The Fed That Ate the World.

Latest news is that the Fed will take over the commercial paper market. Big corporations raise funds by selling debt securities as well as borrowing from banks. But no one wants to buy these securities—"commercial paper"—because no one knows whether the corporations can pay them back. So big corporations like GE suddenly find themselves unable to obtain the funds that they need to meet payroll, make investments, and so forth. In steps the Fed. The Fed will buy up the commercial paper for the time being. If all goes well, the Fed will hold it to maturity or sell it if anyone ever decides to buy it, and the government will not lose any money. If all doesn't go well, the Fed can wallpaper its offices with trillions of dollars of notes.

As David Zaring notes, the commercial paper market, worth $1.6 trillion, is even bigger than the $700 billion borrowing authority contemplated by the bailout bill. Yet no one seems to think that the Fed needs new statutory authority to risk trillions, rather than merely hundreds of billions, of dollars. Why not?

Section 13(3) of the Federal Reserve Act authorizes the Fed to lend money to businesses in "unusual and exigent circumstances." This section was the same one that the Fed used for the AIG deal. There may be some uncertainty whether it is proper for the Fed to make unsecured loans to businesses (and apparently to avoid the appearance of doing so the Fed is lending to a new entity that will buy the commercial paper rather than buying the paper itself), though the statute appears to permit it. But section 13(3) would also permit the Fed to buy up mortgage-backed securities from firms. So the question is, if section 13(3) is the all-powerful authority for everything, why did the Fed bother with the bailout bill? As far as I can tell, the bailout bill was necessary because the Fed and Treasury put their heads together and decided that Treasury should buy the MBS's, and for that, a statute was needed. But was it worth such hullabaloo to give Treasury authority that the Fed already had?

We are in the realm of psychology, maybe political psychology, not law, and not even economics. The Fed, and maybe Treasury, already have all the authority they need to take over the banking system—or I should say the functions that the banks and investment banks once served. It was important for the Fed and Treasury to get to the markets some signal that Congress backed them, but it really didn't matter what exactly Congress authorized, as long as its authorization bore some relationship to whatever it was that the Fed and Treasury would eventually decide to do. After all, only Congress has the authority to raise money to pay back U.S. government debts, so it would be nice to know that Congress is more or less on board. On this view, the great debate about the bailout bill -- what it did, and did not do, and what it should have done, or not done -- entirely missed the point. Treasury and the Fed will decide how to address this financial crisis. A broad congressional endorsement is nice, but Congress had nothing of substance to contribute to policy. Other than the handouts to special interests, I will bet my portfolio of mortgage-backed securities that nothing in that statute will have any impact on how the financial crisis is addressed.