks that could purchase short-term commercial loans
from banks when demand for cash spiked. Member banks
could get cash from their Reserve Bank by exchanging commercial paper for it at the discount window.
(Originally, each Reserve Bank had a physical window
where member banks came for these exchanges; today,
discount window transactions are handled electronically.)
While the Fed was empowered to make loans to banks,
businesses and individuals couldn’t walk into their local
Reserve Bank and ask for a loan — the Fed was envisioned
as a “banker’s bank.”
That began to change during the Great Depression. As
banks failed throughout the country, the normal market
for commercial credit collapsed. Legislators and President
Herbert Hoover worried that it was not enough for the
Fed to support banks if those banks were reluctant or
unable to make loans for productive ventures. In 1932,
Congress made the change to the Federal Reserve Act
that authorized broader lending in “unusual and exigent
circumstances.” The new section 13(3) authorized Reserve
Banks to lend directly to individuals and corporations in
emergencies.
This new power put the Fed in the business of making
commercial loans, but it used that authority sparingly.
Reserve Banks made just 123 loans totaling $1.5 million
between 1932 and 1936 (around $28 million in today’s dollars). In a 2010 article in the University of Pennsylvania’s
Journal of Business Law, Alexander Mehra, a lawyer, argued
that this was likely due to several restrictions contained
in the original text of section 13(3). First, Reserve Banks
were only authorized to lend to individuals and businesses
against the same type of collateral that they accepted for
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lending to banks — short-term loans originating from
commercial activity. Businesses, individuals, and investment banks were unlikely to have this type of collateral,
making them ineligible for loans from the Fed.
Second, each loan required the approval of five of the
Fed’s governors, a difficult procedural hurdle to clear.
Finally, Congress had also created the Reconstruction
Finance Corporation (RFC) in 1932. The RFC was a
government-sponsored enterprise also tasked with making
loans to individuals and businesses. Those loans were generally available at more favorable terms than loans from the
Fed, which may further explain why the Fed had few takers.
Another reason section 13(3) saw little use was that
it was soon superseded by a further amendment to the
Federal Reserve Act in 1934 — the addition of section
13(b). That amendment placed fewer restrictions on
the Fed’s ability to lend to businesses and saw much
wider use. In the first year and a half, the Fed made
nearly 2,000 section 13(b) loans totaling $124.5 million
($2.3 billion today).
The Fed’s Board of Governors was initially supportive of these new lending powers, stating in a 1934 press
release that they would “aid in the recovery of business,
the increase of employment, and the general betterment
of conditions throughout the country.” But as with section
13(3), the Fed’s section 13(b) lending would also be overshadowed by the RFC. The RFC continued to be the industrial
lending agency of choice, and, aside from a brief resurgence
during World War II, the volume of the Fed’s section 13(b)
loans dropped significantly after 1935.

In the postwar period, Fed leaders began to question
whether the central bank should be involved in making
loans to businesses and individuals. In 1957, then-Fed
Chair William McChesney Martin told Congress during
testimony that while there might be a role for the government to address gaps in private sector lending, it was
not one that the Fed should play. Rather, he said it was
the preference of the Board of Governors for the Fed to
“devote itself primarily to the objectives set for it by the
Congress, namely, guiding monetary and credit policy so
as to exert its influence toward maintaining the value of
the dollar and fostering orderly economic progress.”
It took decades after the Fed’s founding, but eventually
economists and political leaders came to see the benefits to the economy of the Fed having monetary policy
independence.
“The question is whether it is appropriate to burden
a central bank that has the mandate of achieving price
stability and maximum sustainable employment with also
managing the supply of credit directly to nonfinancial
organizations, such as businesses, corporations, or municipalities,” says Schoenholtz. “Those credit allocation decisions are politically fraught. Back in the 1930s, I don’t
think anybody really understood the long-run benefits of
having an independent central bank.”
Congress ultimately agreed to remove those credit
allocation powers from the Fed. The Small Business
Investment Company Act of 1958 struck section 13(b)
from the Federal Reserve Act and transferred those
powers to the Small Business Administration (SBA). But

The Fed’s COVID-19 Emergency Lending Programs
Facility

Announced Launched New? Description

Primary Dealer Credit Facility

March 17

March 20 No

Extend credit to primary dealers

Commercial Paper Funding Facility March 17

April 14

No

Provide a liquidity backstop to U.S. issuers of commercial paper

Money Market Mutual Fund
Liquidity Facility

March 18

March 23

No

Makes loans available to eligible financial institutions secured by
high-quality assets purchased from money market mutual funds

Primary Market Corporate
Credit Facility

March 23

June 29

Yes

Purchase corporate bonds from eligible issuers

Secondary Market Corporate
Credit Facility

March 23

May 12

Yes

Purchase corporate bonds from eligible issuers in the secondary
market

Term Asset-Backed Securities
Loan Facility

March 23

June 17

No

Lend to holders of certain asset-backed securities backed by
consumer and small-business loans

Paycheck Protection Program
Liquidity Facility

April 9

April 16

Yes

Supply liquidity to financial institutions making PPP loans

Municipal Liquidity Facility

April 9

May 26

Yes

Purchase short-term notes from eligible U.S. states, counties, and
cities

Main Street Lending Program

April 9

June 15

Yes

Lend to small- and medium-sized businesses and nonprofit
organizations that were in sound financial condition before the
COVID-19 pandemic

soURCE: Federal Reserve Board of Governors

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section 13(3), the original emergency lending authority
granted to the Fed, remained on the books.
Emergency Lending Makes a Comeback
In the decades after the Great Depression, the Fed
invoked section 13(3) on a few occasions but did not
actually make any loans. The emergency lending power
remained unchanged and dormant until the passage of
the 1991 FDIC Improvement Act, or FDICIA. The act
removed the restriction that emergency loans could only
be made against the same collateral accepted from banks
at the discount window. Any securities that the Fed
approved could now suffice as collateral.
As discussed in a 1993 article by Walker Todd, then
an assistant general counsel and research officer at the
Cleveland Fed, there was growing recognition among
policymakers in the aftermath of the savings and loan
crisis of the 1980s and 1990s and the stock market crash
of 1987 that liquidity crises could happen outside of the
traditional banking sector. If the Fed lacked the tools
to address those liquidity needs directly, such problems
could spill out into financial markets, resulting in crises
similar to the banking panics of the 19th century that the
Fed was created to prevent.
This became apparent during the financial crisis of
2007-2008, when troubles at large nonbanks created liquidity problems for the whole financial system. For the first
time since the 1930s, the Fed made emergency loans under
section 13(3) to a variety of financial and nonfinancial firms
when traditional credit markets seized up. These programs
were open to all qualifying firms in broad segments of
financial markets. The Fed also invoked section 13(3) to
offer direct assistance to support the resolution of specific
firms deemed “too big to fail.” This included assisting in
JPMorgan Chase’s purchase of Bear Stearns and extending
credit to American International Group to prevent its
bankruptcy.
After the crisis subsided, legislators debated whether
the Fed had gone too far in its emergency lending.
Providing liquidity on a general basis seemed in keeping
with the central bank’s role as a lender of last resort, but
providing direct assistance to specific firms was more
controversial. It placed the Fed in the role of potentially
picking financial winners and losers.
In the Dodd-Frank Act of 2010, Congress placed new
restrictions on the Fed’s emergency lending powers. The
Fed was no longer authorized to lend directly to individual firms. Instead, emergency loan facilities had to be
available through a “program or facility with broad-based
eligibility.” Dodd-Frank also required that any emergency
assistance needed to be “for the purpose of providing
liquidity to the financial system, and not to aid a failing
financial company.” Finally, any loans the Fed made
needed to be adequately secured to “protect taxpayers
from losses,” and the lending programs required “prior
approval of the Secretary of the Treasury.”
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Fed officials supported these changes. In 2009 testimony before the House Committee on Financial Services,
then-Fed Chair Ben Bernanke acknowledged that the
“activities to stabilize systemically important institutions
seem to me to be quite different in character from the
use of Section 13(3) authority to support the repair of
credit markets.” While he argued that directly intervening
to stabilize systemically important firms was “essential to
protect the financial system as a whole … many of these
actions might not have been necessary in the first place
had there been in place a comprehensive resolution regime
aimed at avoiding the disorderly failure of systemically
critical financial institutions.”
At the same time, Bernanke and his successors
supported giving the Fed some flexibility to respond to
liquidity emergencies where and when they emerged.
“One of the lessons of the crisis is that the financial system evolves so quickly that it is difficult to predict where
threats will emerge and what actions may be needed in the
future to respond,” Powell said in a 2015 speech while he
was a Fed governor. “Further restricting or eliminating the
Fed’s emergency lending authority will not prevent future
crises, but it will hinder the Fed’s ability to limit the harm
from those crises for families and businesses.”
The Next Chapter
The Fed would call upon its emergency lending powers a
few years later during the COVID-19 pandemic. Initially,
the Fed revived many of the same facilities it had used in
2007-2009 to make credit available to financial firms that
can’t access the discount window. But it also created new
facilities to extend credit to a wider range of parties.
Through the Primary and Secondary Market
Corporate Credit Facilities, the Fed can purchase bonds
directly from large, highly rated corporations and supply
loans for companies to pay employees and suppliers. The
Main Street Lending Program, announced in April and
launched in June, offers five-year loans to businesses that
are too small to qualify for the Fed’s other corporate
credit facilities. The Municipal Liquidity Facility makes
loans available to state and local governments. And
the Fed’s largest new program to date is the Paycheck
Protection Program Liquidity Facility, which provides
liquidity to financial institutions participating in the
SBA’s Paycheck Protection Program (PPP). Businesses
can take out loans through the PPP that can be forgiven
if they use the money to retain workers on payroll. The
Fed has agreed to provide credit to financial institutions
making PPP loans, accepting those loans as collateral.
Since the PPP loans are guaranteed by the federal government through the SBA, the Fed faces no risk of losses
on this program.
While the Fed has announced a wider range of emergency lending programs than in 2007-2009, the total dollar
amount of loans has been smaller so far. As of mid-August,
the Fed had about $96 billion in outstanding section 13(3)

Once More Unto the Breach

$BILLIONS

loans. (See chart.) In
Federal Reserve Emergency Loans Outstanding
fact, the Fed began
120
to wind down some
Municipal Liquidity Facility
of the first programs
100
Term Asset-Backed Securities Loan Facility
launched in March
80
as financial markets
Paycheck Protection Program Liquidity Facility
stabilized from the
60
Commercial Paper Funding Facility
initial disruptions of
40
Primary and Secondary Market Corporate Credit Facilities
the pandemic.
The Fed’s emerMoney Market Mutual Fund Liquidity Facility
20
gency lending during
Primary Dealer Credit Facility
0
the pandemic has
March 15
April 15
May 15
June 15
July 15
August 15
been shaped by the
changes made to
Note: Values for the Main Street Lending Program were zero or rounded to zero on the scale of this chart during this period. Main Street Lending Program
section 13(3) by
loans outstanding totaled $226 million as of Aug. 12.
Dodd-Frank. All the
Source: Federal Reserve Board of Governors		
lending facilities have
broad-based eligibility rather than being open only to a
hand, an expectation that the Fed will act as a backstop
specific firm or a small set of firms. The Fed obtained permay distort market prices and encourage excessive levermission from the secretary of the Treasury before creating
age in the long run. It can be challenging for a central bank
each facility, and the Treasury has provided a backstop
to balance these considerations.”
against losses for any facilities that are not inherently risk
Indeed, some Fed scholars have argued that the
free. Those Treasury funds were appropriated through
newly created programs designed to lend to businesses
the Coronavirus Aid, Relief, and Economic Security, or
and governments step beyond the boundaries DoddCARES, Act.
Frank established around emergency lending. In a May
There is some precedent for the Fed providing liquidity
working paper, Lev Menand of Columbia Law School
support during a pandemic. During the Spanish Flu outargued that the new facilities created to extend credit to
break of 1918, banks faced liquidity strains. A recent paper
businesses and municipalities sidestep the Dodd-Frank
by Haelim Anderson of the Federal Deposit Insurance
requirement that section 13(3) lending should be for the
Corporation, Jin-Wook Chang of the Federal Reserve
purpose of “providing liquidity to the financial system”
Board, and Adam Copeland of the New York Fed found
since the recipients are not financial firms. Instead of
that banks that were members of the Federal Reserve
amending the Federal Reserve Act to loosen restrictions
System were able to continue or even expand lending
on Fed emergency lending, when Congress appropriated
during the pandemic because of their access to central
the funds for these facilities in the CARES Act, it simply
bank liquidity, while nonmember banks curtailed lending.
stated that they were for the purpose of providing liquidThe researchers argued that this highlights the impority to the financial system.
tance of the Fed having the flexibility to act as a lender
“If lending directly to business is a way to provide
of last resort to financial firms outside of the traditional
liquidity to the financial system, then any lending meets
banking sector.
the requirement and the words added [to the Federal
But such flexibility may come at a price. “If markets
Reserve Act] in 2010 have no meaning,” Menand wrote.
know the Fed can be relied upon as a liquidity backstop,
After largely walking away from lending to nonfinanthe Fed can nip market disruption in the bud,” says Alex
cial firms for decades, the Fed has found itself acting as
Wolman, vice president for monetary and macroecoa lender of last resort for more than just banks during
nomic research at the Richmond Fed. “We saw that play
two crises in the span of a dozen years. This has sparked
out during the current crisis — initial market volatility in
renewed discussion among economists and policymakers
March subsided after the Fed took action. On the other
over just what it means to be a lender of last resort. EF
Readings

Anderson, Haelim, Jin-Wook Chang, and Adam Copeland. “The
Effect of the Central Bank Liquidity Support during Pandemics:
Evidence from the 1918 Spanish Influenza Pandemic.” Federal
Reserve Board of Governors Finance and Economics Discussion
Series No. 2020-050, June 5, 2020.
Mehra, Alexander. “Legal Authority in Unusual and Exigent
Circumstances: The Federal Reserve and the Financial Crisis.”
Journal of Business Law, Fall 2010, vol. 13, no. 1, pp. 221-273.

Menand, Lev. “Unappropriated Dollars: The Fed’s Ad Hoc Lending
Facilities and the Rules that Govern Them.” ECGI Working Paper
Series in Law No. 518/2020, May 2020.
Sastry, Parinitha. “The Political Origins of Section 13(3) of the
Federal Reserve Act.” Federal Reserve Bank of New York Economic
Policy Review, September 2018.

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