These include temporary changes to open market operations, lending through the “discount window” to eligible banks, and operating special lending facilities for other financial institutions. Under the Dodd-Frank Act, the Fed must get approval from the Treasury Department before exercising its extraordinary lending authority. Reserve Banks also can lend directly to depository institutions, transactions known as “discount window” loans.
These measures played their intended role of stabilizing financial conditions in the midst of the economic turmoil caused by the pandemic. Specifically, the Fed is prepared to provide liquidity—that is, emergency access to cash—to financial markets and institutions in a number of ways. In addition, to increase transparency, the Fed must identify discount window and special lending program borrowers after a two-year waiting period. In addition, the Fed may extend credit under section 13(3) only under a program with broad eligibility.
When the normal functioning of financial markets is disrupted, financial institutions may be hard-pressed to get the funds they need to finance day-to-day operations. With the passage of the Dodd-Frank Act in 2010, the Fed’s authority to carry out emergency measures changed.
In such a rapidly changing environment, the severity of the financial crisis of 2007–2008 prompted the Fed to step beyond its traditional role as lender of last resort to banks. The Fed’s response to financial instability must also take into account the evolution of the financial system.
Most recently, the Fed responded to disruptions in the financial markets due to the COVID-19 global pandemic. But when these markets are severely impaired, as happened during the 2007–2008 financial crisis, the discount window can become the primary source of funds for many banks at the same time. The Fed’s response to financial instability must also take into account the evolution of the financial system.
Because of the unprecedented impact of the pandemic on the economy, the Fed took decisive actions to stabilize financial markets and support the economy and its recovery. Using its Section 13(3) emergency lending powers, with approval from the Treasury, the Fed announced nine special lending programs, ranging from the “Primary Dealer Credit Facility” to the “Main Street Lending Program.” As outlined in the graphic below, all of these lending programs were established within the span of 24 days, beginning March 17, 2020. In addition, the Fed worked with the U.S. Treasury to provide financial support to institutions whose collapse could have threatened the stability of the entire financial system. To strengthen oversight, the Government Accountability Office must audit the Fed’s discount window and emergency lending programs. To stabilize the financial system, the Fed implemented a number of temporary emergency lending programs to provide funding to nonbank financial institutions. The day after the September 2001 terrorist attacks, discount window lending totaled more than 200 times the daily average for the previous month. For example, it can buy government securities on the open market, thereby injecting money into the banking system. In response to the COVID-19 pandemic and associated disruptions to financial markets, the Fed again reduced the difference between the interest charged on discount rate loans and the federal funds rate, and extended loans for longer periods. These actions involved the use of traditional and emergency policy tools.
Private credit markets may seize up, making loans available only at elevated interest rates.
The Fed carried out these extraordinary measures under the authority of section 13(3) of the Federal Reserve Act, a special provision that permits the Fed to lend to “any individual, partnership, or corporation” in “unusual and exigent circumstances.” These included reducing the difference between the interest charged on discount rate loans and the Fed’s target for the federal funds rate, extending loans for longer periods, and conducting auctions for discount window credit.
In such a crisis situation, the Fed’s role as liquidity provider helps to restore confidence in the financial system by enabling banks to meet their short-term payment obligations.